The politics of prosperity

‘Luck always seems to be against those who depend on it.'

THIS IS A lucky country. The challenge is to keep it lucky, and the danger is that thinking we are fortunate may make us complacent about real and ever present vulnerabilities. Avoiding the worst of the global economic crisis of 2008-09 reinforced Australia's sense of providence – waiting for the recession, it turned out, was a bit like waiting for Godot. By early 2010 it appeared that unemployment had peaked and Australia had outperformed the rest of the developed world.

But things change. And then they change again. After a year of dealing with the politics of a booming economy, the Rudd Government had to shift rapidly to avoiding a recession. Kevin Rudd looked to have continued an unfortunate Labor tradition of coming into office at an extremely inopportune moment. James Scullin had to deal with the Great Depression; Gough Whitlam tried to spread the luck of the postwar boom just as that luck ran out; and Bob Hawke took over when it was increasingly obvious that Australia's economic problems went beyond recession, to the very basis of its long-term prosperity. Determined to replicate the excellent record of the Hawke government, rather than the ignominy of Scullin's or Whitlam's, Rudd Labor quickly embarked on a massive program of government spending to stimulate the economy. The Reserve Bank added monetary easing to the stimulus, cutting interest rates by 4.25 per cent between September 2008 and April 2009.

The prescient action of policymakers was in stark contrast to the Hawke and Keating governments' delayed reaction to the early 1990s recession and helped Australia to avoid a technical recession, two quarters of GDP contraction in a row. Australia also benefited from the Chinese Government's huge economic stimulus, which helped to underpin China's continuing demand for Australian resources. Indeed, government actions throughout the world stopped the slide into a global depression.

As the news from the rest of the world started to improve, some Australian policymakers and business figures argued that the real problem for Australia's future would be dealing with the politics of prosperity caused by the rise and rise of Asia. Secretary to the Treasury Ken Henry observed, ‘China and India are only in the early stages of catching up with the living standards of the developed world and this process could have a very long way to run.' On the same day the chair of BHP Billiton, Don Argus, said, ‘I believe we stand at the threshold of an era of unprecedented growth due to demand generated by China and, in the future, India.'

Australians' perceptions of their position in the world have oscillated between optimism and pessimism. Today, they once again believe they are living in a lucky country. When Donald Horne wrote The Lucky Country in 1964, he could not have imagined how iconic the phrase would become, or how completely the ironic intent of his title would disappear. Nevertheless, his argument that Australia's success was not the result of industriousness or innovation did not deny that Australia was genuinely lucky. While an abundance of natural resources has been a curse for many countries, this has not been so for Australia.

But resource wealth has never been, nor will it ever be, enough. It has to be converted into widespread prosperity through political action and the construction of appropriate institutions. According to the economic historian Ian McLean, ‘The institutional framework is seldom offered as a reason for our economic success because it is taken for granted. Yet many growth economists now believe that, perhaps more than any other factor, appropriate institutions are the key to explaining why some countries are rich and others poor.'

By ‘institutional framework', McLean means things such as the form of land ownership in colonial Australia, such as the family farm, the development of education and research facilities, right through to the political system itself. Why did the fortunes of Australia and Argentina diverge so significantly over the twentieth century, given their similar positions in the 1890s? It is the political process in Australia, flawed as it has been and remains, that has helped to spread the benefits of growth across society. Horne may have been too harsh on Australia's politicians, but equally some new counsel might be necessary.

Australians need to be aware that this is a vulnerable country as well as a lucky one. The country's economic history shows that booms are followed by periods of gloom. Maybe this boom is the one that breaks the mould; but regardless, it will not solve the fundamental recurring problem of Australia in the world economy: our vulnerability to changes in international commodity demand and international financial supply. Reliance on resource wealth remains a precarious path for Australia's future, especially when coupled with an explosion of unproductive debt. Australia is more indebted than ever before. Rising concern about global warming makes it even more urgent that we further diversify Australia's productive capacity and export profile. If the more dire predictions of global warming are realised, Australia will need to adapt and reduce its reliance on resource exports.

To these global vulnerabilities we can add a third, domestic one: our vulnerability to rising inequality. Australia cannot control what happens in the rest of the world – it is a minor player in the global economy – but it can control the way we adapt to global events and developments. Embracing the outside world stimulates competition and underpins expansive growth, but it need not come at the expense of the weakest elements of society. Governments should foster a socially sustainable globalisation that allows Australia to ride out the problems caused by our historical vulnerabilities without creating negative reactions that could push us back into insularity and protectionism, which was white Australia's first reaction to vulnerability.


