Vulnerable Country: Australia and the Global Economy [1 ed.] 9781742231938, 9781742230122

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The Vulnerable Country Tom Conley is program director of the Masters of Asian Studies and International Relations in the Griffith Business School at Griffith University. He has published widely and is a frequent commentator on matters economic.

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The

Vulnerable

CounTry

Australia and the global economy

TOM CONLEY

UNSW PRESS

Australian Institute of International Affairs

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For Joan, Mike and Max

A UNSW Press book Published by University of New South Wales Press Ltd University of New South Wales Sydney NSW 2052 AUSTRALIA www.unswpress.com.au © Thomas Conley 2009 First published 2009 This book is copyright. Apart from any fair dealing for the purpose of private study, research, criticism or review, as permitted under the Copyright Act, no part may be reproduced by any process without written permission. Inquiries should be addressed to the publisher. National Library of Australia Cataloguing-in-Publication entry Author: Conley, Tom. Title:  The vulnerable country: Australia and the global economy/Tom Conley. ISBN: 978 1 74223 012 2 (pbk.) Notes: Includes index. Subjects: International economic relations – 21st century.           International business enterprises – 21st century.           Australia – Foreign economic relations – 21st century. Dewey Number: 338.994 Design Josephine Pajor-Markus Printer Ligare This book is printed on paper using fibre supplied from plantation or sustainably managed forests.

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Contents

Acknowledgments

vi

Acronyms

vii

1 The Political Economy of Vulnerability

1

2 Sustainable Globalisation?

27

3 The World Economy in the Twenty-First Century

56

4 Australia in Boom and Gloom

94

5 Asia, Anxiety and Opportunity

128

6 Finance, Investment and Debt

163

7 Trade and Industry Policy

202

8 Socially Sustainable Globalisation for Australia

236

Notes

270

Index

311

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Acknowledgments

I am indebted to Martin Griffiths and Phillipa McGuinness, who agreed to publish the book through collaboration between the Australian Institute of International Affairs and University of New South Wales Press. I am also grateful to the Department of International Business and Asian Studies in the Griffith Business School at Griffith University. Griffith has provided a very supportive environment for academic endeavours. Stephen Atkinson provided editorial and critical assistance beyond what was reasonable to expect for a man paid not nearly enough. The final product has been vastly improved by his suggestions. Robyn White worked beyond the call of duty to make sure I met that second deadline after the first one had passed. Finally, I wish to thank Julia Collingwood for beating the manuscipt into shape and making it remarkably more reader-friendly. Going back in time, just a little, I’d like to thank Greg McCarthy for inspiring an interest in politics and public policy and Doug McEachern for helping me to become an academic. Terry Tooth and Jean Crowther were always willing to provide assistance when required. Veronica, Vin and Nick Conley helped to develop my argumentative skills, and Sarah Tooth, Shelley Kulperger and Jessica Ellis also helped me enormously along the way. The Cartilliers, Carol Leung, Heather Croall, Lyndall Gardiner, Anna Harch, Marni Cordell, and John Butcher helped to get the book over the line. Finally, I want to dedicate the book to my parents, Joan and Mike Conley who have provided love and support over the years, and to my son Max, who matters most of all.

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Acronyms

ABS

Australian Bureau of Statistics

ACCI

Australian Chamber of Commerce and Industry

ACIS

Automotive Competitiveness and Investment Scheme

ACTU

Australian Council of Trade Unions

ADF

Australian Defence Force

AIG

American International Group

APEC

Asia Pacific Economic Co-operation

ASEAN

Association of Southeast Asian Nations

ATS

Automotive Transformation Scheme

AUSFTA

Australia-US Free Trade Agreement

BoP

balance of payments

CAD

current account deficit

CDO

collateralised debt obligation

CDS

credit default swap

CIS

Centre for Independent Studies

DJIA

Dow Jones Industrial Average

EAS

East Asia Summit

EMDG

Export Market Development Grants

ETM

elaborately transformed manufactures

ETS

Emissions Trading Scheme

EU

European Union

FDI

foreign direct investment

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T h e Vu l n e r a ble Countr y

FIRB

Foreign Investment Review Board

FPI

foreign portfolio investment

FTA

free trade agreement

FTAAP

Free Trade Area of the Asia-Pacific

GATT

General Agreement on Tariffs and Trade

GC

Gini coefficient

GCF

Green Car Fund

GDP

gross domestic product

IMF

International Monetary Fund

MNC

multinational company

OECD

Organisation for Economic Co-operation and Development

OPEC

Organisation of Petroleum Exporting Countries

PC

Productivity Commission

PPP

purchasing power parity

RBA

Reserve Bank of Australia

RTA

regional trade agreement

SEATO

South East Asian Treaty Organisation

SIV

structured investment vehicle

SWF

sovereign wealth fund

TAC

Treaty of Amity and Co-operation

TFC

textiles, clothing and footwear

TWI

trade weighted index

WAP

White Australia Policy

WTO

World Trade Organization

v i ii

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1

The Political Economy of Vulnerability

It follows that the only way in which a small country can square the circle of obtaining the economic benefits of competitive trade and protecting the vulnerable is by superseding the market as the source of the distribution of economic rewards to the extent necessary to guarantee all citizens, irrespective of their labour market status, an equitable share in the national product. Francis G Castles1

Australia was born vulnerable. From its beginnings as a precarious convict settlement on the ‘other side of the world’, through the development of self-governing colonies, to Federation and beyond, recognising and dealing with vulnerability led Australians to embrace an insular attitude towards the outside world and particularly towards the Asian region. Such that it was, Australia’s outward focus was set firmly within the protective framework of British power and a reliance on British ‘men, money and markets’. The White Australia Policy, the protection of industry and resource abundance helped to entrench a protectionist mindset and policy structure that encompassed ideas about the ‘tyranny of distance’ and ‘Australian exceptionalism’, all underpinned by a deepseated anxiety about Australia’s proximity to Asia. Through World War One, the Great Depression and World War Two, protectionism

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provided the framework for policy-makers to cope with vulnerability. And while the long post-war boom made Australians feel less vulnerable, politicians, bureaucrats and citizens all believed that prosperity proved that protectionism was the proper path for Australia to follow. Through good times and bad, protectionism provided the foundation stone for the construction of Australian egalitarianism. This ‘Australian settlement’ or ‘the historic compromise between capital and labour’ began to crumble in the 1960s, but it took until the 1980s for a fully-fledged assault on it to occur.2 While Australians abandoned White Australia in the 1960s, trade protectionism, financial restriction and labour market centralisation held on through the global economic crises of the 1970s and the recession of the early 1980s. The Whitlam and Fraser governments began the process of change, but it took two leaders, a former trade union leader and a high school drop-out, to transform Australia from a protected, insular country to an outwardly focused, globalised one. The Labor governments of the 1980s and 1990s, under the leadership of Bob Hawke and Paul Keating, not only engineered a political and economic transformation, but also a reformation of Australians’ perceptions of vulnerability. The economy was the most obvious manifestation of the revolution, but changes extended far beyond the economic realm into Australian politics and culture. The new mantra became ‘adjustment to the world economy and the market’. From 1996 to 2007, the John Howard led Liberal-National Coalition Government consolidated and then augmented the global and liberal shift in policy, despite the continuing reservations of many Australians. Ultimately, Howard’s attempt to transform the workplace by removing protections for lower paid workers was a fundamental factor in his loss of office. Australia had its longest period of growth after the recession of 1990–91, and from the early 2000s experienced one of the biggest and most sustained resources booms in its history. The reservations Australians had about the globalisation of the economy progressively lessened as Australia strode through the Asian financial crisis of the late 1990s and missed the ‘tech wreck’ recession of the early 2000s.

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Australians celebrated their position in the world as unemployment declined to levels believed impossible just a few years earlier, house prices rose to levels never before seen and China boomed to become a global economic force hungry for Australian minerals. After the trauma of the 20-year period from 1971 to 1991 – during which Australia suffered three major recessions and two downturns – it is not surprising that Australians once again reverted to the belief that they lived in a ‘lucky country’.3 A new feeling of invulnerability pervaded the Howard Government as the Australian economy surpassed all historical economic records. Overseas and Australian commentary added to the sense of delirium, with one economist dubbing Australia ‘the miracle economy’.4 Perhaps, given this extended revelry, we could partly excuse the punters for thinking that this time ‘things really were different’. But the pundits should have known better. Whenever ‘analysts’ utter that ahistorical phrase, it is worthwhile preparing for the worst. Booms don’t last forever and capitalism swings, often wildly, between boom and gloom. The resources boom, coming as it did on top of an already long period of growth, blinded Australians to real political and economic vulnerabilities. Too many policy-makers and business people believed the hype of never-ending growth. Howard focused on exploiting political opportunities whenever they presented themselves to further his electoral position and reap the benefits of growth. An incompetent opposition that did not know what it stood for in post-Keating Australia, certainly helped Howard to hold power for so long and to leave his government’s shortcomings unchecked. Despite the long period of growth, when Howard’s rule ended Australia was in a vulnerable position, precariously dependent on debt and subject to changing international financial sentiment. If John Howard was one of the luckiest prime ministers – taking advantage of the reforms of the Labor years and benefiting from a munificent world economy – then Kevin Rudd must be one of the unluckiest. Like his Labor predecessors James Scullin and Gough Whitlam, Rudd took over just as Australia’s luck was running out. Developments in 2008 showed just how quickly boom can turn to

