Australia and the Global Economy
These are notes for a university lecture given on 7 May 2009
The world is moving towards us.
The weight of the global economy is moving away from Western Europe and North America and towards Asia.
More and more of the world’s business is happening in our time zone.
Transport and communications are removing the problem of distance.
We are heavily locked into the global economy, increasingly reliant and enmeshed with China and the rest of Asia.
We have little choice but seek further integration with the global economies and especially the fast growing economies of the Asian region.
Hugh White and the Defence Department might see China as an emerging threat but our economy is dependent on stability and growth in the Asian region.
Instability would be a much greater and more immediate problem for us economically than militarily.
We will be able to rely on the military protection of the US long after we can rely on it economically.
Nevertheless, the GFC has reminded us that the global economy still revolves around the US to a very large extent.
General reflections on the Australian economy
13th largest economy, but less than 1% of global GDP.
Australia is dependent on the global economy more than most because we are a commodity exporter and capital importer. This has been true for our entire history since European settlement.
We have a small domestic market. This makes inward looking policies a mistake.
We are a long way from the world’s wealthy markets, though this is changing.
Over half our exports are primary exports, over half our imports are manufactured goods.
Nearly half (47%) of our exports go to North Asia. Less than one-fifth go to America and Europe combined. Japan (19%), China (15%).
We export more to India than to the UK and just slightly less than to the US.
Australia’s economic history before 1950
1788 to 1850 – Australian population and GDP was growing like an Asian or Celtic Tiger, doubling every seven years spurred on by wool and then gold.
Patrick White and the rivers of money running through NSW.
1850 to 1890s – Australia’s GDP per capita rose to be the highest in the world.
1890s depression led to the Australian Settlement, the political ascendancy of the protectionists and Australia’s experiment with tariffs and quotas began. Free trade between the states in exchange for protection from foreign manufacturers. A deal on arbitration between Labor and the Deakinites.
1900 to 1950 – two world wars and a Great Depression.
Australia’s GDP per capita slipped behind the US. The Great Depression was exacerbated by protectionism throughout the world. Australia suffered badly as a commodity exporter and as a capital importer because credit dried up – Jack Lang and the English bondholders.
The Golden Age, 1950 to 1973
After WW2 policy-makers in Australia, as elsewhere, were concerned about the possibility of another depression.
At home, Chifley developed a White Paper on Full Employment.
And passed the Commonwealth Bank Act which conferred central bank powers and a mandate to manage the financial system in ways that supported the full employment objective.
Abroad, there was the Breton Woods (in New Hampshire) conference which set up the IMF, the World Bank and established a system of fixed exchange rates which lasted about 25 years.
Reconstruction was a major theme in Germany and Japan, to avoid the errors of the treaty of Versailles as well as avoiding another global recession.
These countries along with Italy and Austria achieved the fastest growth rates – they were catching up.
Keynesian demand management and the fixed exchange rate system got most of the credit for the Golden Age.
Fixed exchange rates imposed a rough sort of monetary discipline which kept inflation under control even with full employment.
Growth from 1950 to 1973 in developing countries averaged 5%, more than double the average for the 80 years to 1950.
Unemployment and inflation averaged around 2% during the Golden Age.
Most people thought the problem of economic cycles had been solved.
Protectionism was seen as having exacerbated the Great depression and the liberalisation of international trade was also seen as a major contributor to the Golden Age.
GATT, now called the WTO, played an important role in removing some of the tariffs and quotas put in place in the Depression.
Nevertheless, GATT and WTO still favour the North and West over the South and the East in their treatment of agriculture.
During this time, in the mid 1960s, the UK moved into the Common Market and ended its preferencing of agricultural imports from Commonwealth countries.
This move had a huge impact on the New Zealand economy, which has never really recovered.
While Australia was able to replace the lost agricultural markets with new and growing markets for iron ore and coal in Japan and South Korea.
Some caveats about Australia and the golden age.
Australia did not fare as well. We outperformed the developed world on growth rates in the 80 years prior to 1950 but during the Golden Age we slightly underperformed.
With rapid immigration, our underperformance was even greater on a per capita basis.
Our performance also looks better than it really was because it was a time of great agricultural prosperity.
Moreover our productivity improvement was lower than the OECD average.
Stagflation, why everything went pear-shaped
The period 1973 to 1983
Keynesian stimuluses got pushed too far.
The US used it to fund the Vietnam War
Big deficits were always said to be temporary but politically they proved impossible to wind back.
People ignored the problem of inflation, unemployment was the problem that worried governments not inflation. This was an inevitable reaction to the horrors of the great depression.
