30 Years of Lost Opportunities: 1970-2000 (2001)

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Outline of 16/5/01 Deakin Lecture by Dr Peter Brain

Deakin mapped out an economic vision for Australia based on strong state regulatory control of strategic industry and effective state leadership of national development.

We now have exactly the opposite. We now say that the market (ie the private sector) knows best.

Deakin was right. Those countries that are best positioned in the world are the ones that used the state to drive high tech industries - through provision of strategic infrastructure and strategic regulation of industry eg countries in North Asia; Western Europe and the USA. Deakinesque Ireland has outperformed economic rationalist New Zealand. Australia has not adequately developed advanced industry. Unlike Norway, which used a strong mining sector to build the world's best practice heavy engineering, Australia virtually destroyed its heavy engineering.

Economic rationalism has flourished because it is essentially anti-democratic. Rationalism legitimises the dominance of established private interests over new private interests. Representative democracy was designed to deliver a fair balance between private and collective interests. Economic rationalism has been used in strategic decision making at great national costs.

To overcome the economic problem there is a need for a change in political structure and institutions. The legitimacy of a political system depends on economic and social progress.

Strengths of Australia's recent performance are often highlighted, but weaknesses have been ignored. Positives highlighted have included: absolute growth; higher productivity; low unemployment; low inflation and strong public finance. However this is partly a statistical illusion. Australia (like the USA) makes adjustments to prices to account for product quality - which Europe doesn't do - and so Europe appears to have slower growth. Australia's unemployment is measured as 6.8% - but using 1990 methodology it would be 10% - because long term unemployed have now been taken out of the statistics through disability pensions and work for the dole. In fact, Australia's productivity growth is only at historical levels; inflation is no lower than in comparable countries; and public finance is only strong because of reduced services.  Structural imbalances in the economy worsened during the 1990s - eg declining manufacturing share of GDP. There is an ETM trade deficit of 8% of GDP. Current account deficit has increased vulnerability to external shocks. 3/4 million people have been consigned to a subsistence existence. Those in employment work 2300 hours per annum which is unlike the Dutch choice of low unemployment, a happy labour force, productivity like that in the USA and average 1350 annual working hours.

To break out there is a need to greatly strengthen our system of representative democracy. Three ways in which this might be achieved involve: constitutional change; breakdown of party discipline; or breakdown of two party system (eg by adoption of proportional representation system like NZ). The only practical option is a breakdown of the two party system through political control being taken by independents.

The above is based on Brain P. 'The opportunity cost of misplaced faith', Financial Review, 18/5/01. The Deakin Lecture by Dr Peter Brain which his article summarises is online at http://www.abc.net.au/rn/deakin/stories/s291487.htm

CPDS Comments on 'The Opportunity Cost of Misplaced Faith'
  • firstly, great care is required in developing proposals for a less simplistic economic strategy.  It may be preferable to create new  institutions within civil society to take the lead in strategic economic change as a complement to democratic politics, rather than asking elected representatives to do this directly. This issue (which is very complex) is considered further below in terms of: 
    • the critical importance of distinguishing between the market and the private sector;
    • the real limits to centralised rationality that have been the basis for using market liberalisation to speed economic change;
    • qualifications that need to be applied to the historical role of the state in driving high tech industries in North Asia, USA and Europe;
    • the limits to what democratic institutions can achieve on their own; and
    • an hypothesis about what might be done to improve the situation. 
  • secondly, more than political changes are needed in rebuilding a more viable representative democracy. It is also vital to restore the institutions which provide information and practical support to representative democracy, and to guard against further pathologies in our political regimes.
  • thirdly, Brain highlighted defects in claims which have been made about Australia's 'superior' economic performance in the 1990s (eg the inclusion of allowances for improved quality in Australian and US national accounts, which are not included in European accounts and thus understate European growth).         Other concerns about recent economic performance that might add to his collection (which are explored further below) could include: 
    • a likely overestimation of economic growth and of productivity growth due to ongoing devaluation; and
    • the risk of a currency crisis associated with any appreciable decline in Australia attractiveness for foreign investment - a decline which may well be arising in resource sectors.