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gloom. From late 2007, the seemingly ever-worsening global financial crisis, the rise in the cost of food, and the increase in petrol prices changed the mood of Australians from optimism to pessimism. Policymakers focused on inflation, with the Reserve Bank of Australia (RBA) continuing to raise interest rates and the government planning to cut spending to ‘keep the inflation genie in the bottle’. Given the bullish attitude of so many, it is not surprising how unprepared many commentators were for the downturn. The RBA, determined not to see inflation rise as it had done in the 1970s, continued to believe that rising prices for commodities would bolster Australia’s income.5 Commentators and the mining sector persisted to spruik the ‘China boom’, arguing that China was immune from the cyclical nature of capitalism and if it could decouple from the downturn in the United States, then Australia would continue to prosper. Abruptly, in late 2008, policy concern shifted from inflation to recession. Treasurer Wayne Swan, pre-empting the coming recession, rapidly changed his rhetoric, arguing that Australia was ‘not immune to the fallout from the global financial crisis’. Petrol prices dropped and the government handed out $10 billion to encourage Australians to go on a spending spree before Christmas. But as Australians began 2009, they were more worried about their jobs than anything else. Country after country went into recession and China’s growth slowed dramatically from over 10 per cent to 6 per cent, although some commentators argued that the slowdown could be even more severe.6 Chinese, Japanese and Korean imports dropped off alarmingly, and soon it became clear that the rest of Asia was suddenly going to be buying fewer Australian exports. The recession of 2009 has probably been the most anticipated economic crisis in Australian history. When the fallout from the worst global economic crisis since the Great Depression fully hits Australia, it certainly won’t be a surprise. For the economy as a whole, the omens for a deep recession are bad and Australia is vulnerable. In February, the government outlined plans to spend another $42 billion to maintain economic activity and ‘to build for the future’. While one can query the wisdom of government handouts aimed at bolster-

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ing economic activity, there can be no doubt that a deep recession is an appropriate time for increased government spending. Over the next few years, the Rudd Government will need to ignore the Opposition’s deficit fetish and their political point scoring. Australia’s fiscal problems are the fault of the government that was in power during the boom, not the one that is in power during the gloom. The Rudd Government should think carefully about the composition of increased spending, while the Australian public needs to get used to the idea of deficits over the coming years. State and federal governments should use the recession as a reason to strengthen Australia’s infrastructure – both physical and mental. Australia should develop a faster and more comprehensive broadband network; a better education system from pre-school to post-graduate; a better quality national health system that ensures care for all; and better roads and ports able to handle increased demand when better times eventually comes around again. Australians also need to support research in technologies that lessen global pollution; indeed, we should bolster research and development across the board. To remain a wealthy country, Australia needs to compete on quality not quantity. It cannot rely on increasingly lower wage levels and digging minerals out of the ground to ship overseas. When I started writing this book in 2006, there was little interest in an account of Australia’s economic vulnerabilities. Many people (and, most disappointingly, publishers) apparently weren’t interested in tales of potential gloom. A lecture series by Ian Macfarlane, former governor of the RBA, discounting the RBA’s role in the previous recession and taking credit for the long expansion, was indicative of the fact that Australia’s policy-makers too had erred on the side of optimism.7 While Macfarlane canvassed the potential riskiness of the phenomenal growth of finance, neither he nor his successors believed that policymakers should do anything about it at the time. Policy-makers, both bureaucratic and political, gleefully presided over an increasingly financialised and debt-dependent economy. To be fair, they weren’t alone in this optimism as policy-makers around the world placed their faith in

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market forces and the benevolence of financial market players keen on making a quick buck. As the fallout from the sub-prime crisis turned into a credit crunch, then a financial crisis, and finally a full-blown global recession, even the truest of the true believers in the benevolence of free market (or, in Kevin Rudd’s words, ‘extreme’) capitalism realised they had misplaced their faith. When asked in a late 2008 US Congressional testimony whether ideology pushed him to make decisions he now wished he hadn’t made, former US Federal Reserve Chairman Alan Greenspan conceded: ‘Yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact.’ Most importantly, he noted the flaw in his belief that economic self-interest will necessarily produce beneficial outcomes: ‘Those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity – myself especially – are in a state of shocked disbelief.’ The crisis, he conceded, had ‘turned out to be much broader than anything I could have imagined’. And, of course, worse news has since followed.8 What will replace the quasi-religious faith in the free market, the belief in continuous liberalisation, the assertion that the interests of wealth holders must always overrule workers and the poor, and the perception that developed societies must downgrade the role of politics and government in building egalitarian societies? With the financial and economic debacle still fresh in our minds, it seems ridiculous to think that there won’t be widespread regulatory and philosophical change, but it is possible that once the dust has settled, business and policy elites will abandon their apostasy and revert to devotion. We need to consider the other side of the equation too. If governments abandon free market fundamentalism, will they replace it with something worse? A renewed protectionism would be understandable if the crisis is prolonged, but it would be a disaster for the world economy and for Australia. While we can only guess at what those who seek to shape the world economy over the coming years will decide, what is more certain is that Australia will play only a minor role, despite Kevin Rudd’s grandiosity in the international realm. This is not surprising given Australia accounts for around

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1.5 per cent of global GDP, which does not fit with many politicians’ view that we ‘punch above our weight’. Given this rather painful fact, Australians have no choice but to adapt: to deal with vulnerability and to be ready to adjust as the world changes. John Maynard Keynes, the most important economist of the twentieth century, once said that when the facts changed, he changed his mind. This is the Keynesian spirit that needs to be revived – a willingness to vigorously question long-held assumptions and to grapple with ways to make capitalism and globalisation more sustainable. The world we live in today is different to that of even just a few years ago, let alone the 1930s. Effective adaptation requires constant reappraisal. Australia needed to shift direction in the 1980s away from protection and towards liberalisation and globalisation. Now it needs to develop a new strategy that recognises both the power and limitations of markets to deal with continuing and new vulnerabilities. A ‘strategy’ implies a role for politics and democratic processes. Like it or not, political decisions made here and overseas shape world economic activity, which impacts on all Australians. Decisions to give greater scope to market forces are still political decisions. The market is an abstraction – a metaphor for economic activity – not some natural process that governments can revert to after they have cleared political impediments. While some commentators point to the inability of democracies to take hard decisions, the ability to change is one of the virtues of liberal democracies. Of course democratic processes can sometimes lead to poor outcomes, but democracy means that societies are collectively responsible for their decisions and have the ability to change and ‘get it right’ after they have ‘gotten it wrong’. Without democratic ‘impediments’ one can only wonder what sort of travesties some of Australia’s recent leaders may have visited on the Australian people in the interests of progress. Leaders may believe that they have our longterm interests in mind when making tough decisions that affect some groups more than others, but democratic processes ensure they at least consider short-term costs. The Hawke and Keating governments changed Australia in the

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1980s and 1990s, but the need for transformation did not end with the liberalisation and globalisation of the Australian economy. Free market dogmatism is unlikely to provide a successful adaptive framework for Australia, but neither will a lack of scepticism about state intervention and the possibilities of the state stifling innovation. Policy-makers should seek to harness the power of markets where appropriate and counter their limitations where necessary. Capitalism has made countries rich, but politics has made capitalism more or less beneficial for ‘the people’. The financial crisis, the global recession and the end of the boom should remind Australians that although Australia has been a lucky country, there are no guarantees that its luck will continue.

Economic vulnerability The Australian economy has changed profoundly over the last 25 years. Australians’ attitudes to it have undoubtedly changed as well. The economy is more globalised and liberalised and many Australians have accepted these changes (up until recently at least) as either beneficial or inevitable. Not everything, however, has changed. While the globalisation of the Australian economy has expanded Australian wealth, it has not removed the most important and sustained theme of Australian political and economic history – our vulnerability in the world economy. Australian prosperity remains precarious because of extraordinary levels of foreign and household debt, a high current account deficit, a return to a reliance on resource development and exports, a greater propensity to believe that inequality is an unavoidable by-product of globalisation, and the potential structural changes wrought by the need to address climate change. High levels of foreign debt mean that Australia is more dependent on foreign sources of funds than ever before and therefore extremely vulnerable to changing international financial conditions. In late 2008, as the credit crunch gathered momentum, rolling over and obtaining new loans became more difficult. Government guarantees have helped, but funding problems will continue as credit restrictions remain. High

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household debt means that Australians remain vulnerable to changing economic circumstances. Substantial personal debts makes losing your job a disaster. And as households attempt to reduce their debt, they will spend less and make the economic downturn even worse. The current account – composed of the balance of imports and exports and the flow of interest and dividend payments back to and away from Australia – improved in late 2008 as Australia received massive price increases for its resource exports and the trade balance went into surplus after a sustained period of deficits. The problem is that commodity prices have since fallen and are unlikely to return to previous heights any time soon. Over the next few years, Australia will need to generate exports beyond the resource sector or reduce its call on the savings of foreigners to fund its development if it is to keep its current account deficit at a sustainable level. Resource dependence means a reliance on continuing Asian growth and makes dealing with today’s most pressing environmental issue – climate change – more difficult. Even climate-change sceptics should agree that reducing pollution is necessary as China and the rest of the developing world approach Western living standards. Australia should seek ways to become less reliant on resource exports. A more diversified economy – with vibrant services and manufacturing sectors – will help to sustain longer-term economic and social prosperity. This will especially be the case if Australian governments provide support for the development of environmentally friendly services and technologies. Do Australians really want to live in a country that exports coal and imports environmental technology? While demand for resources has been the basis for Australian prosperity for most of its history, resources are neither a necessary nor a sufficient condition for prosperity. For many countries, resource abundance has been a curse, rather than a blessing. Why did Australia succeed in converting its resource abundance into sustained growth when so many other countries failed? In the late nineteenth century, Australia and Argentina were at similar levels of development and had some of the highest wages for workers in the world. Why did Australia pull far

