QED

Observations on Government Policies

Address at Portsea Liberal Party, 25 May 2009

I was a bit surprised that you asked an economist to talk to you at a time when the economics profession is rather on the outer. But I am assuming that you have not simply invited me to be the lamb for slaughter– or is it the donkey? I will do my best to provide you with meaningful comments not only on the crisis and the involvement of government, but also on some of the other roles governments are playing and the implications for policies that should be adopted by Liberal parties.  

Let me start with what is undoubtedly the worst economic crisis since the 1930s and its possible causes. Some of you may have seen an article by Lord Skidelsky, published in The Age on 25 April and headed “Economists bear blame for bringing planet to brink of abyss”. Skidelsky asserts that the basic cause of the crisis is the free market system and the belief of free market economists that unfettered markets are self-regulating. According to his Lordship, this has led everybody down the garden path of ever higher debt. And, although it is hard to get a precise handle on our current Prime Minister’s views, Kevin 09’s criticisms of those he describes as neo-liberals suggests he may have drawn on Skidelsky’s prize-winning three volume biography on Keynes.

Whether or not such people as Skidelsky and Rudd mean what they say, there is no doubt that their reactions to the crisis reflect a wider view and constitute a serious challenge to those who believe in small governments and the free market system. Suggestions that it means the end of capitalism may be far-fetched. But there will be moves by leftish political parties and governments to have governments and their agencies play a much bigger role. Believers in individual freedom need to have a coherent response. So far I have seen very little of that from Liberal Party sources.

I cannot here delve into detail about the crisis but let me make just a couple of points.

First, while this is a very serious economic crisis, history suggests that human nature has a natural tendency to swing between optimistic and pessimistic attitudes almost regardless of the type of economic organisation prevailing in a country. But such swings have occurred quite frequently in countries that increasingly adopted free market type arrangements after about 1800. Since that time one historian has identified 13 banking crises in the US and a dozen in the UK.

Second, it is also important to recognise that, despite these swings, the countries experiencing the crises have produced an amazing increase in living standards and shown a remarkable capacity to recover from recessions and depressions. In fact, the most authoritative historical analyst of economic growth describes the world’s growth performance since 1820 as “dramatically superior to that in earlier history” and characterizes the period as the “capitalist epoch”. Of course, growth rates varied widely from country to country but the fastest growing have been the USA, Canada, Australia, N Zealand and Western Europe where political and social frameworks have been more receptive to free market policies as well as to technological development and the improvement of both human and physical capital.

Third, even though the onset of the global financial and economic crisis will cause a major setback to the growth in living standards in almost all countries, there is no reason to suppose that the past history of recoveries will not be repeated in due course. Indeed, if current official forecasts were to be believed (which I fear they are not), world GDP will resume growing next year, albeit at a slow pace. The question is why, particularly after the experience of the 1930s, governments and others have not learned how to avoid at least the deep-type recession we are experiencing.

Analyses of the causes of this crisis, and of the possible implications for free market policies, range widely. However, it is apparent that governments and regulators share a good part of the blame. The authorities responsible for regulation of the financial system in the United States and some other major countries, including central banks, evidently failed to maintain adequate control on the amount and type of credit being extended by financial intermediaries, resulting in excessive risk taking based on unsustainable expansions of debt. A moral hazard situation was created in which it almost appeared that debt could just go on up and up without creating any problem.

When questioned in a recent interview about possible mistakes by monetary authorities, US Treasury Secretary, Timothy Geithner, acknowledged that “there were three types of broad errors of policy both here and around the world. One was that monetary policy around the world was too loose, too long. And that created this just huge boom in asset prices, money chasing risk. …That was just overwhelmingly powerful … It was too easy, yes.”

Geithner, who was head of the Federal Reserve Bank of New York and right at the centre of crisis management, went on to cite a lack of supervision over bank risk taking and the slow pace of government response to the problem. But his admission that monetary policy was “too loose, too long” is of major importance in two respects.

First, contrary to popular interpretations, the blame for the panic cannot primarily be placed on the irresponsibility of bankers. That is not to say that all or even most banks and other financial institutions acted responsibly or deserved the remuneration they received. But, if central banks allow credit to be provided plentifully at “low” rates of interest, the main suppliers of credit will naturally dish it out on demand and levels of debt will grow.