The Phillips curve – an inverse relationship between wage inflation and unemployment.
But it doesn’t work for achieving very low levels of unemployment. Inflationary expectations get built in and then you get rising inflation but no reduction in unemployment.
OPEC – a fourfold increase in oil prices in 1973. It pushed up prices and reduced purchasing power – inflationary and contractionary at the same time.
There was another huge shock – OPEC 2 – in 1979.
Australia had another deep recession in the early 1980s.
Many countries were pushed into recession with high and often double digit inflation.
Australia’s unemployment rate more than doubled in 18 months. Inflation was 14%.
Stagflation persisted in Australia from 1973 to 1983. Unemployment peaked at 10.2%, inflation averaged 11.6%.
That is prices tripled in a decade.
Many people also blamed trade union power for the rapid rise in prices during this period.
This period, unlike the Golden Age, was a time of political turmoil as governments struggled and failed to restore stability and growth.
The 1980s – the era of productivity raising reforms
Economic growth depends on rising productivity. It didn’t exist before the Industrial Revolution. Now our world depends on it.
Productivity means getting more output from a given set of resources. It can be generated by many things – capital, technology, skills, market efficiency – but it is hard to define and hard to maintain at a high level for very long in a mature economy.
Our productivity and GDP per capita had declined during the twentieth century, and policy-makers decided that protection made no sense at all for a country in Australia’s position in the global economy.
Stagflation shattered the illusion that the problem of economic cycles had been solved. It also shattered the belief that Keynesianism could solve everything.
So policy makers had to try something else.
Garnaut and the case for free trade / economic rationalism as an ALP policy. Protection as regressive taxation; giving aid to rent-seeking capitalists. A fundamental change in ALP philosophy.
Top of the list was monetary policy.
The exchange float at the end of 1983 allowed the Reserve Bank to manage short-term interest rates.
The float was strongly advocated and supported by our primary commodities exporters.
The float in December 1983 effectively began the process that still continues of opening up the Australian economy and integrating it more fully into the international economy.
The float was supported by five policy strands that together are or were referred to as micro-economic reform:
· Reductions in tariff and quota protection
· Financial deregulation
· Competition policy
· Industrial relations reform
Much of the intellectual for this support came from the Industries Assistance Commission set up by Whitlam (now called the Productivity Commission) and by the Campbell Inquiry commissioned by John Howard when he was Treasurer.
Two major industry statements – 1988 and 1991. Note also Whitlam’s across the board tariff cut in 1973.
Decentralisation of wage fixation in the 1990s.
Privatisation – Commonwealth Bank, Qantas, Telstra.
Trade liberalisation was also a big policy item – APEC, the Uruguay Round, the Cairns Group.
The Garnaut report in 1989 also stressed our need and opportunity to integrate our economy more closely with the newly industrialising countries in north-east Asia.
Note this emphasises the link between micro-economic reform at home and our trade performance.
1991 – The recession we had to have.
The Howard – Costello years
A continuation of the 1980s.
Economic policy direction is bipartisan and elitist. The downfall of the Soviet Union (1989 to 1991) and the opening of China by Chairman Deng (1978) led further support to the American model as the hope of the world.
No major Hawke / Keating reform was reversed.
Pressed ahead in some key areas not addressed or partially addressed – GST, industrial relations, Telstra privatisation.
Endorsed the independence of the Reserve Bank.
Ran up surpluses.
Pursued bilateral free trade agreements. USA, China.
The Long Expansion or the Quiet Boom
1991 until 2007.
A long steady boom averaging just over 3.5% per annum.
Attributed to the reforms of the 1980s and the resources boom.
China’s growth drove up the prices of commodities, and pushed down the prices of manufactured goods. Absolutely ideal for us. Very beneficial for our terms of trade.
We escaped the adverse impacts of Japan’s long recession in the 1990s, the Asian financial crisis of 1997-8, the recession in the USA and elsewhere in the first years of this century.
The GFC and yet another challenge
We have had the Great Depression, the stagflation period and many recessions. Including the recession we had to have.
After each we tend to think: well that’s that sorted.
And a few years ago we were starting to look invincible again.
The resources boom looked unstoppable.
Business investment was at record levels.
We were sophisticated at using monetary policy.
We had no government debt and a stream of surpluses.
But the GFC showed that we are still dependent and still vulnerable.
China learnt just how dependent it is on the US – more than it thought.
The GFC will lead to more reforms especially in managing financial markets.
But there is effectively no option but greater integration.