Beyond the 'Open Economy' - Accelerating Economic Development (2009)

Outline

In May 2009 Dr Craig Emerson, MP (federal Minister for Small Business, Independent Contractors and the Service Economy) made a case for further opening Australia's economy to competition along the lines pursued by the Hawke-Keating governments.

This document will suggest that more effective machinery to develop the economy is needed if Australians are to successfully meet the competitive challenge that he highlighted.

In brief Dr Emerson suggested that: (a) market-liberalization reforms under the Hawke-Keating Governments provided a basis for productivity growth in Australia during the 1990s; (b) since then productivity gains have slowed due to the lack of ongoing reforms, though this was concealed by temporary housing / mining booms; (c) the bursting of the mining boom has now resulted in a painful $210bn loss of government revenue; (d) even though financial regulations now require review because of financial excesses in US / Europe, future prosperity would best be ensured by continued efforts to develop an open competitive economy (noting the risks associated with a retreat into protectionism and heavy regulation that the Prime Minister warned about in his Monthly article); and (e) this basically requires investment in education, infrastructure and innovation as well as further deregulation.

Outline: Open economy reforms by Hawke-Keating ALP governments enabled sustained global growth from 1991 to 2007 - and turned closed / sclerotic economy into successful competitor. A decade-long productivity boom commenced in 1991, and though growth continued in 21st century productivity growth weakened due to lack of ongoing reforms. This was concealed by two booms - a housing boom starting in 2000 fed by cheap and easy global credit, and a mining boom based on China's need for raw materials. The housing boom lifted Australia's net foreign debt from $200bn in 1996 to $550bn in 2007. Warnings about this were ignored on the basis that private debt didn't matter. A boom which increased national debt by borrowing to buy houses at inflated prices did nothing for productivity. As this faded the mining boom emerged, and a great deal (though not all) of was spent on consumption. Now that boom has deflated, Australia has a poor balance sheet - run-down infrastructure; and an inadequate education system. Productivity growth has halted. Mining bust in 2008 stripped $208bn from Commonwealth revenues. Recent federal budget seeks to share the burden fairly. The key question now is whether to stick with open competitive model or abandon it in favour of re-regulation and protectionism. Demands for the latter have increased world-wide - and the Prime Minister's Monthly essay warned about the risks with this approach. Yet there is a need for effective new regulation - as failures in US and Europe allowed lenders to take unconscionable / hidden risks. Protectionism must be resisted. Competition drives innovation - and this must be applied to business. Strategy reliant on housing / mining booms (rather than improving productivity) must eventually fail. Australia should embrace open, competitive model, support investment in productivity-raising education, innovation and infrastructure (eg high speed broadband) and press ahead with deregulation (through COAG). (Emerson C., "Open economy our best hope", The Australian, 28/5/09)

While the issues raised are critically important, the matter is more complex because: 

• there is reason for doubt about the adequacy of the market-liberalization policies introduced by the Hawke-Keating governments in boosting productivity (eg requiring competition does not ensure the economy is sufficiently developed for individuals / enterprises to compete successfully in high value-added activities);
• many apparently-informed observers seemed to conclude that the Prime Minister's Monthly essay involved a critique of the market-liberalization reforms that Dr Emerson article credited with boosting Australia's productivity in the 1990s;
• the issues involved in the global financial crisis (GFC) are not simply financial excesses in the US and Europe, as global financial imbalances (reflecting both demand deficits in East Asia and corresponding excess demand, supported by asset bubbles, mainly in the US) were both: (a) factors in the emergence of the GFC; and (b) vital to the economic 'miracles' in East Asia based on economic models in which 'productivity' considerations played only a minor role;
• while education, infrastructure, innovation and breaking regulatory barriers will have a role in boosting future productivity, such inputs could be much better integrated into a well functioning and developed economy than has been the case to date (eg there must be a strong demand for, and ability to productively use, highly educated people or advanced research, if public investment in such economic inputs is to significantly boost productivity).

More general suggestions about meeting the challenges posed by the GFC (which also refers, for example, to the need for stronger support to the democratic process) are in Managing Australia's Economic Crisis.