THE ESTABLISHMENT OF of a resource-based economy in the first half of the nineteenth century, through the colonies' support for private initiative, set the scene for Australia's future economic development. While boom times between 1861 and 1891 disguised inequalities and vulnerabilities, the 1890s revealed how external developments could exacerbate domestic economic problems. When the British bank Barings nearly went bankrupt through bad deals in Argentina, its investors undertook the sort of wholesale reassessment of developing-country investments that has in recent years been common at times of crisis. The substantial decline in the demand and price of commodities, and the drying up of foreign sources of capital, intensified the problems caused by over-expansion in the wool industry, property speculation (especially in Melbourne), banking collapse and over-investment by colonial governments in infrastructure. The severe drought from 1895 to 1903 added to the colonies' woes and delayed recovery.

Despite the Depression the view remained that Australia was a ‘fundamentally prosperous economy', and in their attempts to establish the policy principles for the new Federation, policymakers ‘set out to defend the economic structure as it presently existed', according to the professor of public policy Francis Castles. Both boom and gloom, therefore, helped to create the conditions for protectionism. Castles suggests that there were four main components of the protectionist policy structure: protection of manufacturing industry, the conciliation and arbitration of industrial disputes, the control of immigration, and a residual system of income maintenance for those outside the labour market. In The End of Certainty Paul Kelly adds Imperial benevolence – Australia's reliance on ‘great and powerful friends' – as an integral part of the structure.

Recovery from the Depression of the 1890s was not dependent on foreign investment and immigration; rather, it was bolstered by gold discoveries in Coolgardie and Kalgoorlie, and development in Western Australia generally. Governments were trying to diversify the economy, with shifts towards manufacturing, mining, services and non-pastoral land use dominating their efforts. The good times did not last, however, as the world descended into depression during the early 1930s, exposing yet again Australia's dependence on primary commodity exports and reliance on foreign capital.

Public debt during this period was high – about 128 per cent of gross domestic product – because of government efforts to develop the economy through the provision of infrastructure and support. Rolling over debt was no longer possible after the crash of 1929, and unemployment skyrocketed. While governments were unable to find a way out of the downward spiral, Australia's more diverse economy meant that it fared better than did other primary producers around the world.

War finally brought an end to the Depression and showed how state planning could deliver beneficial economic results: full employment with low inflation. It also provided an impetus to the development of the Australian manufacturing sector. By the late 1940s Australia was booming, with the Korean War sparking massive American demand for Australian wool. With the addition of increased demand for metals, exports reached 30 per cent of GDP (compared with a low of 12.2 per cent in 1969, and 21.5 per cent in September 2009). The fall, though, was just as spectacular and the subsequent recession severe.

Again the Australian economy recovered, and international demand and the inflow of labour and capital stimulated a ‘long boom'. Protectionism provided an institutional strategy – political and economic – for distributing Australia's resource wealth and developing a more diversified economy. Manufacturing became a significant export earner for the first time in Australian history, but from the 1960s a series of technological and competitive pressures undermined its postwar expansion. The growth of mineral exports helped reduce Australia's reliance on agricultural exports. Trade shifted away from Britain and Europe to Japan and the US, and by the early 1970s Asia accounted for half of Australia's exports.

Postwar prosperity meant that unemployment remained low and welfare remained minimal. While social conditions improved throughout the developed world, poverty did not disappear, as studies of poverty in the 1960s and 1970s revealed. Research by Ronald Henderson turned into a wide-ranging inquiry into the nature of poverty in Australia, and the findings of the Henderson Report shocked many. In Western Europe a philosophy of social compensation was providing high levels of social protection within efficient capitalist economies. Sustained growth encouraged policymakers here to believe that they could do even more. Such was the position of Whitlam Labor when it won government in 1972.

Regrettably, the 1970s was a time of turmoil for both Australian politics and the economy. Whitlam's ambitious social-democratic program assumed continuing prosperity, but as the mid-1970s mining boom waned and stagflation beset the global economy, conditions for social reform became less favourable. The world economic downturn would have made managing the economy difficult for even the most economically competent and politically united government.

