BALANCING ACT

Correspondence

Saul Eslake

George Megalogenis writes about today’s economy with a grasp of the broad sweep of Australian history and an awareness of the social consequences of economic performance and policy – attributes which have been all too rare among economic commentators of the past two decades. He is thus able to diagnose aspects of Australia’s economic performance – and the strengths and weaknesses of Australian economic policy-making – which elude many others.

In Balancing Act, Megalogenis draws attention to what he sees as the shortcomings of Australian economic management during and after the China-driven “commodities boom,” which, together with the global financial crisis of 2008–09 and its aftermath, has been the most important phenomenon shaping Australia’s economic experience thus far in the twenty-first century.

There is much to admire in Megalogenis’s analysis of this period. But his prognosis – that Australia has entered a “danger zone,” where “a recession of some kind will be difficult to avoid” – does not follow ineluctably from that analysis. And his proposed course of treatment hardly amounts to the radical surgery that he suggests it does.

With the exception of China itself, probably no other country benefited as much from China’s rapid economic growth, industrialisation and urbanisation as Australia. This was because Australia’s resource endowment was uniquely suited to China’s needs. Of the four commodities at the heart of China’s transformation – iron ore, coal, oil and LNG – Australia, alone among the world’s major commodity exporters, possessed three in ample quantities. Moreover, Australia also benefited from China’s emergence as a major manufacturing exporter, so that we paid lower prices for imported manufactured goods. 

Australia’s terms of trade – the ratio of the prices received for our exports to the prices paid for our imports – improved by 97 per cent between 2000 and their peak in 2011. No other commodity-exporting nation gained as much: over the same interval, Canada’s terms of trade improved by 18 per cent, New Zealand’s by 26 per cent, Norway’s and Brazil’s by 39 and 40 per cent respectively, and South Africa’s by 42 per cent. Only Russia and Chile came close to recording terms of trade gains close to Australia’s, but even they fell around 10 percentage points short of our gains. And of course for most of Australia’s peers among the advanced economies, this rise in the prices of commodities and fall in the prices of manufactures represented a loss of income, rather than a gain as it did for Australia.

Megalogenis is right to point out that during this period, Australia’s (public) finances “suddenly assumed the character of a magic pudding.” As the Parliamentary Budget Office has recently calculated, between 2002–03 and 2008–09 “parameter variations” (that is, unexpected windfalls) boosted revenues by a minimum of $222 billion. Yet, rather than save the bulk of this in a form of “sovereign wealth fund” – as Ross Garnaut, Chris Richardson and I advocated at the time – to be drawn down in order to cushion the inevitable downturn after commodity prices peaked at some (then unknowable) point in the future – the Howard government (in its last five years in office) and the Rudd government (in its first year) spent the lot, and more – giving away, according to the PBO’s calculations, $89 billion in tax cuts and deliberately increasing spending by $175 billion.

This was when the “age of entitlement” which Joe Hockey bemoaned in 2012 was created. And it was then that the seeds of Australia’s present budgetary difficulties were sown – although they were subsequently well watered by the Gillard government’s inability to reverse the spending increases undertaken during the financial crisis, and its insistence on yet more discretionary increases in entitlement spending. As Megalogenis concludes, “we … failed to live up to our own previous high standard of prudence.”

Precisely because Australia benefited so much from the “up” phase of the commodities boom, it was almost inevitable that we would find the subsequent “down” phase difficult – especially since we did so little to prepare for it. Since 2011 Australia’s terms of trade have deteriorated by 29 per cent. Apart from Russia, whose terms of trade have fallen by 30 per cent over this period, no other commodity-exporting nation has seen a similar decline: Brazil’s have fallen by 18 per cent, Norway’s by 14 per cent, Chile’s by 12 per cent, Canada’s by 10 per cent, and South Africa’s by 9 per cent, while New Zealand’s terms of trade have actually risen by 3 per cent over this period (though they have declined from a somewhat later peak in 2014). And of course most other advanced economies’ terms of trade have improved since 2011.

The remarkable thing, therefore, is not that Australia’s economic performance has deteriorated since the peak in commodity prices in 2011 – which, of course, it has – but rather that Australia has thus far managed this challenging period better than virtually all of the other countries which gained much less than us from the “up” phase of the commodities boom, and thus prima facie had less to fear during the “down” phase.