Secondly, Prime Minister Rudd is clearly wrong in attributing the crisis to policies that reflect the neo-liberal views of free marketeers. President Obama is also wrong in taking a similar view in the United States, as is Prime Minister Gordon Brown in the UK. Few, if any supporters of free market policies say there should be no regulation of monetary conditions let alone no limits on the supply of credit. Furthermore, although Rudd has argued that Australian banks were well-regulated and are in much better shape than overseas counterparts, he has overlooked the fact that even our central bank allowed credit to grow at rates well above the growth in nominal GDP. Increasing bad debts amongst Australian banks are not simply a result of the recession overseas.

Where does all this leave us in regard to crises, monetary policies and the role of government? Central banks are created by governments and it seems clear that major changes are needed to the way in which monetary policy is operated, probably involving in Australia’s case new guidelines set by the Government. Some, including our very own believer in international institutions, have suggested an increased supervisory role for institutions such as the IMF. I suspect that will go nowhere. And while others have advocated a return to state-owned banks, historical experience with that phenomenon suggests it is not the way to go and would certainly not prevent financial crises. But what has the Liberal Party got to say about this? Very little it seems apart from trying to score the odd political point off Rudd.  

I regret to say that the same comment applies to the role of government more generally.
 
When I joined the Treasury in 1958 I did so in the belief that governments had the potential to adopt policies that would increase economic growth and living standards generally. It did not take long for me to realise that many of the measures designed to achieve such objectives do not necessarily work out in practice as they are supposed to do. Through a succession of governments, but particularly those headed by Whitlam, Fraser and Keating, it became clear that many governments are often far more concerned with short term political objectives rather than the longer term national economic interest.

That led me to re-think the role of government and to examine the development of public choice theory in the US, where I spent some time just before I resigned from Treasury in 1987. The essence of that theory is that politicians have an inbuilt tendency to increase the size of government by making promises to marginal voters – what politely might be called vote buying. The costs of this to non-recipients is small and hence can be done without necessarily attracting adverse reactions from the electorate in general. By contrast, the alternative of smaller government helps to increase living standards across the board through the incentives provided by lower taxation and the provision of services on a more efficient basis. The country which has maintained the smallest government sector since its inception – the United States – has real per capita income levels about 25 per cent higher than the next highest and is a society in which individual freedom is at a high level.

How have we performed on this in Australia? The short answer is better than most but not as well as we should have. The Whitlam Government started us down the wrong path when it increased federal government spending from 19 per cent of GDP to nearly 25% in 1975-76. But even though we have since had two Liberal/ National party governments, there has been virtually no reduction in discretionary spending levels relative to GDP. Although under Howard the Liberal/National parties’ total spending at the end of their period in government was lower than at the start, that was primarily due to the reduction in the cost of debt servicing brought about by lower interest rates. The end story of the Howard government is that it finished in 2007-08 with total spending at 24% of GDP – only fractionally lower than at the end of Whitlam. Moreover, contrary to popular belief, taxes actually increased by about 2.5 percentage points of GDP compared with 1995-96. Looking at that in a different way, at the end of Howard Australians paid over $30 billion more in taxes than at the start.

Why did this occur? The main reason is the one I have already mentioned. To put it crudely, the Howard government engaged in vote buying mainly by providing increased payments for all kinds of so-called social security benefits to those with incomes that were far from being low. I refer particularly to family tax benefits but other benefits, such as disability support, parenting payments, and the like were also liberalised. In 2005 I was asked by the Australian Chamber of Commerce and Industry to identify the scope for cutting spending and I readily identified nearly $20 billion worth, equivalent to about 2% of GDP. I noted that a significant proportion of the tax and social security system consisted of churning taxes back from whence they came – that is, higher income groups paid their taxes and then received a lot back via benefits. Implementation of my proposed cuts would have allowed income tax to be reduced to a top rate of 30% but, despite the support of Australia’s largest business organisation, no minister in the Coalition government gave any substantive response to my proposals.

Towards the end of the reign of the federal Coalition there was some tightening of the access requirements to benefits but no attempt was made to expound the general advantages of a move to smaller government and lower taxes. Although small government is stated as an objective, the attitude of the present Liberal Party leadership appears, if anything, to be less supportive of that cause than its predecessors.

I might add that the Coalition at the State level appears to have a similar reticence. Since the defeat of the Kennett Government the State Liberal Party has been reluctant to identify itself with, or promote the benefits from, the reforms undertaken under Kennett, let alone present a general policy program involving smaller government. It constantly amazes me that there seems to be an inability to recognise the considerable benefits Victorians obtain from, for example, being able to choose between the private and government provision of school education and hospital services, not to mention the privatisation of electricity and, deficient as it may be, public transport. The State Liberal party seems reluctant to promulgate the advantages of arrangements that allow for public services to be provided on a more competitive basis, let alone to move further in that direction.