Whitlam's Liberal successor, Malcolm Fraser, continued to believe that the rural and resources industries would provide for Australia's future. He and many others saw the resources boom of the late 1970s as the solution to Australia's economic woes. In the lead-up to the 1980 election, Fraser claimed: ‘In my policy speech of 1977 I said Australia could look forward to $6,000 million in development. Some amazement was expressed in this – even disbelief...And now prospective development is $29,000 million. This development promises to be as important to Australia and individual Australians as anything in the last thirty-five years.'

Unfortunately, the mooted boom failed to bring the economic windfall that some believed would present Australian policymakers with the ‘problem' of working out what to do with excessive trade surpluses. Optimism was not just home-grown, with the OECD arguing that Australia had the best prospects of all developed countries in 1981.

The recession of the early 1980s was a turning point. The Hawke government's decision to float the dollar and liberalise the financial sector was the beginning of the end of the old Australia. Donald Horne's famous phrase was trotted out, but this time in commemoration rather than celebration. Resource optimism turned into pessimism and the perception was that Australia had a ‘third-world' economy.

Nothing illustrates this decline better than the terms of trade: the average price level of exports versus the average price level of imports. It fell significantly after the short-lived mineral booms of the mid-1970s and early 1980s. And after gradually climbing from late 1982, it plummeted during 1985 and early 1986. Another marker of decline was the current account deficit: the balance between exports and imports, and the flow of interest and dividend payments into and away from Australia. The already growing deficit substantially worsened in 1986.

The implications seemed clear: Australia was in terminal decline. Paul Keating's infamous ‘banana republic' warning was the public manifestation of crisis. ‘We took the view in the 1970s – it's the old cargo cult mentality of Australia that she'll be right,' he said. ‘This is the lucky country, we can dig up another mound of rock and someone will buy it from us, or we can sell a bit of wheat and bit of wool and we will just sort of muddle through...In the 1970s...we became a third-world economy selling raw materials and food and we let the sophisticated industrial side fall apart...We must let Australians know truthfully, honestly, earnestly, just what sort of international hole Australia is in. It's the price of our commodities – they are as bad in real terms since the Depression...If this government cannot get the adjustment, get manufacturing going again and keep moderate wage outcomes and a sensible economic policy, then Australia is basically done for...If in the final analysis Australia is so undisciplined, so disinterested in its salvation and its economic well being, that it doesn't deal with these fundamental are gone. You are a banana republic.'

The severity of the early 1990s recession had much to do with the zealotry of Keating and his coterie of economic advisers. Keating made what was perhaps one of the stupidest remarks in Australian political history when he claimed it was the ‘recession we had to have'. He said it because he meant it: Keating believed that a recession would be good for the economy, because it would ‘fix' the current account deficit (CAD), lower inflation and set up Australia for long-term growth. There's no doubt that it helped to quell inflation, and since the recession Australia has not had two consecutive quarters of GDP contraction. But it certainly didn't fix the CAD. In the lead-up to the 1996 election, the Howard-led Opposition exploited the recession, the worsening CAD and the growing level of foreign debt, arguing that Labor had solved none of Australia's economic problems despite its long hold on power.


THE AUSTRALIAN ECONOMY performed poorly between the early 1970s and early 1990s. But since then, Australia has experienced a record eighteen years without a technical recession, its economy expanding by around 80 per cent. Failing to enter recession in the global crisis of 2008-09 meant that Australia avoided two international recessions in a row, which is unprecedented. Most of this growth occurred under Howard's watch, just as Keating had feared back in 1991, when he declared: ‘frankly, the only difficulty for the government is being around long enough.'

John Howard may have taken office at the most opportune time in Australian history, but it wasn't all plain sailing. Howard faced the Asian crisis in the late 1990s. And in 2000 and 2001, at the height of the technology boom, many commentators, attempting to justify the collapse of the value of the dollar, derided Australia as an ‘old' economy with an archaic economic structure. These statements were the residue of the mid-1980s anxiety about Australia's primary commodity dependency and were remarkably ill-timed, because commodity prices were at the beginning of a steep and sustained ascent.

Revenue from the mining sector rose from an average of 7 per cent of GDP for most of the 1980s and 1990s to 11 per cent in 2008. Royalties and taxes boomed as well; together they contributed more than 1 per cent of GDP in 2005-06 and undoubtedly more in following years. Despite this largesse, the percentage contribution of mining and, indeed, agriculture to GDP would probably surprise most Australians. Agriculture accounted for 2.5 per cent of GDP, down from 4.9 per cent in 1990, and mining accounted for 8.3 per cent of GDP in 2008, down from 4.9 per cent as well. Manufacturing declined from 15.8 per cent to 10.1 per cent over the same time.