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ahead of Argentina during the twentieth century? One of Australia’s pre-eminent economic historians, Ian McLean, finds the answer not in economic models, but in ‘institutional arrangements, social values, and political decisions’.9 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.10

Previous generations of Australian policy-makers realised that fortunes emerging from resources rose and fell, and throughout the twentieth century governments took steps to address this vulnerability. Australians now find many of these steps regressive (restrictive immigration practices) and stultifying (the protection of industry). But there was a sense of strategic purpose that led to a policy framework that made resource abundance a blessing in Australia rather than a curse. Australia is a prosperous country today in large part because policymakers have continuously redistributed Australia’s resource wealth across Australian society. Such redistribution should have been more extensive and included Australia’s indigenous population among the beneficiaries. Governments could also have used it to build a more competitive, less insular, manufacturing sector. Nevertheless it is Australia’s ability to adapt – though often imperfect – over time to vulnerabilities that have allowed it to be in a position today to respond effectively to new vulnerabilities. Fundamental to future adaptation is redistribution – a word that caused such a stir in the recent US presidential election when Barack Obama suggested the United States could do with ‘spreading the wealth around’. Those same shocked commentators were not so concerned about the redistribution of wealth to the richest Americans, just to the poorest. Despite continual reference to egalitarianism by both Coalition and Labor politicians, rising inequality over the past 25 years increases the risk of negative political reactions to globalisation, Asian

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economic engagement and dealing with environmental problems. A less fair Australia will be less able to cope with sustained economic crisis because the temptation to resist change increases if people believe that burdens are being unfairly shared. The sight of executives paying themselves large bonuses and bountiful termination packages, despite poor performance, while at the same time sacking workers with little or no compensation, is an obvious manifestation of an unfair system. But perhaps more important is the provision of a decent level of compensation for economic dislocation, such as adequate welfare payments and support for re-training and re-location. Comprehensive social services also mean that losing your job does not mean losing access to decent healthcare or a decent education for your children and yourself if necessary. Contrary to the arguments of many economic liberals, globalisation and the pursuit of economic growth do not undermine the ability of governments to promote egalitarianism; instead, egalitarianism helps to support a globalising, dynamic economy. As Peter Lindert points out in his authoritative two-volume study on social spending and economic growth since the eighteenth century: There is no clear net cost to the welfare state, either in our first glance at the raw numbers or in deeper statistical analyses that hold many other things equal … It turns out there are many good reasons why radically different approaches to the welfare state have little or no net difference in their economic costs. Those reasons … boil down to a unified logic: Electoral democracy, for all its messiness and clumsiness, keeps the costs of either too much welfare or too little under control.11

Lindert also points out that ‘the history of economic growth is unkind’ to those with a suspicion that higher taxes and social spending are bad for productivity. Beyond this basic fact is another unpleasant one for those who argue that the welfare state must be cut in the interests of growth or productivity: ‘people in the countries with higher social budgets get to enjoy more free time every year and retire earlier’.12 Well

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educated, healthy workers are more productive workers. Parents with access to childcare and leave can continue careers sooner or later and maintain their productivity. Providing even more options in this area enhances the productivity of a large section of the population with parental responsibilities. It is therefore very important that the Rudd Government creates a ‘socially sustainable’ globalising economy as well as an environmentally sustainable one. Australia’s vulnerabilities and the need to improve social outcomes should not encourage a shift away from globalisation towards protectionism. Far from it. Globalisation, liberalisation and engagement with Asia have increased prosperity. Sustaining these benefits requires governments to increase opportunities, spread the benefits of prosperity, and share the costs of adaptation – there should be no return to past solutions to vulnerability. There should also be no going back to a belief that resources alone can sustain Australian prosperity over the long term. The risks involved in global engagement are worth it and a renewed strategy of insularity, of closing off to the world, would simply change the parameters of vulnerability, leading to a reduction in living standards and the possibilities of severe future adjustments. Over the long term, the creation of wealth is the fundamental component of state and societal security. History can provide a guide but it cannot lead us to where we need to go in the future. Australians should be confident about their ability to change when necessary. During the 1980s, many commentators expressed profound doubt that Australia had the ability, or the inclination, to abandon protectionism and adapt to a changing world. Although it took longer than it should have, Australians did switch direction and embrace globalisation. The successful embrace of globalisation has not made us less vulnerable, however. Indeed, quite the opposite. The path Australia has chosen makes us more vulnerable because exposure to the outside world is the very essence of the policy structure developed since the mid-1980s. As Francis Castles put it in the late 1980s, ‘The price that must be paid for increased international exposure is an enhanced degree of economic vulnerability’.13

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Australia has shifted from one strategy of dealing with economic vulnerability – protectionism – to another – globalisation. Australia, it appears, now deals with its vulnerabilities by embracing them. From the 1980s, policy-makers and business people spent considerable effort attempting to educate Australians about the benefits of globalisation and to foster a greater level of responsibility for their own outcomes: an adjustment of popular expectations towards the expectation of continual adjustment. Policy elites argued that economic reform must be an ongoing process. Keating argued ominously that the process of adaptation to the world economy did not have an endpoint: global economic competition was like ‘a long-distance race – a very long distance race … Like the modern marathon it gets faster and faster. But unlike the marathon it has no finish line’.14 Despite beginning his term of office with the soothing suggestion that Australians should be relaxed and comfortable, Howard soon argued that ‘doing well in a globalised economy is a race that never finishes’. 15 It seems that there are only so many clichés that can be employed to describe the ‘imperatives’ of globalisation.16 But governments need to go beyond education and persuasion. They must lessen the negative aspects of globalisation by providing support for both economic flexibility – a willingness to adapt – and structural diversity – support for a wide range of industries. They must also support both economic dynamism and social security: a high growth economy that sustains a fair standard of living for all Australians. We need a new balance in Australia’s political economy. Australians should temper liberalisation with egalitarianism; to comprehend the limits of both politics and markets; to understand that if something is unsustainable, it will not be sustained; to lessen our reliance on those commodities and manufactures that cause excessive pollution and contribute to global environmental problems; to recognise boom-bust cycles and think of ways to flatten those cycles by true counter-cyclical policy – on the way up as well as on the way down; and to regulate the financial sector in a way that avoids the build up of excessive debt and bubbles.

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The major problem with the concept of vulnerability is that it is a permanent state of affairs. We cannot become invulnerable. Nations and societies, however, can become more resilient and adaptable. The world and hence Australia is facing the gravest economic crisis since the 1930s. We do not currently know how deep and for how long this crisis will go, but we do know that how governments respond now will make a difference. While the response of the United States matters most for the world economy, the response of the Australian government matters most for Australians. Kevin Rudd argues that the world needs social democracy to save capitalism from itself. Whatever the label one puts on it, governments need to temper the inequitable outcomes of market processes, not only in the aftermath of crisis, but also in the ways that they regulate markets. But there is no guarantee that the United States or any of the other major countries will develop a system of sounder market regulation or that they will not embrace protectionism. The only certainty is that the political choices that Australians make will determine the fate of Australians. Domestic politics still matters.

A political economy approach Institutions, norms and the political environment matter a lot more for the distribution of income – and that the impersonal market forces matter less – than Economics 101 might lead you to believe.17

This book utilises a political economy approach to understand the impact of the world economy on Australia. The basic premise of political economy is a simple one: that it is impossible to understand economic forces and developments, without considering political forces and developments, and vice versa: Economics and politics are alternative ways of making allocations regarding scarce resources. Politics refers not to the formal structures of government but to a distinctive way of making decisions about producing and distributing resources.