Boosting Productivity: History

There is considerable doubt about the productivity gains attributable to the simple market liberalism introduced (mainly but not only) by the Hawke-Keating Governments (eg see Impact of Economic Liberalism in Australia, 2002). For example:

• while many observers suggested that market liberalization had provided considerable productivity benefits, many others raised plausible concerns about this;
• assessing Australia's productivity performance during the 1990s is quite complex. For example, ongoing devaluation of the $A gave a windfall boost to the perceived value of mineral and energy exports for many years - and thus to measures of Australia's 'productivity' improvement;
• there were many indicators of unsatisfactory progress including: weak export performance; diversification into capital intensive sectors whose competitiveness is hard to maintain relative to emerging economies with low wage rates; declining innovation ranking; under-employment (reflecting poor job quality); persistent unemployment; and an apparent need for increasing welfare payments to guard against increasing social inequality.

Economic Environment: Future

Dr Emerson's article noted that the Prime Minister's essay in The Monthly, had warned about the dangers of protectionism. However Mr Rudd's essay was anything but clear as many observers concluded that the 'neo-liberalism' that he criticised was the same as the market-liberalization policies introduced mainly by the Hawke-Keating governments which Dr Emerson article credited with improving productivity (see Observer's Reactions in A Social Democratic Alternative to 'Neo-Liberalism'?, 2009).

However it is seriously misleading (as Mr Rudd's essay did) to suggest that the GFC was solely due to excesses in the US and Europe, so that all that is required is more effective regulation of US / European financial institutions.

Economic 'miracles' in East Asia have been based on socially-coordinated economic production with very limited attention to productivity (see Understanding East Asia's Economic Models). This created a severe risk of financial crisis (as illustrated by the 1997 Asian crisis) unless demand was suppressed to the point that large current account surpluses emerged to make it unnecessary to borrow in international markets. Thus such economies have been macroeconomically unbalanced and characterised by demand-deficits. The latter would have led to a failure in global growth (for reasons identified by Keynes in the 1930s) unless the US (mainly) had compensated for those demand deficits using income ultimately generated by what proved to be asset bubbles (see Impacting the Global Economy).

The global financial imbalances that resulted from US attempts to drive growth despite the defects in East Asian economic models had a major role in the GFC (eg see Financial Imbalances, 2003; Global Financial Crisis: The Second Test of Globalization?, 2008). In the post-GFC environment the lack of emphasis on productivity in the socially-coordinated East Asian economic models may make them unsustainable.

While the challenges that this creates are difficult, failure to take them into account can not result in economic success.

Boosting Productivity: Future

Competition by itself is not enough to raise productivity. Competition increases the pressure on individuals / enterprises - but does not ensure that they gain the ability to compete successfully in high value-added activities (see The Inadequacy of Market Liberalization, 2004). Competing successfully depends on many systemic factors within regional economies which may not be in place, and may not emerge simply as a result of competition. Knowledge is widely regarded by economists as the key factor in economic productivity. However this need not merely be of benefit at the level of individuals and enterprises - but may also be applied usefully to accelerate the development of regional economies (eg see Probable Breakthrough in Understanding Economic Development, 2004). Ways in which this might be applied in practice are speculated in A Case for Innovative Economic Leadership (2009).

Dr Emerson's article stressed the importance of government support for economic inputs such as education and infrastructure. These inputs are important, but only if they are effectively integrated into well developed economic systems. Strengthening human resources with education and training is no use unless there is a demand for, and ability to productively employ, the resulting knowledge and skills (see Is Education Spending the Key to Raising Economic Productivity?). The ability to use such inputs might be lifted much more effectively than in the past using methods such as those suggested above. And the machinery for developing infrastructure in Australia seems ineffectual and in need of renewal (eg see Infrastructure Constraints on Australia's Economy, 2005 and Infrastructure Magic?, 2008).

Innovation is of considerable potential benefit in raising productivity, but only if the systems which support that activity are market driven - rather than being mainly responsive to political lobbying as has often been the case in Australia (eg see The Economic Futility of 'Backing Australia's Ability 2', 2004; and Commentary on 'Smart State': Illustrating Queensland's Lack of Serious Public Policy). As suggested in A Case for Innovative Economic Leadership (2009) there is arguably a need for a different type of economic leadership if economically-beneficial rather than politically-appealing innovation systems are to be created.

The front-line government role in promoting the 'development' of Australia's economy (which influences its productivity) is taken by state governments. However the latter lack the financial incentives to take that responsibility seriously because of: (a) their narrow tax bases; and (b) federal financial arrangements which compensate them for weak tax bases that result from defective economic strategies. Broadening the tax revenue sources directly available to state governments might make a major contribution to a more serious approach to the development of Australia's economy (see Providing Incentives for Economic Development)