Part I: A Generation of Reform

Political leadership in a democracy implies keeping oneself at the head of the flock, wherever it is drifting … the steady pedagogical urge to rationality in political questions must be provided largely by [other] people … In the institutional set-up of modern democracy, a function most important for its survival falls on the social scientists: the long-range intellectual leadership thrusting society forward to overcome primitive impulses … and to move in the direction of rationality.
      Gunnar Myrdal, Value in Social Theory  

A glance at Australian economic history, 1800–1972

Australian economic policy and performance over the past generation cannot be understood without a little historical background. During the nineteenth century, this huge, harsh continent was developed by amazingly few people with great energy and speed thanks to ample, though not easily extracted, natural resources, the influx of entrepreneurs, workers, capital and—very importantly—the liberal institutions of Victorian Britain[1]. The private initiatives of predominantly British settlers “transformed a prison-yard and hunting-ground of savages into a productive annex to Europe and Asia”[2]. The “Colonials” soon became great institutional innovators, who created a free, dynamic and democratic society based, in the words of John Howard, on “Judeo-Christian ethics, the progressive spirit of the Enlightenment and the institutions and values of British political culture. Its democratic and egalitarian temper also [bore, and still does bear] the imprint of … non-conformist traditions”.

By 1870, a free-enterprise culture had caused discoveries of gold to be turned into a major growth push. “Marvellous Melbourne” became one of the world’s most splendid cities south of the Equator, rivalled only by Buenos Aires. The continent’s inhabitants had attained an average real living standard some 80 per cent higher than that of the West European average and 50 per cent higher than that of the United States. The formidable Australian income lead narrowed late in the nineteenth century in the wake of an extended drought, major speculative excesses, a subsequent economic crash and the organisation of a political and industrial labour movement amidst a wave of strikes. Although the liberal tradition was understood and promulgated in Australia as well as anywhere else, a new generation acquired preferences for protectionism, unionisation and redistribution, not least at the expense of the “wealthy graziers” who had developed successful export industries. These political preferences were to shape the policy regime permanently after the six colonies federated in 1901 to form the Commonwealth of Australia.

The new nation adopted what Paul Kelly has called the “Australian Settlement”: whites-only immigration, protectionism to push inward-looking industrialisation, centralised quasi-judicial wage fixing, state paternalism, and trust in imperial benevolence. These were utilitarian political choices. The main economic development strategy was to ensure highly profitable national markets for industry and then force industry to pay high wages. Artificially high wage levels and a leisure-rich life facilitated continuing immigration. After the Second World War, the political decision was made to “populate or perish”, in practice to promote mass immigration from Europe.

Alas, the policy choices of the first half of the twentieth century entrenched a political landscape that was wide open to vested interests. More and more, it also hampered the inflows of capital, enterprise and knowledge, on which an affluent developing country depends. Featherbedded industries gradually slid into a notorious industrial malaise. By the 1960s, the Australian growth performance was anaemic by postwar international standards. Pervasive interventionism served the interest of established industries, unions and governments, but discouraged development. For example, local scarcities had long served as the reason to embargo the export of iron ore and scrap metal. In late 1960, the embargo was modified—and (miraculously!) high-grade ore deposits were immediately discovered and soon developed. An iron ore boom followed, turning Western Australia into one of the biggest exporters of high-grade iron ore in the world.

At the time of the first oil crisis in the early 1970s, Australian living standards had fallen 25 per cent below those in the USA and were only a scant 10 per cent above the West European average. And Australians were suffering from a palpable “confidence deficit”. 

The Whitlam experiment (1972–75)

When I came here on a visit in 1973, I was puzzled why an economy so rich in natural resources, a relatively young, English-speaking population, a high savings rate and well placed in the dynamic East Asian time zone, should manage such pitiful economic growth and suffer from a cultural and industrial cringe. None of my new economist colleagues at the Australian National University were able to offer good explanations. Instead, most were excited about the experiment of the newly elected, impatient Whitlam Labor government to remake society and inject massive macroeconomic stimulation, a hasty strategy that pushed the ratio of total government outlays to GDP from about one-quarter in the 1960s to one-third by 1974 — a massive structural shift, from which Australians were not to recover for the next generation[3]. There was talk in Labor ranks of nationalising industries such as oil and gas. The political activism was accompanied by strikes and rapidly accelerating inflation.