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Unlike economics, which emphasises juridically voluntary exchange, the system of political allocation involves authority.18

If politics involves the authoritative allocation of values, and economics entails voluntary exchange, then we can say that politics shapes the structures within which free exchange takes place, but that power derived from free exchange shapes the political process. And around it goes, as each continually interacts with, and shapes, the other.19 It is important that the definition of politics is wide, extending beyond a narrow association with the activities of governments or states. Politics defined as ‘what governments do’ often contributes to a negative perception of politics in public debate, and encourages the idea that alternatives to market outcomes should be limited. ‘Good politics’ is often seen as a fundamental impediment to ‘good economics’. But politics is also the basis for developing the ‘good society’. Many economists have argued that electoral pressures and excessive expectations impede governments from making ‘sound’ policy decisions by forcing politicians to make unrealistic promises and delivering policies that lead to economic inefficiencies.20 Indeed, some commentators argue that one of the major benefits of economic globalisation is that it supposedly has limited political discretion. While there can be no doubt that the political process leads to inefficiencies and dubious practices, such as pork-barrelling, political action also leads to many of the desirable attributes of modern societies, such as the fairer distribution of wealth and social services across society thereby allowing more people to live fulfilling and capable lives. Political action can also contribute to social mobility, a cleaner environment and improved civil liberties. Positive political action involves the idea that co-operation can benefit societies as a whole. As Crick points out: The market determines prices, but it does not solve, indeed can exacerbate, moral problems of distribution and the environment, ultimately of human survival. It must always be responded to and mediated by a democratic politics.21

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Politics, like the poor, will always be with us. The task for policymakers and citizens is to try to ensure that political action contributes to the development of a just society and a benevolent, rather than a repressive, state. A restrictive definition of politics helps to reinforce the arguments of those seeking to limit the role of government (and political action) in shaping social outcomes that represent alternatives to supposed natural market outcomes. If governments set up a policy framework where market outcomes dominate then those who have more market power will also have more political power. Held and Leftwich argue that ‘politics is about power; about the forces which influence and reflect its distribution and use; and about the effect of this on resource use and distribution’.22 If we associate politics with power, it is plainly obvious that the economy is political.23 Economic power has a profound affect on outcomes within societies and in the wider world, and irrefutably shapes the political process. Economic actors continually ‘act’ politically, attempting to shape policy and garner state-directed resources. In certain circumstances, no overt action is necessary as policy-makers realise the potential power of major economic actors to augment or impede their aims.24 According to Colin Hay and David Marsh, to limit our understanding of politics to formal politics or to ‘politics as government’ is to ‘exclude a consideration of the mechanisms, processes and, above all, struggles and conflicts in and through which the “political” comes to be thus understood’.25 The term ‘economic’ came from Greek and referred to ‘household management’.26 James Caporaso and David Levine outline three broad ways the term is now used. Firstly, it is used as a description of ‘a way of doing things, as in the word “economically”’; secondly, it is used as a description of ‘a kind of activity, usually aimed (as in production) at acquiring the things we want or need’; and, thirdly, it is used in a way that ‘ties it to market institutions’.27 Economists connect these three usages by arguing that markets efficiently satisfy society’s wants. The concept of the ‘economy’ allows for the separation of society into a ‘polity’ and an ‘economy’.28 This does not mean that economists believe

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that the economy can exist as a stand-alone entity; even the most liberal economists acknowledge the need for a minimal or what is often called a ‘night watchman state’. However, the classic conceptions of economics, from Smith to Marx to Schumpeter, all treat economics as the study of the logic of the ‘self-regulating market’. But the self-regulating market is a myth. Markets do not exist prior to, or separately from, political actions and forces; they must be ‘socially constructed via a set of agreed upon or imposed rules of the game’.29 Underpinning market transactions is a complex set of political, legal and cultural factors that free market and laissez-faire rhetoric obscures.30 As Block explains, ‘the economy’ is a ‘product of a combination of state action and the logic of individual or institutional economic actors’.31 Choosing to intervene or not, in other words, is a political decision. Karl Polanyi turned the standard liberal version of the relationship between politics and markets on its head by arguing that: ‘While laissez-faire economy was the product of deliberate state action, subsequent restrictions on laissez-faire started in a spontaneous way. Laissez-faire was planned; planning was not’.32 What Polanyi meant is that the construction of a liberal-market economy requires extensive and deliberate state (that is political) action, and that reactions against this project arise spontaneously. It is particularly important to emphasise the role of politics in the world economy. In its widest meaning, the world economy refers to the sum total of economic transactions both domestic and international, but the world economy should really be seen as a world political economy wherein states and other forms of political authority continuously shape economic activity and vice versa. When people refer to the world economy, they are actually referring to a complex array of economic transactions and politically constructed institutional structures that support these transactions. For the global market to function, it requires a range of rules and regulations. Sometimes these rules and regulations are efficient and rational, and at other times they’re not. Sometimes, as we have discovered to our cost, they are manifestly inadequate. Determining rationality is of course a matter of debate.

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What is clear is that in recent years, particularly in the financial realm, these rules and regulations have not been able to stop a systemic financial crisis. Understanding Australia’s relationship with the world economy requires a consideration of how political and economic forces and developments interact. For example, consider how business influences the political process and how government regulations affect business; or how changes in political regimes can affect economic activity and how economic events can affect a government’s hold on power. China’s decision to move away from a command economy in the late 1970s has had a huge impact on economic activities. From the other direction, the Asian financial crisis led to the fall of the Suharto regime in Indonesia and the development of democracy. We also need to consider how domestic factors interact with global ones. For example, how global financial markets affect domestic business and shape a government’s ability to tax and spend; or how domestic politics in the United States can shape the world economy. It is important to remain wary about placing too much emphasis on economics, particularly given the dominance of globalisation as a frame of reference for understanding today’s world. In a world where economic issues and faith in the market dominate, it is vital that we do not underestimate the importance of politics, with both its positive and negative ramifications.

The chapters We begin our story with an historical analysis of the interaction between politics and economics in the progress of economic globalisation. Economic globalisation has been with us for a long time. Its history has been marked by periods of advancement, stagnation and reversal. It is the struggle to shape the processes and forces of integration and interdependence and the ebbs and flows of globalisation over time that are of most interest. The global economy expanded enormously from 1870 to 1913, before succumbing to a long crisis marked by two world wars separated by the Great Depression. Influenced by these disasters,

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the success of planning during World War Two and the growing power of the labour movement, developed capitalist states embraced a moderated economic liberalism that produced mixed economies with a large role for government. The post-war prosperity of the long boom eventually succumbed to declining productivity and profits, rising labour militancy and wages, and accelerating inflation. The stagflation of the 1970s – stagnant growth and high inflation – eventually led to a search for an alternative policy paradigm for capitalist economies. Policy-makers and business people argued that government was the problem and that markets were the answer. The economic liberal ascendancy in the West, the end of communism, technological progress and the search for profit spurred globalising forces to never-before-seen levels in the 1990s. Economic crisis and a renewed faith in markets undermined the belief that government could play a beneficial role in regulating capitalist economies. Many argued that economics had finally trumped politics, that the state was in decline and that rising inequality was an unavoidable consequence of globalisation. Such views ignored the fact that throughout history, politics has shaped – spurring and retarding – the progress of global economic connection and that political action can lead to egalitarian societies with efficient capitalist economies. By the 2000s, it was clear that economic integration had not made the role of government less important. Now, the financial crisis shows clearly that states are ultimately responsible for underpinning and regulating economic activity. With economic liberalism, the incumbent philosophy in this time of crisis, it is likely that regulatory impulses will swing away from liberalisation and market-based regulation towards a more direct role for governments. The chapter argues that sustainable globalisation entails spreading the benefits of growth and openness as widely as possible by redistributing wealth and compensating the losers for the continual structural change necessary for adaptation to a globalising world. While most countries have to adjust to the world ‘as it is’, the choice of adjustment strategy is not set by the forces of globalisation. Varying responses and outcomes are always possible: both the progress

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of globalisation and adjustments to its opportunities and constraints involve political choices shaped by citizens and the governments they elect. There is much scepticism about the novelty of the current era and about globalisation itself, but there can be no doubt that we live in a rapidly globalising world, at least until recently. Regardless of one’s ideological position, an increased role for the state is unavoidable over the medium term given the need for governments to bolster and bailout large parts of the banking sector. The United States and the rest of the West still dominate the world economy, but China, India and many other developing countries will challenge this pre-eminence over coming decades. Nevertheless, the United States remains the indispensable political economy, and how it deals with the current economic trauma will shape the course of globalisation and the destiny of small countries like Australia for years to come. We should not mistake US relative economic decline for declining impact and we should be wary of substituting possible futures for present realities. Chapter 3 outlines the state of play in the global economy and analyses recent developments in global finance and trade. Despite the many benefits of globalisation, global finance unhinged itself from productive economic activity and became a casino with devastating consequences. Finance has the power to both drive and impede economic growth, and the crisis shows the dangers of financial integration and expansion. While developments in global trade have not been as spectacular as events in the financial realm, ultimately trade underpins improving living standards in all countries. Understanding the global economy and its key components is essential for defining the opportunities and constraints facing Australia’s policy-makers and businesses in the twenty-first century. Chapter 4 shifts the focus to Australia and the continuing story of swings between boom and gloom in Australian economic history. Australian prosperity has long been dependent on the world beyond its shores. To maintain Australia’s status as a wealthy egalitarian country, an overarching protectionist-policy structure emerged out of the depression of the 1890s, supported by the growing labour movement

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and an accommodating liberal establishment. The Great Depression reinforced the hold of protection and the long post-war boom sustained it until the bust of the 1970s. For the first 70 years of Federation, protectionism provided a mechanism for redistributing resource wealth across Australian society. By the 1980s, however, it had outlived its usefulness. Punctuated by the ‘Banana Republic’ crisis of 1986, the perception was that Australia had a ‘third world’ economy inappropriate for the late twentieth century; that resource wealth could no longer underpin a first world standard of living. A low point for Australia’s ‘terms of trade’ – a statistical measure of the prices Australia receives for its predominantly resource exports and the prices it pays for its mainly manufactured imports – provided a marker of the crisis. This termsof-trade crisis spurred Australian policy-makers to quicken the pace of liberalisation and to make a conscious effort to globalise the economy. Governments made some progress in increasing Australian exports and restructuring the economy in the late 1980s and 1990s, but the China-driven mining boom led to a return to the belief that resource development could underpin Australian prosperity indefinitely. Australia’s economic liberal elite ignored or pilloried arguments about the need for a more diverse economic structure as economically illiterate, market unfriendly or attempting to pick winners. The optimistic outlook about the sustainability of Australia’s improving terms of trade was a shortsighted and ahistorical understanding of Australia’s global economic relationships. An analysis of boom and gloom in Australian history should have made policy-makers wary of complacency. While resource wealth has been fundamental to Australian prosperity, it alone cannot sustain that prosperity. Now that the boom is over, it is obvious that Australia has not overcome the fundamental problem of its economic development – vulnerability to changes in international demand. The increased focus on climate change in recent years makes the need for increased economic diversity even more important. Australia needs to shift away from a reliance on resource exports that are major sources of global pollution. But any major changes will be difficult given the current structure of the Australian economy and exports.