In Brain's Deakin Lecture, he described Australia's symptoms well and was quite right in pointing out that the legitimacy of a political system depends on achieving economic and social gains. And in this respect our current arrangements are in serious risk of losing legitimacy - so something has to change. The question is: What?
Brain's lecture suggested strengthening the role of representative democracy, so as to take the lead in strategic economic change (eg through strategic infrastructure and industry regulation).   
While Australia clearly needs to create a more effective system of governance if it is to overcome the types of economic weaknesses that exist, there is much more to this than simply changing the political system.  In particular that there is probably also a need to (a) strengthen  institutions within civil society that might be able to take the economic lead, as a complement to representative democracy and to (b) strengthen the institutions that provide direct support to the democratic process.
Comments on Brain's Deakin Lecture:
This will be introduced by first submitting a couple of observations in relation to what Brain's Deakin Lecture suggested about a market economy and about the role of the state in other countries: 
  • it is not really correct to say that the 'market' and  the private sector are the same thing. The market (which could be either 'free' or closely regulated) is one possible framework within which a private sector may operate. However the market (as a system of relationships amongst firms and their customers) has characteristics and dynamics which are quite different to those of the private sector (as actors within such a system). It is critically important to distinguish the two because: 
    • an effectively regulated market is one way of keeping the private sector under control (which is one of the reasons that liberal market advocates suggest that the private sector usually prefers establishing political channels of influence to avoid competition as much as possible);
    • traditional state corporatism (in which 'private' firms are regarded as agents of the state is one of the alternatives to a market economy (see Williamson Varieties of Corporatism) - an alternative that is occasionally associated with fascism. Any suggestion that a 'strong state' should orchestrate economic change needs to address the corporatism question (eg how to avoid interests that have the best market information and the strongest motives from capturing the political process and thus the said 'strong state' for their own benefit - a predicament of which  Queensland has had some past experience - and which is increasingly likely as the effectiveness of political institutions decline);
    • an effectively developed market economy (ie one in which individual firms receive appropriate information and support) is vital to their performance and to their ability to make good decisions. 
  • the liberal market viewpoint (which its opponents in Australia have called economic rationalism) seems to be based on the very reasonable premise that  there are limits to rationality which make central planning of economic outcomes impossible - because what has to be done to make a profit from meeting consumer preferences depends on distributed and often tacit (ie in-expressible) information that can never be assembled by any central decision maker. This  argument appears to have originated with Hayek's 1945 work on The Use of Knowledge in Society. From that viewpoint the market seems to be thought of as a sort of huge 'calculating machine' which is capable of reducing the limits to rationality  (because it incorporates and processes the information which is required to know what consumers actually want). Any alternative economic strategy has to take account of the 'limits to rationality' problem - and I am not aware of anything but a market economy that is capable of doing so;
  • Brain's observations about the strong state role in various countries in driving high tech industries requires qualification. In particular:
    • the undoubted ability of the state to orchestrate rapid industrial-era economic advancement in North Asia has depended on cultural and institutional arrangements that are not available in Australia (see online introduction to Transforming the Tortoise: A breakthrough to improve Australia's place in the economic race). In particular this has depended on:
      • an epistemology (ie theory about knowledge) which is based on ancient Chinese traditions and is quite different from the concept of 'rationality' that Western societies inherited from classical Greece. The central precept of Daoism (which was the ingredient that turned traditional Confucianism - which oversaw a century of economic malaise in China - into dynamic neo-Confucianism) is that 'The Dao (way) that can be named is not the true Dao'. The latter is a simple statement of the limits to rationality which is equivalent to Hayek's observations (as recognised in Barrow and Tipler, The Anthropic Cosmological Principle). This epistemology leads to:
      • an 'information-divergent / chaos-creating' role for leaders in identifying strategic issues, rather than a 'convergent' role in making strategic decisions, and: 
      • a  concept of power as the avoidance of decisions (rather than as being a decision maker) - see Pye Asian Power and Politics. The consequence of this is 'bottom up' decision making (by employees within organizations, and by firms on behalf of government) whereby subordinates make decisions on behalf of their social superiors - and so overcome to some extent the limits-to-rationality problem Hayek identified
      • a society built on social hierarchy - rather than on equality before law;
      • communitarian economic goals, ie building the power of particular ethic and cultural communities, rather than meeting consumer wants;
      • a strong concept of obligation - which means that (a) precedence is given to customer's requirements in 'bottom up' decisions and (b) any help provided must be repaid somehow - so no one asks for help (eg from government) if they can avoid doing so
      • a Confucian concept of government as teacher and guide, rather than as regulator, and of government by man rather than by a rule of law;
      • control of government by a bureaucratic elite selected through the education system, while 'democratic politics' exists only for show;
      • an approach to industry policy which long involved (a) 'vision development and administrative guidance' through MITI whose effect was to accelerate learning within firms, rather than to make centralised strategic decisions and (b) similar leadership of change within business groups through banks and trading companies.
    • these processes have clear limits (eg rely on learning from someone else's technology, someone else's markets to provide demand and are not effective in dealing with finance as a problem in itself). They are also strongly anti-democratic. 
    • Brain's example of government driving defence industries in the USA arises in an area in which the government itself (rather than consumers) is the main customer - which makes it possible for government uniquely in that case to really know what customers will want. However control resides with the (so-called) military-industrial complex which is often described as a serious challenge to real democracy in the USA (noting the famous caution to 'Beware the military industrial complex').
    • the US had an 'industry policy' debate (led by Robert Reich) in 1984 - which argued that government should coordinate its actions to favour strategic economic capabilities.  However the debate ended almost as soon as it started, because it was realised that (a) any attempt to define strategic industries for support would be immediately captured politically by those industries representatives (the military-industrial complex revisited) and that (b) government did not seem to be capable of administratively coordinating anything to the required degree.
    • the improvement in the US's economic competitiveness during the 1990s can be traced to (a) a change in the organization of production that has characterised its new economy - from hierarchical to networked organizations - a change which has accelerated relevant learning (b) a probably unsustainable asset bubble created by monetary authorities.
    • in considering the role of the state in Europe it is essential to again consider cultural and institutional difference from the situation applying in Australia, which have a major impact on (a) what the words we used (eg state) actually mean (b) what can successfully be done. In particular:
      • many European countries operate under Roman Law - which has a quite different concept of the state to that under British Law. The latter  tradition sees the state as legally equal to members of society, while under Roman Law the state is seen as legally superior to members of society as it represent the society as a whole, and ideally the state is above taking a partisan position on anything. A reference on this is