After many years of steady, though unspectacular economic performance, the Whitlam experiment appeared to many like a revolution. At a forum of the Fabian Society in Canberra, to which I had been invited, I remarked that an evil sorcerer out to harm the self-confidence of Australians would expand public expenditure, massively boost the number and pay of civil servants, raise the general wage level, pursue an accommodating monetary policy and devalue the currency. When someone in the audience shouted: “But this is what we are doing”, I rested my case.

The reckless stimulus experiment of the Whitlam government coincided with the first global oil-price explosion. The combination produced inflation of around 17 per cent, as well as rising unemployment. The Keynesian prescription obviously failed. Cured of the last vestiges of money illusion and encouraged by the political wing of the labour movement, the trade unions used their clout to obtain rising real wages, a tactic of course not unique to Australia.

In an attempt to undercut runaway inflation, the government suddenly cut tariffs across the board by 25 per cent. As was to be expected, this proved disruptive; and the government soon imposed “corrective” quota restrictions. When the Whitlam government attempted to keep on spending without proper parliamentary approval, it was sacked in 1975. 

The Fraser Government’s Slow Crawl towards Economic Freedom (1975–83)

The Fraser governments undid some of the Whitlam-era changes, made some fiscal adjustments though without drastic expenditure cuts, and imposed strict monetary restraint to slow the “inflationary flywheel”. Inflation eased slowly at first, but then seemed stuck around 7 to 10 per cent. Faced with wage-cost pressures and high real interest rates, many small firms went under. The government was engaged in a painful tug of war with the unions in what John Stone described as “reminiscent of the to-and-fro surges of First World War trench warfare”. Alas, making industry more competitive and opening up to international competition was not part of the stolid Fraser government’s policy design. Unemployment rose to unprecedented heights (to 6 per cent in 1978, after twenty years of less than 2 per cent). The public mood was sombre. Many derided this as the “Land of the Long Weekend” and believed what some arrogant Asian leaders were now saying: that Australians were destined to become the “poor white trash of Asia’.

By the mid-1970s, it was obvious to me that the central cause of the Australian predicament was a rigid supply apparatus, the consequence of seven decades of protectionism and redistributive meddling. The challenge was to make industries and the workforce more responsive to evolving circumstances by fostering a climate of competitive enterprise and innovation. It seemed necessary to limit the size of government and to deregulate capital, labour and product markets across the board, above all to remove the linchpin from the entire interventionist regime, namely the controls of international trade and capital movements. I began to argue for a pre-announced and gradual opening-up of the economy. My thinking on these matters was based on what was soon to become known as “supply-side economics”. It soon became apparent that more and more leading figures in public administration and industry were thinking likewise.

To illustrate the point that a comprehensive liberalisation strategy could enhance economic performance and everyone’s living standards, I described two twenty-five-year scenarios. One was to muddle on with the mercantilist status quo; the other was comprehensive liberalisation. To my surprise, some economists and political observers found my line of argument plausible, namely that comprehensive reforms could more than double the growth rate of real per capita incomes. My essays caught the eye of the Shell Company, who were at the time contemplating a costly and technically risky new gas venture off the north-west coast of Australia and who had been spooked by the Whitlam government’s talk of nationalisation. The company asked me to gather a five-man team of free-market experts, and we wrote a book, Australia at the Crossroads (1980), to elaborate the merits of liberalisation and structural change.

The book came out at a fortuitous time. The Tariff Board/Industry Assistance Commission[4] and the Australian Treasury—though not the Treasurers whom they advised—had long argued for productivity growth through a rational, market-friendly economic policy[5]. Keynesian demand management was discredited by the woeful experiences of the early 1970s. Moreover, visits by Milton Friedman and Friedrich Hayek to Australia, as well as wider intellectual currents, which foreshadowed the coming Thatcher–Reagan spring, had made thoughtful Australians receptive to what had been deemed outright heresy only half a decade earlier. The “Australian Settlement” was crumbling.