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Chapter 5 investigates Australia’s changing relationship with Asia. Asia is the most important part of the outside world for Australia for the simple reason that it is the most immediate. Australian-Asian relations began the twentieth century with anxiety and ended with optimism. Historically, many Australians have viewed Asia as a source of potential peril. Ideas about Asia as a threat were manifest in the White Australia Policy, which attempted to preserve the racial purity of Australia by restricting Asian immigration. The Japanese drive to control East Asia before and during World War Two reinforced the belief that ‘Asia’ constituted an imminent danger to Australia. From the 1960s through to the 1980s, however, the economic rise of Japan accompanied security fears associated with Chinese communism, Indonesian aggression and the Vietnam War. Despite lingering fears about communism, by the 1980s there was a growing concern about how best to take advantage of the region’s economic dynamism. The amazing growth of the so-called Asian tigers (South Korea, Taiwan, Hong Kong and Singapore) added to the momentum of changing perception. Bob Hawke actively sought ‘enmeshment’ with Asia, and his successor Paul Keating believed that Asian ‘engagement’ was one of his government’s most important tasks. The Howard Government came into office criticising what it called Labor’s ‘Asia only’ policy and reinvigorated Australia’s relationship with the United States. The Asian financial crisis of 1997–98 made Asia temporarily appear less lucrative for Australia’s economic interests, and then East Timorese independence fundamentally tested Australia’s relationship with its closest neighbour, Indonesia. The Howard Government’s occasionally clumsy diplomacy often obscured important Australian progress in the region. In the 2000s, China’s sustained demand for Australian resources dominated economic concerns and terrorism dominated the political sphere. Kevin Rudd’s close affinity with China caused some concern in Japan, but Australia’s Asian relationships are currently in good shape. We cannot say the same for our short-term economic prospects with Asia. The global recession has hit Asia particularly hard and will curtail demand for Australian exports in Asia over the next few years. The

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Chinese desire to control resource supply in Australia will also cause considerable controversy. The Rudd Government will need to deal with the consequences of these dilemmas in a way that balances Australian domestic politics and regional diplomacy. Australia is likely to continue as an important supplier of resources for Asian industrialisation when the global economy eventually recovers. Asian development has benefited Australia more than any other developed country, but Australians need to understand the continuing economic challenges Asian development entails as well as the abundant opportunities. Policy-makers must ensure that the benefits of Asian economic engagement are widely spread by distributing the wealth generated by Australia’s resource exports. While it is fine for Australia’s resources to be exploited by foreign investors there must be benefits for the owners of these resources. The wide distribution of resource wealth will help to avoid a return to Australia’s negative attitudes to Asia racist past. The popularity of Pauline Hanson in the late 1990s shows the potential appeal of anti-Asian attitudes among sections of the Australian population. The Australian government needs to manage Australia’s relationships in the region and be careful that we do not simply become a resource supplier for Asian industrialisation. A hard-headed assessment of economic relationships and interests in the region is vital for future prosperity. Australia must participate in the development of regional institutions, encourage the United States to engage more productively, and provide support for continuing and widespread Asian prosperity. Chapter 6 begins a detailed analysis of key Australian economic vulnerabilities. As recent times have made clear, finance has increasingly dominated the Australian and world economies. Huge flows of money and investment can support development, but can also severely destabilise an economy and hamper the policy freedom of governments. Australia’s answer to the rise of global finance in the 1980s was to embrace financial globalisation rather than resist it. The subsequent ‘financialisation’ of the economy provided enormous opportunities to make money, but also left Australia exposed to the dangers of financial instability. Foreign borrowing led to a massive increase in house-

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hold debt, with much of it going into the housing sector. Access to cheap finance led to increased house prices, which led homeowners to expand their levels of other forms of debt as well. The financial crisis that began as a credit crunch in 2007 curtailed the continuous expansion of credit, but the next couple of years will be vital in determining whether Australia’s high level of debt will exacerbate the coming economic downturn. The increase in foreign debt to unprecedented levels has led to a corresponding increase in Australia’s vulnerability to changes in international financial sentiment. Australia’s current account deficit has consistently been one of the highest in the world, not just as a percentage of GDP, but in absolute terms as well. And Australia’s income deficit with other countries – the amount of money Australians must pay to service financial obligations and pay dividends – is the major component of the current account deficit. Policy-makers need to stabilise foreign debt and keep the current account deficit at sustainable levels. Governments should not be afraid to impose a tighter financial regulatory framework, limit irresponsible financial practices and discourage policies that generate unsustainable asset price inflation. Being wary of debt does not imply a negative attitude to foreign financial interactions. Australia has always relied on foreign investment and capital for its economic development. Not all investment, however, is necessarily beneficial. The Treasurer will have to weigh up Chinese state-controlled investment in Australian resources very carefully over the next few years. Despite the argument from economic liberals that Australia cannot afford to be choosy when it comes to foreign investment, Australian governments should continue their discretionary power over major foreign investments. Chapter 7 considers Australian trade and industry policy. An open global trading system profits Australia and supports living standards of all Australians. There is bipartisan support for freer trade in Australia, although there are slight differences in emphasis. Labor emphasises the benefits of the multilateral (World Trade Organization) trading system, while the Coalition backs bilateral trade agreements with major trading

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partners. What matters most is access to markets. Australian governments should use whatever means possible to increase access. For most of the twentieth century, Australia had a low level of trade as a percentage of GDP, compared to other small countries. Since the low point of the 1980s, Australia has significantly increased its exports, but imports have grown even more, resulting in continuing trade deficits. These trade deficits are the second major component of Australia’s high current account deficit. Despite the resources boom, Australia’s trade performance has been poor. While the values of Australia’s resource exports – particularly coal and iron ore – skyrocketed, export volumes increased only slightly. The deficit disappeared as the boom ended making it doubtful whether Australia can sustain a surplus through the global economic downturn. In the 1980s, tariff reform was an essential component of the Hawke Government’s industry policy and efforts to transform the Australian economy. Active, market-friendly industry policies supported tradepolicy changes leading to a marked increase in exports, including manufactured exports. Upon coming to office, the Coalition downgraded industry policy. The housing boom, followed by the China boom, helped to hide the costs of neglect. The Rudd Government appears to be more willing to develop industry policies that acknowledge that market outcomes do not always create the most appropriate structural outcomes for the Australian economy. This position also has it dangers, however, and leaves governments susceptible to special interest pleading and picking losers. While Australia needs comprehensive industry policies, the government should focus its support on innovation and diversity. It will also have to deal with the structural adjustments in industry associated with climate-change policy. Our final chapter analyses the relationship between globalisation, liberalisation, growth and social outcomes. To assess the long boom of the 1990s and 2000s and to understand how globalisation and policy change have affected social outcomes in Australia, it is necessary to unpack the growth story and provide a more detailed, disaggregated assessment of economic outcomes. Creating a fairer Australia does not

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mean curbing the productivity improvements that underpin prosperity. Indeed, a fairer distribution of wealth and incomes will support the sustainability of Australia’s continuing global and Asian engagement. Government can maintain a dynamic, innovative economy and provide comprehensive health, education and welfare services to enhance the quality of life of all citizens in such a prosperous country. Effective social policy requires the efficient public provision of services, rather than simply providing handouts to individuals. An important test of social policy is its ability to provide all children with access to education and health services that allow them the possibility of advancement regardless of the choices made by their parents or their socio-economic circumstances. Australia needs a revitalised role for government to improve social outcomes. Government must reinvigorate Australia’s economic infrastructure which policy-makers should define widely so as to include transportation, communication, education, health and research. Spreading the benefits of a dynamic economy widely will help to set up a self-reinforcing process of sustainable and equitable globalisation. Australia needs a government that understands that successful countries utilise market forces in the interests of efficiency, while at the same time recognising that the market should be the servant, not the master of Australia’s destiny.

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2

Sustainable Globalisation?