Indeed, the Liberal Party appears to be reluctant to challenge what is popularly regarded as the current status quo: it is almost as though it does not want to be seen as an advocate of major change. This is particularly true in regard to the environmental movement. Fear of losing votes to the Green movement has been allowed to prevent the advocacy of a major program of building new dams or of much greater clearing and burning off arrangements to reduce the risk of fire damage. It should be possible to identify the disadvantages of the kind of environmental policies advocated by the Greens while still presenting a balanced environmental policy yourself.

Mention of the environmental movement provides the opportunity for moving to discuss the assertion that the most dangerous threat to humans comes from increased temperatures caused by increasing emissions of greenhouse gases. So that you know where I’m coming from I want to give you the essence of my view right at the start.

My position is that, even though the temperature threat danger has come to be accepted by all major political parties both here and overseas as requiring urgent action to save the planet, this view has no substantive justification, and certainly none in regard to the alleged need for urgent action. By contrast, the threat from extremist Islamic terrorism is a very real and increasing danger that could cause enormous damage to lives and property in the near future and governments need to take additional preventative measures.

Let me take first the supposed environmental threat. There is sufficient time to make only some brief responses to the usual claims made by those claiming dangerously rising temperatures.

First, although it is claimed that, as reflected in reports by the Intergovernmental Panel on Climate Change, there is a consensus on the danger amongst expert scientists, there are in fact large numbers of scientists who do not accept those reports’ conclusions. These include highly qualified Australians with expertise in climate analysis and, as our professionally respected Productivity Commission has stated, “uncertainty continues to pervade the science and geopolitics and, notwithstanding the Stern Report, the economics”. In the United States over 31,000 scientists have signed a petition declaring “there is no convincing scientific evidence that human release of carbon dioxide, methane, or other greenhouse gases is causing or will, in the foreseeable future, cause catastrophic heating of the Earth’s atmosphere and disruption of the Earth’s climate". Recent opinion polls in the US suggest that a majority of the population are now sceptical of the supposed threat.

Second, it is important to recognise that there is a long history of claims by scientists which have been either totally wrong or grossly exaggerated about possible serious threats to continued human activity unless governments take countervailing action. In the 1970s, for example, the world was warned by many supposed scientific experts that, unless governments acted to drastically reduce economic activity and population, a shortage of resources and starvation would quickly develop. A recently published study of similar type scares in the UK reveals many more recent examples of interventions by governments on the basis of supposedly expert views of scientists which have proved mistaken, and where the interventions had serious adverse consequences for those involved. In those examples the views of scientific dissenters were ignored or over-ruled until after much damage was done.

Third, while the global temperature designated as the “official” measurement is about three quarters of a degree higher than it was about a century ago, an examination of temperature changes over the last 128 years shows that those years included three periods, covering 56 years in all, in which temperatures fell or did not increase. How much confidence can one have in a theory that claims that temperatures will increase as CO2 emissions do – but that doesn’t work for almost half the time?.

Fourth, given that the latest period of cooling or no increase covers the years since 1997 and despite to 5% increase in CO2 emissions shows no sign of a resumption of rising temperatures, how much confidence can one have in the claim that urgent action is needed to reduce emissions? Let me take that one step further. Why should we who are alive today accept the need to immediately turn our lives upside down when the research by adviser Garnaut is that, even if no action is taken to reduce emissions, the GDP in 2100 would be only slightly smaller than if we were to make a large cut in emissions in the years ahead? Of course, one should help protect future generations where that can be done for sensible reasons. But as Garnaut also concludes that, even with no emission cuts, those living in 2100 would be very much richer than we are today, why can’t our children’s children children handle the temperature problem, if indeed there is one. In the meantime, remember that humans show a capacity to adapt to widely different temperatures: Singapore has an average temperature of well over 20 degrees while Helsinki’s is less than 10.

This is highly relevant to Rudd’s continued assertions that, if emission reducing action is not started now, it will cost a lot more when it is needed later on. Should this matter if those living in 70 or 80 years would be very much more able to afford to take such remedial action?

Fifth, one response by consensus scientists to the recent cessation of temperature increases is to claim that, even so, such temperatures remain the hottest since industrialisation started. However, there is ample evidence demonstrating the existence of periods of higher temperatures before industrialisation and in circumstances where no fossil fuels were used. Moreover, an authoritative independent study of the method of calculating global temperatures in recent years indicates that the so-called official figures considerably overstate the levels reached because they fail to take account of the heating effects from urban areas. In other word, it is very likely that temperatures increased by considerably less than three quarters of a degree over the past century.