The contribution of mining and agriculture, however, is vastly more important in exports. From the early 2000s Australia reinvigorated its dependence on commodity exports. Exports of primary commodities increased from 56.1 per cent of merchandise exports in 2003 to 68.5 per cent in 2008. Manufacturing exports declined from 31 per cent in 2003 to 21.2 per cent in 2008; elaborately transformed manufactures declined from 21.8 per cent to 13.9 per cent.

Considering the increase in export values for primary commodities, it is not surprising that concerns about resource dependence have almost disappeared. The best indicator of this change in fortunes is again the terms of trade, which increased by 88 per cent between the September quarter of 1999 and the same quarter in 2008. It then fell dramatically from late 2009, but it still remains more than 50 per cent higher than the average of the 1980s and 1990s. Peter Costello said in 2007: ‘our terms of trade will moderate, but will not be in long-term decline, which was the story of the twentieth century.' This appears to be the new policy consensus, but it is a big call given Australia's history.

There is reason to be confident, given Australia's efficient mining operations. Because much of Asia is in developmental mode, the region will require considerable resource-intensive development. When starting from a low base, growth can be very rapid indeed: Asia's share of world GDP was only 7 per cent of GDP in 1990 (at market exchange rates), increasing to around 15 per cent by 2008. Growth in East Asia averaged 7 per cent a year during this period, compared with 2 per cent for the developed world. In industrial production Asia, especially China, has fared even better. In 1990, China's share of global industrial production was 2 per cent; in 2008, the figure was 13 per cent.

The major short-term issue is whether commodity prices will stay high or revert to the long-term trend decline. Even if Asia continues to expand, without major reversals or periods of stagnation, it's likely that resource prices will decline as their supply increases. The most important growing market for Australian resources, China, is actively seeking to diversify its sources of supply. It will also eventually reduce its resource-heavy manufacturing profile, and is already striving for greater industrial efficiency. Technological change could also undermine demand, as happened with Australian's pre-eminent export until the 1950s, wool, now the nation's twenty-sixth most important export.

Another significant policy concern of the late 1980s and early 1990s was debt. Australia's major problem is private debt, although public debt is also increasing due to government efforts to stimulate the economy. After reaching a high of 18.5 per cent of GDP in 1995-96, Australia's general government net debt fell markedly to a net surplus in 2005-06. Continuous growth and a sustained resources boom can do wonders for a government's fiscal position; but given the revenue created by the boom, greater efforts could have been made to accumulate a true counter-cyclical budget surplus that could be used in a sustained downturn. In 1990 Norway legislated for the creation of a sovereign wealth fund to invest surpluses from its resource earnings, so that when the oil revenue runs out Norwegians will continue to reap the benefits of resource abundance. Still, counter to the scare tactics of the current Opposition and economic liberals, Australia's public debt position is sounder than that of most developed countries.

However, that concern about foreign (private) debt has lessened the more the debt has risen. High levels of foreign borrowings are not new in Australia, although previously this has been associated with particularly bleak economic periods. Before the 1980s, the highest debt levels were recorded during the depressions of the 1890s (34 per cent of GDP) and 1930s (39 per cent of GDP). In 2008-09, foreign debt was 50.3 per cent of GDP.

There has also been a huge expansion in household debt, most of it in housing. This has helped to make Australia one of the dearest places in the world to buy a house. Household debt is now at unprecedented levels – about 160 per cent of disposable income (or more than 100 per cent of GDP). Now that interest rates are on the rise, interest payments as a percentage of income will increase. The sustainability of the debt will be affected by the economy's capacity to maintain high levels of employment over the next few years.

Both major political parties now appear to accept the ‘consenting adults' view of foreign debt – that so long as debt is a matter between private businesses with the aim of creating economic activity, it should not be a concern of government policy. Those who are concerned worry that not enough money has gone into creating the productive capacity that will contribute to increased domestic savings and a lower level of foreign debt. The warning of some analysts that expanding debt leaves Australia vulnerable to a change in global financial sentiment will eventually be tested if the debt doesn't stabilise.

Worsening current account deficits are often the spark that ignites the concerns of investors and analysts. By far the largest component of the CAD is the net income deficit, which includes interest paid to foreign lenders and dividends paid to foreign shareholders. Running a long-term trade deficit hasn't helped either. Ultimately, CADs can only be lowered through increasing exports, decreasing imports, increasing saving or decreasing investment. Australia's CAD has risen significantly over the past thirty years. The thirty-year average is a deficit of 4.6 per cent of GDP, while the twentieth-century average is a deficit of 2.6 per cent.