The idea of a self-adjusting market implied a stark utopia. Such an institution could not exist for any length of time without annihilating the human and natural substance of society … Inevitably, society took measures to protect itself, but whatever measures it took impaired the self-regulation of the market, disorganized industrial life, and thus endangered society in yet another way. Karl Polanyi1

An historically informed understanding of economic globalisation alerts us to the potential for politics to either enhance or retard its progress. The belief that globalisation means that economics has usurped politics is wrong in two ways. First, nations and societies can make positive choices about the extent to which they engage with the world economy and the ways that they distribute the benefits and costs of doing so. Second, politics can intervene in negative ways, whether as a result of unsustainable political choices in the first instance, or possibly as an outcome of sheer human or societal malevolence. Globalisation needs to be managed both domestically and internationally, and a failure to deal with political problems will lead to economic problems. The great powers mould the progress of economic interconnection but smaller states also contribute by influencing the larger states and by shaping the impact of globalisation on their societies. Sustainable globalisation entails spreading the benefits of growth and openness as

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widely as possible by redistributing wealth and compensating those sections of society adversely affected by making the continual structural changes necessary for adaptation to the world economy. While most countries might have to adjust to the world ‘as it is’, the choice of adjustment strategy is shaped but not determined by the world political economy. Varying responses and outcomes are always possible: both the progress of globalisation and adjustments to its opportunities and constraints involve political choices made by citizens and their governments. Ironically, the future progress of globalisation may require some restrictions on liberalisation. The world may return to rapid globalisation in coming years, but we would do well to remember, following Keynes, that in the long run we are all dead! In the short run, we cannot guarantee the uninterrupted development of globalisation, as two world wars and the Great Depression showed us in the twentieth century and as the global economic crisis now portends. Historical analysis will not reveal the future and it is possible that we will misinterpret the ‘lessons of history’ or that an event without precedent changes everything. But history and analysis of the present do enable us to consider future possibilities. A longer-term perspective also has the benefit of making us wary about assumptions of destiny and faith.

Globalisation in an historical context The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages; or he could decide to couple the security of his fortunes with the townspeople of any substantial municipality in any continent that fancy or information might

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recommend. He could secure forthwith, if he wished it, cheap and comfortable means of transit to any country or climate without passport or other formality.2

Globalisation is not just a recent phenomenon, even if the word itself is relatively new. Writers often use globalisation as a shorthand term to describe either the changes in the world economy and the restructuring of national political economies since the 1970s or the expansion of the capitalist world in the 1990s after the collapse of communism and the abandonment of insularity in much of the developing world.3 These usages are not incorrect, just short-sighted. If our definition of globalisation focuses on integration, interdependence and liberalisation, then it is clear that the process is much older indeed.4 Especially important are the high levels of integration and the interdependence of the world economy before World War One. The growing support for freer trade in Great Britain over the nineteenth century led to other countries in Europe also breaking the shackles of mercantilism. Add to this, the rise of the United States, the development of settler colonies, like Australia, Argentina and Canada, and the continuing European exploitation of Asia, Africa and Latin America, and it is evident that a truly global economy was in existence at the beginning of the twentieth century.5 While there was widespread support for global capitalism among political and economic elites in developed countries, there were also many opponents. The two countries emerging today as potential economic powerhouses of the twentyfirst century – China and India – began the previous century as victims of capitalism and imperialism, as did the rest of Asia and Africa and much of Latin America. The depression of the late nineteenth century impeded the progress of economic liberalism and global capitalism, and increased the legitimacy of ideas about economic and societal protection. Socialists saw in these developments the seeds of capitalism’s self-destruction and the beginning of the working class’s historic mission to usurp power from the bourgeoisie.6 Political and economic elites began to respond to

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popular demand for greater representation and equality by extending the franchise and making other minor concessions such as the provision of limited welfare. Redistribution, however, was relatively insignificant compared to the level achieved through social spending in the second half of the twentieth century. Whereas social transfers (not including spending on education) as a percentage of GDP in OECD countries rose to a median level of 20 per cent by the late twentieth century, in the 1880s the median figure was 0.3 per cent. By 1930, median social transfers had risen to only 1.7 per cent.7 Peter Lindert points out that from 1880 the ‘scope of social transfers widened’ as the ‘political voice’ of supporters of welfare increased.8 The extension of the franchise in Britain and concessions in Germany were attempts to curtail the rise of socialist parties, which had mass working-class appeal and provided the spectre of social and political revolution. But it was the rise of nationalism that really undermined socialist optimism as Europe headed towards World War One.9 External threats to nation states rallied populations and provided political elites with a powerful justification to centralise power and suppress opposition. World War One also destroyed liberal optimism about capitalism and human nature. Writing before the war, Norman Angell argued that economic interdependence had made the consequences of war between the major powers extremely costly and, hence, made war unlikely: [I]nternational finance has become so interdependent and so interwoven with trade and industry that the intangibility of an enemy’s property extends to his trade. It results that political and military power can in reality do nothing for trade, since the individual merchants and manufacturers of small nations exercising no such power compete successfully with those of the great.10

Angell’s aim was to show there was no advantage in winning a war because the costs of war will exceed the benefits. But as World War One showed, politics overruled economics in the final analysis. Optimists

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about the inevitability and irreversibility of today’s globalisation should be wary of Angell’s folly.11 Despite the rise of ‘mass society’ during this period, the major economic policy battles were between liberals and protectionists, and between supporters and opponents of the Gold Standard.12 Adherence to gold underpinned the expansion of trade and increased trade dependence, which then made adhering to gold even more important. ‘Being on gold’ meant that governments had to adjust their economies and hence societies as well to maintain exchange rates. As Barry Eichengreen notes: ‘neither trade unions nor parliamentary labor parties had developed to the point where workers could insist that defense of the exchange rate be tempered by the pursuit of other objectives’.13 The result of such discipline, according to Jeffrey Frieden, meant that the ‘opening years of the twentieth century were the closest thing the world had seen to a free world market for goods, capital and labour’.14 Today regular elections make it more difficult for states to act with such impunity. This earlier globalisation ‘reinforced itself ’ until it became very costly for nations to move away from the Gold Standard and liberal trade, but move away they eventually did, with the resulting tragedy of two world wars and the Great Depression. While the nineteenth century world economy had its flaws, Frieden contends that it was better than what came before and definitely preferable to what came after. Nevertheless, ‘the one undeniable failing of the world economy in the decades before 1914 was that it was incapable of avoiding – indeed may have contributed to – what came after it’.15 It took until 1970 for trade and 1990 for direct investment to catch up to the relative levels of the early twentieth century.16 Krugman argues that it is a ‘conceit’ to argue that a global economy emerged only in the late twentieth century, and asserts that the telegraph and the steam engine were the key enabling technologies of globalisation.17 In the case of Australia, the establishment of an electric telegraph link to international lines in 1872 (by submarine cable to Java), increased the potential for the global integration of the Australian economy, as much as any development that has taken place since. The connection

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to international lines ‘reduced the communication time between Australia’s commercial centres and England – and therefore world capital and commodity markets – to a matter of hours rather than weeks or months’.18 Many writers argue that the classical liberal period was ended by World War One. Others stress the inability of Britain in the interwar period to continue to support a liberal world political economy and the failure of the United States to take over Britain’s hegemonic role.19 In an argument pertinent to today, Thomas Palley argues that financial crisis, rather than war, finished off the ‘first globalisation’. The turn to protectionism in the 1930s, he contends, was a response to depression rather than its cause.20 Significant social changes had taken place in Europe, North America and Australasia, and increasing demands for social protection once again clashed with state efforts to ensure the efficient operation of the market economy. The inequalities of liberal democratic capitalism were stark and increasingly contested. As Beth Simmons points out: ‘In the face of balance of payments deficits governments could choose to adjust internally by reducing prices and demand, or adjust externally with beggar-thy-neighbour policies that pushed the problem of adjustment onto a country’s trade partners’.21 The initial policy response to the Great Depression by most nations was the maintenance or reinforcement of free market orthodoxy: deflation, reducing the costs of production (especially wages), balancing budgets and maintaining the Gold Standard.22 As the economic crisis continued, responses increasingly turned from internal to external adjustment. States resorted to traditional deviations from economic liberalism: industry protection, currency devaluations, abandonment of the Gold Standard and an increase in domestic economic regulations.23 Powerful economic interests pushing for increases in trade protection and exchange-rate devaluation led to a comprehensive retreat from economic liberalism. When even these neo-orthodox solutions failed to revive growth, new policy ideas and programs began to appear. According to Gourevitch, states ‘experimented with demand stimulus … social welfare systems, extensive regulation of and subsidies

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for markets, and some degree of public ownership of production’.24 The1930s were dangerous times for capitalism, democracy and liberalism. Unemployment reached over 30 per cent in some countries (29 per cent in Australia) and suffering was widespread. Economic crises made alternatives to democratic capitalism, like fascism and communism, more appealing when liberal capitalism was obviously failing an increasingly large proportion of the world’s population. To fight off extremism, policies had to change to lift countries out of depression. Keynes argued that governments could help to bolster demand in an economy when the private sector could not. To illustrate his point, Keynes argued in 1936 that: If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.25

Keynes rejected Say’s Law, which states that supply creates its own demand, refuting the idea that ‘capitalism tended to sustain an equilibrium rate of employment given that wage levels were sufficiently flexible’.26 Keynes’s ideas had progressive benefits because they meant that the redistribution of income through the taxation system was not just equitable, but also beneficial for a capitalist economy; that increased consumption would provide a spur for production; and, most importantly, that greater equality was good for growth. Keynes had a pivotal effect on modern economics, but during the Great Depression, his impact on policy was limited. As Frieden points