I sensed a change in the zeitgeist when some conservative members of parliament began to talk to me. They were the “Dries” in the Liberal Party, at the time the most visible opposition to the stolid, protectionist Fraser government. To my great surprise, a number of bankers, industrialists, academics, parliamentarians and publicists came together to turn the policy blueprint contained in the Crossroads book into a feasible reform program. Some five dozen of us kept meeting informally from 1981 onwards as the Crossroads Group[6]. We began to write op-ed pieces advocating heresies such as the complete removal of all capital controls, the gradual, but across-the-board lowering of all tariffs, vouchers for socialised services, deregulated labour markets, lower, simpler taxes and balanced budgets. All of a sudden, I enjoyed the imaginative, inspiring and energetic camaraderie of people of a truly liberal mindset.

The media were mildly amused, but sceptical. Observers pointed out that Australia’s was a thoroughly Benthamite polity—pragmatic, utilitarian, individualistic, not given to abstract principles, but rather to expedient fixes. I was told that this was not America or New Zealand, where a commitment to high, abstract principles elicits popular resonance, but rather a polity dominated by vested interests given to the interventionist calculus of immediate advantage to most individuals. In short, the “Hayek push” was bound to fail. Most who lectured me that politics was the art of the possible rejected my counter-argument that this attitude was an un-Enlightened cop-out, the recipe for foul compromise, contradictions, the loss of liberty and long-term sclerosis. My position was then—and still is now—that the role of the academic observer is to help make the impossible possible by arguing the case for rational policy from basic, consistent principles. Though at the time not fully aware of the great Australian tradition of pragmatic muddling through, I certainly discovered that individualism and liberalism had deep roots in some circles and that the case for principled liberalisation policies could be argued successfully.

Let me relate two experiences of how new liberal thinking could be made to matter at the retail level of the market for ideas. I harbour fond memories of a heated debate in the boardroom of a steel producer over cutting exorbitant steel tariffs to reap big gains from specialisation and scale economies. This so annoyed the directors that they withheld dessert. However, a year later I was invited back, taken seriously … and served dessert! ­­When, in 1981, I drafted a letter to the editor calling for free trade in motor vehicles, which twenty-eight fellow economists co-signed, the immensely mollycoddled car producers responded with hostile phone calls. Yet, in 1990, they commissioned a fellow Crossroads campaigner and me to help them prepare a submission to the Australian Industry Commission, in which they acquiesced to gradual, pre-announced tariff cuts on certain conditions. Our submission pointed out that the exposure of the car industry to more and more international competition made it necessary that internationally immobile production factors—namely organised labour and government administrations—behave like support organisations for those producers, such as the car makers, who are competing internationally[7]. The idea that purely domestic operators, such as trade unions, the public service and infrastructure providers, must also compete internationally was later, in the early 1990s, pursued systematically by Labor governments who badgered and bribed state governments to behave responsibly and abandon “subsidy wars” among themselves. This “National Competition Policy” was to become an important ingredient in the transformation of the Australian polity and economy. 

The Hawke–Keating Era (1983–96): Lop-Sided Liberalisation

When a rejuvenated Labor Party won the election in 1983, I was initially pessimistic. However, the Hawke government—with the more or less tacit support of the Opposition—promptly embarked on financial deregulation, floated the dollar, removed controls of international capital flows, admitted foreign banks and introduced staged tariff cuts. Successive Labor governments gradually lowered the “effective rate of protection and subsidisation” of manufacturing, which had stood at an arch-protectionist near-40 per cent in 1970 and 25 per cent when they took office, to a near-free-trading 5 per cent during the 1980s and 1990s. The conservative Opposition had shed its past commitment to high industry protection and now desisted from opposing liberalisation on grounds of job losses, which would in any event only be industry-specific and transitional. Seen against the background of pervasive interventionism and disregard for supply-side rigidities during the preceding eighty years, these were truly game-changing moves towards economic freedom.