Sixth, although quite a few danger-believers suggest that even their very own IPCC has underestimated the increase in sea levels and the likely further rise, there is no evidence to support that view – and, incidentally, no reason for local governments in Victoria to restrict building on low lying land near the sea. Satellite measurements of sea levels since 1994 show a rate of increase close to the lower end of the very modest predicted rate of increase by the IPCC and those measurements show no increase at all in the last four years. Similarly, the various scares started by danger-believers about supposed meltings of the Arctic and Antarctic have turned out to be furphies and are clearly an attempt to heighten concerns in the lead-up to the Copenhagen conference in December.

The scare about the Arctic was a monstrous furphy because the ice there is mostly sea ice and any such meltings would not increase sea levels. It is symbolic of the deception by both the danger-believers and sections of the media that there has been minimal reporting of the recent recovery of ice in the Arctic to above average levels. The scare in the Antarctic was based on dicey estimates of temperatures in large areas where there are no weather stations and in circumstances where the total ice area in the Antarctic has actually been increasing and reached record levels in 2008. The Dutch, who have adapted to live above the sea level and are very watchful of changes, stated last year through their Meteorological Institute that sea levels have risen a modest 20 centimetres (about 8 inches) in the past century. They added that “there is no evidence for accelerated sea-level rise”. Perhaps our worried sea-side local authorities should consult the Dutch.

Seventh, the dangerous temperature thesis is based on the fact that, in addition to the direct warming from the sun, further warming occurs because the earth radiates back into the atmosphere and some of that hits the concentrations of greenhouse gases remaining in the atmosphere which, in turn, radiate back to the earth. Hence, it is argued, as the greenhouse gas concentrations are continually increasing due to increased emissions of CO2, so to will the warming effect from the radiation back to earth process. However, the problem with this analysis is that it is an established fact that the warming from increased concentrations of CO2 diminishes progressively as concentration levels grow. Thus, even a doubling of concentrations in the atmosphere would only increase temperatures very slightly.

Even though this established fact is reported in IPCC reports, it has not been taken into account by the IPCC when framing its conclusion that urgent action is needed to reduce CO2 emissions. A further major defect in the IPCC analysis derives from the modelling it undertakes to estimate possible temperature increases from the warming. That modelling is based on assumptions that grossly understate the extent to which the warming is cooled by evaporation. This serious deficiency in the models produces much larger increases in surface temperatures than could actually occur.

What do these faults in scientific analysis mean? It is difficult to avoid the conclusion that they mean that the conclusions reached by the IPCC and its supporters have a political rather than scientific motivation.

My eighth and final comment relates to the point that, while some people accept that the science consensus may be wrong, for various reasons they go along with the idea that precautionary action should be taken to reduce CO2 emissions. In this context, such people refer to Treasury modelling that purports to demonstrate that the cost of implementing an emissions reduction program will be very small or to the argument that there will be no loss of jobs because production of alternative sources of energy and different motor vehicles and the like will require replacement jobs. However, the Treasury modelling is based on the highly unrealistic assumptions that Australia will be operating within an effective global agreement on emission reductions and that coal will remain usable because carbon capture and storage will become “commercial” and be generally deployed by 2020. But the Rudd Government is proposing that Australia start reducing emissions in mid 2011 even if there is no global agreement, which would put Australian companies at a serious competitive disadvantage on world markets. More importantly, a shift to alternative sources of energy and different machinery would be more expensive and would lower living standards.

The eight responses I have made to claims by the danger believers could be increased. My conclusion is that the case is not made for an emission reduction scheme and that, while advanced countries may agree on some kind of scheme in Copenhagen, the Coalition should adopt the position that Australia should undertake further investigations of the dangerous warming thesis. A list of doubts/concerns about that thesis along the lines set out above could readily be listed. However, although it is rumoured that more than half of the Coalition as well as a proportion of Labor members are sceptics, few are prepared to express their doubts publicly and the Leader of the Coalition seems to have swallowed the danger story hook line and sinker. Unfortunately, it looks as though there will be no proper independent inquiry and that Australian major political parties will allow some kind of emission reduction scheme to be established.