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out, ‘very few democratic governments in the 1930s made conscious, concerted, or sustained use of fiscal policy as a tool against the Depression’.27 Keynes was not the originator of the shift to deficit spending but he was its intellectual champion. The early deficit spenders were Germany and Sweden.28 The major factor in the US recovery in the 1930s was the abandonment of the Gold Standard, which allowed the relaxation of monetary policy and the devaluation of the dollar.29 Roosevelt continued to believe that balancing the budget was vital and it was only in the late 1930s that he finally accepted ‘Keynesian style economic reasoning to justify public expenditures for social purposes’.30 While there will be many comparisons between today’s crisis and the Great Depression, it is important to know the major structural differences. Most important are the extent of government involvement in the economy and the limited nature of the welfare state in the earlier crisis. The impact of the Great Depression was so severe mainly because welfare was so undeveloped. Political and economic structures were different – agriculture was vastly more important and labour was on the rise, rather than in decline as it is today. Nevertheless, we still live in societies shaped by the labour struggles of the pre- and postwar period. In the current recession, increased spending has been the initial response. If this fails then it is possible that we will see a reversion to trade and currency protectionism. If the recession turns into depression, we might even see a new innovative approach. The Great Depression undermined the established economic order and, in those countries that did not succumb to authoritarianism, it led eventually to new ideas about how states could protect populations from the vagaries of impersonal market forces. Unfortunately, such shifts were fleeting at best and economic malaise soon descended into total war. World War Two destroyed much of Europe and accelerated the decline of European colonial empires. At the war’s end, the United States was hegemonic, communism was ascendant and people everywhere wanted, and believed that they had the right to, better living standards. War strengthened and centralised state power in the developed world, especially in relation to taxation, and showed the benefits

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of state planning and sustained economic demand.31 In times of crisis, states forced private interests to give way to public purpose. After the war, pressured by popular demands for full employment, improvements to welfare and a more regulated capitalism, states sought a more conducive international environment for pursuing domestic priorities. Depression and war provided the impetus for the development of a system of international economic governance that was ‘both open and institutionalized’.32 The negotiations between the Allied powers at Bretton Woods, beginning in 1944, aimed to restore an international economy based on the principles of gradual economic liberalisation and domestic interventionism – a compromise between a liberal world economy and domestic stability. Freer trade and full employment were compatible: if states could generate full employment, political pressures for protection would remain low and the competitive effects of freer trade would offset inflationary pressures resulting from tight labour markets.33 Rather than the economic liberalism of the nineteenth century, Ruggie argues that a ‘modified liberal capitalism, which he calls “embedded liberalism”, emerged out of the trauma of the first half of the twentieth century’.34 The post-war political economy needed to reflect that ‘demands for social protection were very nearly universal, coming from all sides of the political spectrum and from all ranks of the social hierarchy (with the possible exception of orthodox financial circles)’.35 There were, however, many in the United States who did not want to compromise on a liberal world economy and in the end the US commitment to Bretton Woods was not really a fulsome endorsement of an ‘embedded liberal’ world order, but rather a pragmatic response to the growing threat of communism in Western Europe and Asia.36 The Bretton Woods institutions – the International Monetary Fund (IMF) and the International Bank of Reconstruction and Development (World Bank) – were under-funded and unable to fulfil their planned roles; instead, the United States used the Marshall Plan to reconstruct post-war Europe.37 By channelling capital and technology into Europe, the United States stimulated purchasing power ‘without

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creating burdensome repayment obligations’, and provided opportunities for US business.38 US policy-makers deemed a growing world economy to be favourable for US economic and strategic interests, and used extensive aid to bolster the Western alliance against the Soviet threat. Economic growth and support for the political centre in Europe was the best defence against communism.39 The US failure to ratify the International Trade Organization meant that the interim General Agreement on Tariffs and Trade (GATT) agreed in 1947 became the primary mechanism for institutionalising a more liberal world trading system, based on the principle of nondiscrimination. Trade was to be liberalised through multilateralism, but the regime allowed significant exceptions, which were ‘designed to protect the balance of payments and a variety of domestic social policies’.40 Negotiators saw aberrations from the free trade ideal, paradoxically, as an integral support mechanism for the gradual development of a more sustainable liberal world economy. And aberrations there were, in abundance. States could avoid the basic principle of the GATT – the most-favoured nation clause – through customs unions, free trade areas and imperial preference areas; they could avoid removing non-tariff barriers for balance-of-payments and security reasons; and could make allowances for excessive increases in imports. The GATT excluded agricultural trade completely, which was significant because agriculture then was a much larger component of most economies than it is today. Overall, the trade regime was strong on exceptions and weak on enforcement, fitting with the general shift in the post-war period to allow states a significant measure of autonomy in the management of their economies. Despite this, negotiations still led to gradual but substantial progress in liberalising tariff barriers. The Bretton Woods planners argued that finance was different from trade and that international and domestic stability required restrictive financial regulations.41 Keynes, Britain’s chief negotiator at Bretton Woods, said, ‘what used to be a heresy is now endorsed as orthodox’.42 Not just abnormal or speculative flows of financial capital needed to be controlled, but normal flows in response to international interest-rate

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differentials as well. Keynes argued that ‘the whole management of the domestic economy depends upon being free to have the appropriate rate of interest without reference to the rates prevailing elsewhere in the world. Capital control is a corollary to this’.43 Bretton Woods aimed to avoid the disaster of the Gold Standard of the inter-war period.44 Capital controls helped to lessen ‘the link between domestic and foreign economic policies, providing governments room to pursue other objectives like the maintenance of full employment’.45 Governments could more easily maintain expansionary macroeconomic policy regimes and increase the scope of welfare states. With continuing restrictions on financial flows, dominant economic forces within nation-states had fewer ‘exit’ options than they do today, enabling states to pursue a wider range of objectives that did not necessarily accord with the immediate demands of business and investors.46 A product of both domestic and international politics, the post-war order helped to strengthen state autonomy from external forces. States did not have unlimited policy freedom during this period. As Cox points out, ‘Bretton Woods was a compromise between accountability of governments (especially of debtor countries) to institutions of the world economy and accountability of governments to domestic opinion for their economic performance and the maintenance of welfare’.47 States increasingly regulated market developments, but efforts to confront the market system were limited and seen as unnecessary as prosperity returned after the war. Left-wing governments with socialist aims did not challenge private control of investment.48 State policy discretion continued to be constrained by the need to maintain a business environment favourable for growth. Social democrats still needed growth to pay for social programs, and major economic actors, including foreign corporations, still exerted preponderant influence on policy-makers. Despite these continuing constraints, the expansion of the state in the West over the post-war period did provide a challenge to liberal notions of state limitation. While many saw increases in the state’s protective and interventionist role as a necessary component of

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developing a more humane society, others warned that it was a step along the ‘road to serfdom’.49 States and societies, however, paid little heed to such voices during the long economic boom, as social-democratic consensus, full employment, welfare and the mixed economy expanded the role of the state and increased the power of labour.50 The 1950s and 1960s were decades of unprecedented economic prosperity in the developed world. Many analysts of the ‘golden age of capitalism’ or the ‘age of affluence’ believed that state intervention had fundamentally transformed capitalism.51 British Labour politician Anthony Crosland argued in 1956 that, ‘[w]e stand, in Britain, on the threshold of mass abundance; and within a decade the average family will enjoy a standard of living which, whether or not it fully satisfies their aspirations, will convince the reformer that he should turn his main attention elsewhere’.52 Growth and state support for investment strengthened business confidence and high investment underpinned growth.53 Continued growth meant an expanded revenue base for government spending, and full employment meant governments could improve social welfare payments, such as unemployment benefits, while keeping their total cost reasonably low. Buoyant economic conditions increased people’s expectations that their living standards would progressively improve, and they came to accept that expanded and activist states were a fundamental part of capitalism. In relation to the advanced capitalist countries, Andrew Shonfeld argued in the early 1960s that: The preoccupation with social welfare leads to the use of public funds on a rising scale … In the private sector the violence of the market has been tamed … It has now come to be taken for granted, both by governments and by the average person in the Western capitalist countries, that each year should bring a noticeable increase in the real income per head of the population … The characteristic attitude in large-scale economic management, both inside government and in the private sector, which has made itself increasingly felt during the post-war

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period, is the pursuit of intellectual coherence. Its most obvious manifestation is in long-range national planning.54

While social conditions improved, poverty did not disappear as studies in the 1960s and 1970s have shown.55 In Australia, research done by Ronald Henderson turned into a wide-ranging inquiry into the nature of poverty in Australia.56 The findings of the Henderson Report about the extent of poverty shocked many Australians. Such findings gave further impetus for the further development of welfare states. In Western Europe, in particular, a philosophy of social compensation provided high levels of social protection within efficient capitalist economies.57 Extensive growth encouraged policy-makers to believe that they could do more. Much of the developing world struggled to deal with the lingering social, political and economic consequences of colonialism and imperialism in the aftermath of political independence. Some countries completely failed to engage with the world political economy, and a communist alternative to the global capitalist system, led initially by the Soviet Union but eventually becoming more diverse, co-existed uneasily with the capitalist world economy. Other countries, such as India and Brazil, embarked on inwardly-focused development strategies that at first had some success in fostering industrial development, but eventually led to low growth and rising inequality.58 Until the late 1980s, Asia was largely divided into authoritarian capitalist states and authoritarian communist states. The amazing postwar growth of Japan to become the world’s second largest economy by the 1970s, followed by the rapid development of the so-called Asian tigers (South Korea, Taiwan, Hong Kong and Singapore) and then Malaysia, Thailand, Indonesia and the Philippines were remarkable events in the history of capitalism. Their success provides a stark contrast to the failures of centrally planned development in other Asian nations. China attempted to collectivise and control economic development from the centre, Vietnam struggled with war and its aftermath, and India fostered autarkic import substitution policies that led to stunted growth.