        Riha T. (1985) 'German Political Economy - The History of an Alternative Economics', International Journal of Social Economics, Vol 12 Numbers 3/4/5:- Theme: There are different forms of philosophy, jurisprudence and sociology to those known in Anglo Saxon societies. German philosophy puts state in pivotal position in society, prior to individuals. Individualism is rejected. Ordo-liberalism was the basis of the post war economic miracle.

        One consequence of this is that the outcome of consensus under European traditions (where the state ideally facilitates consensus rather than bringing a point of view) is quite different from that under British Law - where the state acts as a 'heavyweight' citizen to allow politically influential interest groups to get their way. This is also the reason that proportional representation electoral systems that have been adopted in Europe (to minimise the chances that the state will represent any point of view) are unlikely to work in the same way under British legal traditions (eg in New Zealand).
      • the German post-war economic miracle was (as noted in Riha's book) based on ordo-liberalism - which involved a liberal market economy, in which the role of the state was to determine the nature of the economic order (ie the economic system) but it was to be a liberal order in which the state did not attempt to determine economic outcomes. A strong catalytic role in economic change has been taken by institutions such as banks and the major companies that are the core of business groups;
      • in France, so I understand, a strong role in facilitating economic change has often been taken by a coalition of engineers and bureaucrats - without partisan political engagement, and operating through indicative planning - which once again seeks to speed up the learning process within firms without dictating economic outcomes.
    • in all of the regions Brain mentioned, North Asia, USA and Europe there is a strong tradition of private sector leadership of change within the market economic system. In North Asia the state forces the private sector to do this, in the USA it happens because business is strong and expects to take this role, while in Europe an economic order is created through the state which involves such leadership. In Australia by contrast the private sector is traditionally dependent on the political system (and foreign investors) to take major economic initiatives.
  • New Zealand can't be directly compared with Ireland - because the latter's main attraction for industrial location has probably been its status as a low wage, English-speaking country within the European Community, for which New Zealand has nothing comparable.
The main point of the above comments is that, while Brain is quite right that Australia needs to create a more effective system of governance to improve its economic performance, there is much more to this than simply strengthening the democratic process through political changes.
Representative Democracy can't Solve the Problem Alone
In fact there are serious limits to what the democratic process can do by itself in terms of stimulating economic change. 
In theory some limits arise because:
  • our political process is mainly responsive to interest groups which may capture the agenda for their own benefit - particularly because the political system is generally dependent on those interests for leading edge information, and (a more subtle point);
  • any strategic change which is to be economically productive (ie confer competitive advantages) must be a response to opportunities and threats at the time they first become obvious to the most expert / experienced observers, yet the political process can not initiate action on systemic economic changes until virtually 'everyone' understands the need - by which time it will be too late to profit thereby as smart competitors will already have acted. For example, innovation had become 'flavour of the month' with all governments by 2000 - 15 years after the need for this had become obvious to expert observers, a lag which has been typical of that in making many other necessary economic-system changes in Australia. 
In practice, the limits to what can be done through the democratic process alone are demonstrated by examples such as:
  • a politically driven process of 'reform' of Queensland's Public Service in the early 1990s which seriously eroded the often-tacit knowledge and skill base required  for the Goss government to successfully implement its political agenda, carry on competently with basic administration and cope with the requirements of economic change in practice. How 'reform' led to this outcome is outlined in Towards Good Government in Queensland while the way in which this translated into an inability to cope with economic change is outlined in  Defects in Economic Tactics, Strategy and Outcomes ;