I have already suggested that, by contrast with the dangerous temperature scare, the threat from extremist Islamic terrorism is seriously serious. This, of course, is the area where we rely most on governments to protect us and, since September 2001, the previous Government did in fact implement numerous counter-terrorism measures, including many pieces of legislation dealing specifically with terrorist acts and an increase in intelligence analysts. It is encouraging that, although some government proposals had to be modified, there was general bipartisan support.

Although the measures were not justified on the basis of threats from any single groups, it is obvious that the main concern relates to extremist Islamic groups.

As recent events in Pakistan demonstrate, these groups aim to establish a theocratic state operating under sharia law, which would apply to a wide range of social behaviour and for which capital punishment can be applied for non-observance. Other religions would be extinguished and the role of women subordinated.

Those who argue that the establishment of sharia law is unachievable in modern society fail to recognise that European countries, including the UK, are already accepting allowing the establishment of separate Muslim communities that apply their own law within the existing law. The book written by the brave Muslim woman, Hirsi Ali, who emigrated to Europe illustrates the antipathy to western society engendered within Islamic communities and the enormous difficulties faced by an individual, particularly a woman, in trying to behave differently from the norm even in a non-Muslim country. Relevant in the European context is the point made by author Mark Steyn that, if the low fertility rates of European “Westerners” and the high fertility rates of Muslims continue, Europe will effectively become Muslim dominated in the not too distant future.  

Worrying as such trends are for our culture, even more important is the potential for extremist Islamic groups to use violent methods to attack, even to attempt to destroy, Western societies. The new President of the United States, Barack Obama, recognised this when, after his recent meeting with the presidents of Afghanistan and Pakistan in Washington, he made the following extremely important statement:

“We meet today as three sovereign nations joined by a common goal: to disrupt, dismantle and defeat al-Qaeda and its extremist allies in Pakistan and Afghanistan, and to prevent their ability to operate in another country in the future. Our strategy reflects a fundamental truth: the security of Pakistan, Afghanistan and the United States are linked.”

Remarkably, only one newspaper in Australia appears to have reported this statement. That report also quoted important comments by the US Special Envoy to Pakistan and Afghanistan, Richard Holbrooke, to the US House of Representatives foreign affairs committee on the situation in those two countries. Those comments included the following:

“So we need to be very clear that we are talking about an issue that is of direct importance to our national security.”

The threat to US national security is also a threat, albeit a smaller one, to Australian security and it comes of course from the increasing potential for extremist Islamic groups to obtain sophisticated weapons with great destructive power. The week-end report of an attempt in New York to not only blow up synagogues with car bombs but to use deadly missiles to attack US military planes was treated by our press in a rather matter of fact way as though it was just another example of the behaviour of drop outs. But one motive was clearly revenge for the killing by the US of Muslims in Afghanistan and drop outs are capable to squeeze a trigger.

At a defence conference in Canberra in 2007 a US expert on nuclear proliferation pointed out that there is an increasing risk of a terrorist group obtaining and using a nuclear weapon without being detected. “We have”, he said, “no defence against a nuclear weapon delivered by a terrorist group, because we could be sure that it will be delivered in an unconventional way”

Like the US, Australia has troops in Afghanistan and we also have extremist Islamisicists. Although the powers of police and intelligence agencies have been increased, in my view the power to detain, interrogate and control needs to be further increased. Greater legitimization of early action will impinge on civil liberties and be resisted by human rights groups and my fear is that the present government may adopt measures supported by those groups. In a speech reported over the week-end Attorney General McClelland indicated that torture will be made a federal crime because “we must establish a moral counterpoint to the immorality of terrorism.” But, as the current debate in the United States indicates, complete abandonment of the use of torture might be costly in terms of national security and innocent lives. Will the Attorney General be morally accountable if the outlawing of torture, however defined, leads to innocent Australian deaths?

There is no easy solution to the threat from extremist terrorism. But it is important that the very real danger be more fully recognised by both the Government and the Opposition in determining immigration, defence and legal policies. Unfortunately, while the recent White Paper on Defence acknowledged that terrorists are seeking nuclear and radiological weapons, it also stated that terrorism is not a strategic danger. That is not a good sign.

CONCLUSION

I hope you will agree that what I have had to say suggests that the Liberal Party has many opportunities to pursue the objectives for which it is supposed to stand and to differentiate itself from the Labor Party. My concern is that, even though appropriate policies may be consistent with liberal beliefs, there seems to be a fear within the Liberal party that too much differentiation is politically risky. I submit that fear is something to be overcome, not to succumb to.

Des Moore is the Director of the Institute for Private Enterprise.

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