In the Hawke years, the most effective way to promote liberalisation was to talk to the “Dries” in the Liberal Party and trust that the Labor government would soon pinch many of their reform ideas. Yet—as apparently behoves a social-democratic government—the Hawke–Keating administrations treated socialised welfare and labour market regulations, by and large, as sacrosanct. The Labor Party and the unions realised that wage explosions and massive deficit spending a decade earlier had cost them office. In 1983, the political and industrial wings of the labour movement therefore adopted an incomes policy to constrain nominal wage increases, the “Wages Accord”. Treasury and others pointed to a “wage overhang” (uncompetitive wage-cost levels), but the obvious solution—namely to lower labour-unit costs by job-market deregulation and tax reform—was almost completely cold-shouldered. Instead, the unions—deprived by the “Accord” of opportunities to demonstrate their relevance to their dwindling membership through high nominal wage claims—concentrated on obtaining easier (productivity-destroying) work practices. Some employers stood up to union powerbrokers and offered rewards for more flexible work practices, which allowed better productivity. The outstanding example was Robe River mine in Western Australia, which demonstrated that iron ore output per employee could be tripled and work accidents drastically reduced if only employers and employees co-operated.

The “Accord” era was of no benefit to the average worker: between 1983 and 1991, when Keating replaced Hawke, unemployment had risen from 9.9 to 10.5 per cent and weekly earnings, when adjusted for inflation, had hardly changed. These facts were projected into public view by the H.R. Nicholls Society, a high-powered private group. Time and again, they showed that union control of the work sphere and government protection of union privileges facilitated outrageous infringements of individual liberty and property rights, including the right to use one’s own labour and skills as one sees fit.

In 1993, Keating criticised collective bargaining that was underpinned by minimum awards and advocated that permission be given for non-union enterprise deals. The Industrial Relations Reform Act incorporated these ideas, but also laid down “unfair dismissals clauses”, which made firing workers costly and cumbersome. It of course created a new obstacle for job creation.

Given the progressive ageing of the population, the Labor government initiated a regime of forced, tax-favoured savings (superannuation). Predictably it has become a political football. Whatever liberals might think about individual self-responsibility, forced savings are a virtually inevitable consequence of the Australian tradition of providing tax-funded pensions for those who failed to save for their old age. It is also not clear to what extent forced savings have replaced voluntary saving.

On the important monetary front, Australian policy also made progress (in line with other OECD countries). Money supply had blown out during the Whitlam era, in some years by as much as 25 per cent. Politically directed and confronted with a rigid economy, the Reserve Bank of Australia had followed an erratic course—with the unsettling consequences that Milton Friedman would have predicted. During the Hawke–Keating years, after financial deregulation, money growth became steadier, but still ran at around 10 per cent per annum. In 1993, the Bank switched to inflation targeting; prudential bank supervision was introduced in 1998. The new rule set, which boosted the regulatory apparatus and increased compliance costs, nevertheless helped to ensure that the Australian financial system fared reasonably well over the following decade, during the Asian financial turmoil of 1998 and the recent global financial crisis. However, the early 1990s saw the onset of asset-price inflation, globally and in Australia. In 2007, towards the end of the prolonged boom of the 2000s, broad money supply again grew by more than 20 per cent per annum, but this rate of expansion was brought down more rapidly than in most other OECD countries, to 6.3 per cent during financial year 2009-10. This is part of the global financial crisis story to which I shall return.

Since the Australian dollar was introduced in 1966, it has lost more than 90 per cent of its purchase power, most of it during the years of Keynesian demand management and regulated rigidity of the supply side. As elsewhere in the developed world, inflation has been much lower since the 1980s. In Australia’s case, consumers benefited greatly from the tariff cuts and the free importation of cheap consumer goods made in China.

After considerable, though lop-sided progress towards economic freedom, the Labor regime eventually soured.

Continue reading Part II here…