  • the severe financial difficulties which the Victorian Government under Cain (and the Western Australian Government at the same time) experienced as a result of attempts to drive strategic economic change, arose after eliminating the practical skill base of the Public Service through a process that was reportedly the same as that later used by the Goss Government (See Attachment C of Towards Good Government);
  • attempts now being made in Queensland to use the state to provide a strategic impetus to the economy, are failing. In this respect, on-line papers identify fatal technical defects in attempts to define  Strategic Infrastructure and Innovation infrastructure. And an incredibly naive Local Industry Policy has been developed in Queensland that seeks to do what Brain's Deakin Lecture suggested - ie leverage heavy engineering on the back of mining industries. However the tactic which this strategy encourages for local firms is one of reliance on demand from major investments in Queensland, rather than pursuing specialised global opportunities - at the very time that their customers in the mining industry are all moving to global supply chains;
  • a similar Heavy Engineering Action Agenda which has recently been developed by the Commonwealth Government - which suffers from the same sort of economic problem that other such efforts seem to - namely that it represents what the stakeholders in the industry want, rather than what their customers (who were not consulted in developing the Action Agenda) want, and would be prepared to pay for.
Moreover market liberalisation was rationalised in Australia in the 1980s because, in the face of a perceived need for economic adjustment, recommendations about this were at that time coming from the OECD on Positive Structural Adjustment Policies (written in about 1980). The OECD's work was in turn a result of the disastrous outcomes of attempts in Europe in the 1970s to force the pace of strategic economic change in the face of the loss of competitiveness which European manufacturing was suffering - and the resulting de-industrialisation (ie general loss of traditional manufacturing industry and jobs in the face of NIC competition). In practice 1970s efforts by European Governments to stimulate strategic changes always seemed to defend losers, rather than effectively 'pick winners' - and the OECD's conclusion was that it would be better for governments to do nothing.
However in Australia 'doing nothing' has clearly not been enough.
An hypothesis is presented in Defects in Economic Tactics, Strategy and Outcomes (which refers to Queensland's situation but has national parallels) about why this is so, and what might be done that would be more effective.

In brief, this argues that there has been general recognition since the early 1980s of the need to strengthen and diversify Australia's economy into higher productivity activities - because of the slow growth and poor terms of trade of traditional resource-based commodity exports. Neo-liberal ('free-market') policies were generally adopted to facilitate change.

However, at the same time, competitive pressure from newly industrialised countries forced developed economies to switch from industrial-era economic tactics to a "new" / knowledge-based economic style. This raised the goal-posts for Australia's economy.  In particular, because of the need to shift to a 'knowledge' economy, the economic development tactics of an 'industrial' economy were no longer adequate.

Methods for strengthening market capabilities in parallel with market liberalisation were developed during the 1980s [[which incidentally were similar to West German ordo-liberalism as described briefly above]] but the capabilities required to understand or implement this were eliminated by politically driven 'reform'.

Thus  during the 1990s Queensland continued its traditional policies (low taxes and supporting 'major projects') that had the effect of encouraging the growth of low productivity industries and continued using industrial-era economic tactics in seeking to promote 'development'.

In simple terms, 1990s attempts at economic change failed because exposure to competitive pressure was not enough to ensure the ability to compete successfully. Systematic development of stronger practical and economically relevant support  through the market by stimulating informed leadership within industry clusters was a feasible alternative - and would have dramatically improved the performance of the mainstream economy and the plight of marginal regions. 