Australia's two most important economic bureaucrats both argue that higher CADs will not be a problem. Treasury Secretary Ken Henry has said: ‘Australia has a long history of CADs, reflecting the need to supplement the savings of a relatively small population to take advantage of an abundance of investment opportunities.' The CAD, as an accounting entity, represents the extent to which investment exceeds saving, meaning that it represents either a ‘deficiency of national saving or an excess of national investment'. There are several ways that governments can increase national saving; forced superannuation is perhaps the most direct. Henry contends that the major cause of the CAD is Australia's high level of investment.

The Reserve Bank governor, Glenn Stevens, also thinks that larger CADs will not necessarily be a problem. Instead, the capital inflow will mean that the risks of investment in Australia's resource capacity will be shared between Australians and foreigners. As growing CADs have in the past worried international investors when they have gotten too large, Stevens believes that some persuasion of international financiers might be necessary.

Not everyone agrees. The economics commentator Ross Garnaut argues that the failure to deal with Australia's CAD problem has been one of the major shortfalls in economic policy over the past decade. Garnaut maintains that much of Australia's growth rate is unsustainable, because it is not possible to keep increasing foreign debt indefinitely. Australians, he says, have been living beyond their means, with living standards bolstered by unsustainable increases in debt.


YET NOT ALL Australians have been living beyond their means: as in the late 1960s, many Australians have not benefited from the good times. Doing well has led to less concern about those left behind – partly because there have been fewer of them in recent years, and partly because of the view that if most have been doing well, then why haven't these people?

The final vulnerability – the dangers of rising inequality – appears almost to have disappeared from public debate in Australia. Most commentary on social outcomes now centres on whether outcomes have worsened, not whether they have improved after eighteen years of continuous growth. Not only is it a poor outcome in itself if a wealthy country doesn't provide widespread opportunities across society; it is also unproductive to have sections of the population disengaged and reactionary. And it's definitely not productive to have poor health and education outcomes.

A reasonable test for social policy should be whether children can access health services (preventative and remedial) and an education system (pre-school to tertiary) that allows them the possibility of advancement, regardless of the socioeconomic status or predilections of their parents. While expanding the range of education and health choices may be desirable, it is not desirable if it is aimed at only one section of society at the expense of the rest, who don't get to choose.

Australians do not have to make a diabolical choice between growth and equality. Rising inequality is not inevitable, but egalitarianism requires a greater role for government – something that should be self-evident, yet has either been forgotten in the haze of economic transformation, liberalisation and globalisation, or is seen as anathema to it. A more determined egalitarian government requires, in turn, an electorate prepared to support increased social spending and fairer regulations. A widespread belief that fairer societies are not possible under economic globalisation is likely to be a self-fulfilling prophecy.

Social outlays have increased over the past twenty-five years, contrary to the argument that globalisation would force a decline in the welfare state. This is even true of the three supposedly neo-liberal countries in the OECD: the United States, the United Kingdom and Australia. Even Sweden, which commentators constantly argued needed to reduce its social outlays, ended up spending more in the 2000s than in the 1980s. While social spending has not been forced down, it is also evident that spending has not been comprehensive enough to stop poverty and inequality from rising in many countries. What matters is the composition of spending. While social outlays increased in Australia during the Howard years, there was also an increase in the percentage of non-cash benefits – government services, spending on health and education, and so on – directed to higher-income households.

Australia is a prosperous country today in large part because policy-makers have redistributed its resource wealth across society. Such redistribution should have been more extensive, and governments could have used it to underpin a more competitive, less insular, manufacturing sector. Even so, Australia's ability to adapt – though often imperfect – has enabled it to be in a position today to respond more effectively to new vulnerabilities. Central to this future adaptation is continued redistribution – a dirty word for many, but a concept essential to a sustainable approach to globalisation.

Allowing inequality to rise could have a detrimental effect on Australians' receptivity to the very process that has contributed to our recent success, globalisation and engagement with Asia (which Donald Horne advocated all those years ago). While Australia should never go back to protectionism, it should retain some of that associated spirit of egalitarianism which meant that it remained a lucky country for many and not just a few.

It is worth remembering, too, that this is a wealthy and relatively equal country because of political interventions, not despite them, as many economists would have us believe. Australia must use its luck to lessen its vulnerabilities.

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