Australia has not experienced a recession, in the widely used sense of that term, as Canada and (more dramatically) Brazil and Russia have. Australia’s growth rate has slowed, to be sure – to 2.5 per cent in 2015 – but not as much as Chile’s (2.1 per cent), Norway’s (1.7 per cent) or South Africa’s (1.3 per cent). Our unemployment rate is higher than at the peak of the boom, but it has risen by less than in South Africa, Brazil and Norway, and remains lower than in Canada. Of the commodity-exporters with which it is legitimate to compare Australia, only New Zealand has weathered the “down” phase of the boom better than Australia – and, as noted earlier, the “down” phase for New Zealand has been both more recent and milder than for hard-commodity exporters like Australia.

Far from demonstrating the limitations of Australia’s “open model,” as Megalogenis calls it, Australia’s comparative resilience is, arguably, a vindication of it. An open door to (authorised) migration (giving Australia a faster rate of population growth than most other commodity-exporting, or “advanced,” economies), a capacity and willingness to cut interest rates to record lows, a flexible exchange rate, a more flexible labour market than most conservative critics are prepared to acknowledge, and a willingness to eschew the more dramatic forms of fiscal austerity pursued in most other advanced economies – all these things together have served Australia very well.

Megalogenis’s more telling observation is that we could have done even better – had, as he cogently and persuasively argues, Australian governments (federal and state) been willing to spend significantly more on infrastructure. Not only would our economy have been stronger, but so would the quality of life in our cities – and maybe in some of our regions – have improved too.

Australia would have been better placed to spend more on much-needed infrastructure if we hadn’t frittered away so many – indeed, more than all – of the gains that accrued to governments during the “up” phase of the boom. As the Reserve Bank Governor, Glenn Stevens, has pointed out, albeit subtly, on several occasions, we could have done this had governments been more willing to borrow at the record-low long-term interest rates available to them in recent years. The appetite for Australian government debt suggests that both local and foreign investors would have financed infrastructure spending equivalent to at least one, and possibly more than two, percentage points of GDP – provided that the infrastructure projects were demonstrably well chosen, and especially if successive (federal) governments had sought to improve their “operating” budget positions over this period.

But even if, as Megalogenis advocates, infrastructure spending “should probably return to the levels of the 1960s, when it was closer to 10 per cent of GDP,” this hardly amounts to a repudiation of the “open model,” where “four key prices – the currency, interest rates, tariffs and wages” are “removed … from political control.” On the contrary – as Megalogenis acknowledges at one point – it represents an “augmentation” of that model. We now have what Megalogenis calls for – “a Reserve Bank–style model … to identify and rank projects on economic and social grounds, and to recommend timelines for implementation” – in the form of Infrastructure Australia. We simply need to provide stronger guarantees of its independence from governments, and more powerful incentives for them to follow its recommendations.

Much the same is true of Megalogenis’s other suggestions. He’s right to draw attention to the risks associated with Australia’s love affair with property investment, and the role that Australia’s tax system has played in promoting that form of infatuation. And, yes, it would have been better if negative gearing had been curtailed during the global financial crisis – a suggestion which Wayne Swan repudiated upon belatedly releasing the Henry Review in May 2010, even though the Henry Review hadn’t actually recommended it – or, indeed, at any time in the past three decades. But that’s no reason to cavil at doing so now. Indeed, as Megalogenis says elsewhere, “the political dialogue about tax has to change”: but with the exception of superannuation, he doesn’t say where, or how.

Similarly, he’s right to draw attention to Australia’s below-average rate of female workforce participation, especially compared to Canada or New Zealand. However, Megalogenis’s recommendation amounts to a plea for prime ministers to follow Canadian prime minister Justin Trudeau’s example in allocating Cabinet positions among men and women – sound advice, to be sure, but hardly a radical expansion of the role of government in the economy.

Megalogenis’s essay doesn’t really amount to an argument for much bigger government – such as Jeff Madrick, who at one time held a similar role at the New York Times to the one Megalogenis held at the Australian, sought to make in the aptly titled The Case for Big Government (2009). Rather, it is a plea for better government – government which looks, thinks and plans ahead, which does what governments are supposed to do and does it well, which is willing and able to “lean against” the “irrational exuberance” to which markets are from time to time inclined, and which is concerned about issues like fairness and opportunity. As such, it’s both well-argued and timely.

Saul Eslake

Saul Eslake is a vice-chancellor’s fellow at the University of Tasmania and an independent consulting economist. He has previously been chief economist at ANZ, chief economist at Bank of America Merrill Lynch Australia, and director of the Productivity Growth Program at the Grattan Institute.