Brain's paper laid a great deal of stress on strengthening representative democracy.  He is absolutely right. However this can't be achieved just by changing the political system. 
Just as private firms can only perform well if they exist in a well developed market environment that provides them with information and support, so too our  system of representative democracy can only produce good decisions if it gets good policy raw material (eg from public policy research entities, and from the Public Service), and can only produce practical results if governments receive practical support from the Public Service.
The source of the growing problem in Australia's political system is that, as part of politically driven reform to achieve simple-minded economic goals, the information and support required for government itself to be effective has often been demolished - through both
  • making commercial motives dominant in universities - which traditionally (but no longer) provided substantial public policy input; and
  • politicisation of Public Services - without recognition of the clear difference between the political system's concern for whether policy sounds good, and the traditional concern of professional Public Servants for whether a policy will work in practice - which makes their roles complementary in ensuring effective governance. 
As noted previously, the quality of practical support with policy advice and implementation collapsed in Queensland's case in the early 1990s as  recorded in Toward Good Government in Queensland, and this translated into a failure to cope with economic change that has led to severe social symptoms and political instability as suggested in Defects in Economic Tactics, Strategy and Outcomes. The consequent continuation of severe practical difficulties facing government in Queensland is demonstrated in Queensland's Challenge and its Continuation
However this phenomenon has not been unique to Queensland, and appears to be the major factor in the unexpected electoral backlashes that many governments  have experienced - when they have been perceived to be arrogant because superficially sensible policy ideas have not translated into practical benefits (see online Note 21).  The massive electoral reversal recently suffered by the Howard Government appears to be yet another example of this phenomena - which arguably resulted from a lack of administrative competence in the implementation of quite pedestrian tax policies.
Thus as well as changing the political system (perhaps along the lines Brain suggest) there is also a need to upgrade the technical competence of those who provide advice and support to democratic representatives - so that the latter can operate effectively once elected. A Direct Action proposal on the CPDS web-site suggests how this might be achieved.
A consideration in trying to repair the system of representative democracy is that there seems to be an increasing trend towards community disrespect for elected representatives and towards political populism (ie politicians seem to gain electoral support by making popular promises that have no realistic prospect of long term viability because none of the players in the political game have access to constructive proposals about what to do). The emergence of populism is illustrated by: One Nation; the second Beattie Government in Queensland; and the Howard Government's 2001 budget.

Political pathologies: Populism is not only another one of the recognisable steps on the road to a real 'banana republic' (see online Note 24). It is also not far removed from fascism - ie from populist leaders who attempt to cut out elected representatives altogether.  As I understand it, fascism rejects 'representative' democracy on the grounds that representatives make decisions in their own, rather than the people's, interests - and fascism tends to favour directly determining the will of the people on particular matters through the use of frequent plebiscites (Jayasuria K. 'Beware the fascist roots of populism', Australian, 17/2/99).  However this also allows 'populist' demagogues who capture the public's affections (but do not have a well considered agenda) to manipulate both the public's emotions, and their decisions.   Representative democracy by contrast allows representative to gain an  understanding of the issues involved  to base decisions on that understanding rather than on emotion. Indications of fascism in Australia include (a) the emerging electoral success of populist politics and (b) popular support for direct election of a President under a republican constitution - which would over-ride the role of elected 'representatives'.

Thus fixing our system of representative democracy is going to be anything but a simple matter - and could even become dangerous.
  • has ongoing devaluation of the $A further created a misleading impression of rapid 'productivity' growth? Suppose goods and services with a value of A$100bn (initially $US75bn say) are produced for export, and then, through devaluation, those goods and services are declared to be worth $A100bn ($US50bn). The fact is that they are still worth exactly what they were in (say) $US - and as they are sold at that value it will appear that 'productivity' is growing very rapidly in $A terms. This naturally only has a large impact on perceived 'productivity' growth in the export sectors of the economy - but this will translate into some upward distortion of measured productivity overall which actually merely reflects the devaluation of the unit of measurement. 
  • rapid growth during the 1990s has been stimulated partly by large capital inflows - which have led to rapidly growing foreign obligations and to a structural current account deficit.  This does not just create the risk Brain identified of a currency crisis in the event of an external shock. Capital inflows of $30bn+ are required now just to cover the cost of debt service, and when too few productive investment opportunities are available, investor demand for the $A will be insufficient to maintain the $A value - and signs of this were emerging in 2000. Very fast devaluation due to an inward investment slowdown could trigger a crisis at some stage. In particular it can be noted that there have been very large capital inflows for resource projects over recent decades, yet such investments have typically been quite unprofitable for structural reasons. Thus simple resource investments seem likely to be far more constrained in future (See online Note 9).
  • ownership and control of many Australian enterprises has been passing overseas, because the corollary of the current account deficit was large capital inflow to buy those enterprises. One consequence is that the strategic information which is required to build competitive advantages and to raise productivity (and to advise governments about sensible economic policy options) has become increasingly scarce.  Limited access to such strategic information to guide state efforts to overcome serious economic difficulties is apparently one of the characteristics of a classic Latin American 'banana republic' (See online Note 24).