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Even before the end of the Cold War, the communist states realised that shifts in economic direction were vital if they were going to replicate the high growth rates of capitalist Asia. After switching direction in the late 1970s, China joined this Asian success story and, in recent years, India and Vietnam have begun to rise. Asian economic development challenged liberal notions of development, although, ironically, Asia’s economic success has been due to an embrace of economic globalisation and at least some aspects of liberalisation. Many see Asia’s transition from backward victim of colonialism to economic powerhouse as an economic miracle, but massive mobilisation of resources and export orientation, led by developmentally minded authoritarian regimes, provides a more accurate explanation.59

The shift to economic liberalism From the mid-1960s, structural problems began to emerge in developed economies: productivity growth and profit share declined, labour militancy and wages increased, and inflation escalated.60 The Bretton Woods system of financial regulation became increasingly unstable and collapsed in 1971 after the United States unilaterally reneged on its obligations. The oil shock of 1973 compounded all of these problems and led to simultaneous economic stagnation and high inflation. This ‘stagflation’ increased pressures on states to shift policy direction much more than any other putative process of globalisation did.61 Indeed, stagflation pushed states to liberalise, which spurred globalisation. Dealing with inflation curbed growth as more and more states resorted to restrictive monetary and fiscal policies. Policy-makers saw inflation as the most pressing economic problem, and the post-war goal of full employment fell by the wayside. Continuous growth and low inflation are essential for capitalist economies to function effectively. While Milton Friedman argued that inflation was a monetary phenomenon and a product of profligate policy, many political scientists and sociologists argued that it was a sociological phenomenon – a result of distributional conflict.62 The growing power of labour and public-sector

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expansion undermined profitability and productivity, and enhanced inflationary pressures ‘imported’ from the world political economy. From the early 1970s, a growing number of commentators argued that the political process had become ‘overloaded’ and that developed societies were increasingly ‘ungovernable’. Electoral pressures, excessive expectations and interest-group demands, they argued, posed dangers for continued economic prosperity and even the longer-term survival of democracy.63 Anthony King complained that: ‘Governments have tried to play God. They have failed. But they go on trying’.64 Samuel Brittan pointed out the ‘economic contradictions of democracy’ resulting from ‘the generation of excessive expectations’ and ‘the disruptive effects of the pursuit of group self-interest in the market place’.65 Economic liberals contended that governments were impeded from making ‘sound’ policy decisions by politicians being forced to make promises and enact policies that were sub-optimal for economies over the long term. Good politics, they argued, had led to bad economics. Liberal democracies, Brittan argued, did not need ‘another revolution in economic theory, but a revolution in constitutional and political ideas, which will save us from the snare of unlimited democracy, before we find ourselves with no democracy – and very little freedom – left’.66 Many on the Left agreed with the analysis that the redistributive ‘social democratic’ state had reached its limits, although their prescriptions were somewhat different. The growing economic malaise of the late 1960s and early 1970s had led, according to James O’Connor, to a ‘fiscal crisis of the state’, because of an expanding ‘structural gap’ between expenditure and revenue.67 The fiscal crisis emerged because the state supported and subsidised private investment and provided social and technical infrastructure and welfare services, while needing to restrict taxation levels. Others outlined the increasing contradictions that the state faced in supporting growth while maintaining state and capitalist ‘legitimacy’.68 In the crises of the late nineteenth century and the 1930s, the market was blamed for economic problems, but in the 1970s, because ‘activism was the incumbent philosophy’, the state was held responsible.69

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Taking responsibility for the performance of the economy was a comfortable role for governments while growth continued. But in times of crisis, the ‘political visibility of economic management became a political liability’.70 As past solutions no longer seemed to work, disillusionment with the political process grew. Low growth and higher levels of unemployment meant that burgeoning welfare payments required higher taxes. Increased demands on state budgets sparked louder calls from business and the wealthy to reduce government spending. All the while, business and citizens continued to demand (and expect) industry assistance and more services. As governments attempted to cut back on the growth of the state to appease business and middle-class interests, half-hearted and under-funded government programs reinforced the sense of state failure.71 Continuing economic and political pressures led policy-makers to seek a new policy paradigm that could cope with capitalist crises and reshape public expectations about the role of the state. Particularly important for the increased acceptance of economic liberal ideas was the belief that exposure to the world political economy, and market disciplines on policy, would ease some of the domestic difficulties in controlling inflation and public spending.72 Economic stagnation forced policy-makers to allocate sacrifices and this politically damaging task encouraged them to seek ways to reduce their responsibility for economic outcomes in the eyes of voters. According to Hall: Relying on markets to allocate resources poses many problems but – in hard times – it has some distinct political advantages. For one, it is a way of enforcing economic sacrifices that is not so clearly visible in political terms as neo-corporatist or interventionist alternatives. For another, the operation of market forces can be readily presented as a ‘natural process’ to which one must accede. Any suffering that results, as companies go bankrupt or individuals are laid off, can be presented as the consequences of their own unfortunate decisions or poor placement on the market. Finally, let us not mince words.

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Loosening the restrictions on markets in a setting of high unemployment could be an effective way to reduce the power of organized labor …73

A growing number of citizens also saw expanding state and trade union power as the fundamental cause of economic problems.74 Internationally focused sections of business and finance wanting to weaken labour power and break free of restrictive regulations were supportive of this position.75 Governments of the Right moved first to stem the growth of the state, and those of the Left soon followed, abandoning even rhetorical commitments to socialism and the redistribution of wealth.76 Political and economic elites increasingly argued that restoring economic growth required a shift to economic liberalism – reducing the scope of welfare, privatising and corporatising public enterprises, loosening boundary controls, intensifying competition and liberalising labour relations. The reluctance of voters to accept increasing taxation, and of political parties to advocate it, was particularly important in restricting expansionary and redistributive policy options.77 The basis of the postwar international economic order – the compromise between economic liberalisation and domestic stability – broke down as stagflation undermined existing policy priorities and structures. Domestic and global pressures converged during this period and reinforced policy-maker perceptions that embracing globalisation was superior to resisting it. From the late 1980s and into the 1990s, policymakers and business people in the developed countries increasingly called for their societies to ‘compete not retreat’ in the face of economic competition, particularly from Asia. The lowering of trade barriers and the freeing up of foreign investment regulations were particularly important. As more countries liberalised, the result was further globalisation, especially in finance. Political reactions to domestic and international pressures greatly accelerated economic globalisation. US support for liberalisation and globalisation was pivotal to their progress. The Clinton administration believed in the opportunities

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of globalisation and argued that the United States had to reinvigorate its economy to avoid Japan, Germany or China overtaking it in the twenty-first century. The increasingly outward focus of the United States in the 1990s spurred globalisation as US business and investors sought new markets and opportunities, and as the United States put pressure on other major capitalist nations in Europe and Asia to liberalise. The United States pushed strongly for financial and services liberalisation, and access to its markets provided an important bargaining chip in trade and financial negotiations. Clinton argued that the United States had to adjust domestically, but, at the same time, he attempted to create a more favourable international environment for US investors and firms. The United States has always been a ‘strategic’ free trader. It is a large, extremely productive economy and open markets suit the profit motives of many of its major firms, particularly in finance and other services. The Clinton and GW Bush administrations generally resisted frequent calls for increased protectionism by US business, labour and Congress. The United States continued, however, to subsidise its agricultural sector and to maintain protectionism in many other industry sectors. Current concerns over supposedly unfair Chinese trading practices, most importantly currency manipulation and the failure to protect copyright, make the task of resisting protectionism in the United States at least as difficult as the one faced by policy-makers in the 1980s, when concerns about unfair Japanese trading practices were prevalent. While the preceding historical perspective on globalisation is necessary for understanding its political underpinnings, it does not negate the fact that the world political economy did enter a new phase in the 1990s.78 The fall of communism in Eastern Europe and the Soviet Union enlarged the globalising capitalist sphere. China had already shifted direction in the late 1970s, but by the 1990s it was abandoning any notion of socialism, except in government rhetoric, and exploding as a capitalist force majeure. Vietnam – a possible star performer of the next decade – switched direction earlier as well, with the collapse of communism reinforcing its capitalist shift. Other major developing

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countries, such as India and Brazil, also abandoned inwardly-focused development strategies, embracing exports and foreign investment. In sum, the collapse of communism and shift in attitudes of developing countries extended the dominion of capitalism across the globe and increased competitive pressures, both real and potential. Faced with the challenge from developing countries, the developed world became obsessed with competitiveness and increasingly consolidated the shift to economic liberalism, which had begun in the 1980s.79

Politics, the state and globalisation However compelling external pressures may be, they are unlikely to be fully determining, save for the case of outright occupation. Some leeway of response to pressure is always possible, at least conceptually. The choice of response therefore requires explanation. Such an explanation necessarily entails an examination of politics; the struggle among competing responses. The interpenetrated quality of international relations and domestic politics seems as old as the existence of states.80 For all the often-reported ‘crisis’ or ‘demise’ of the welfare state, all one really sees after 1980 is a slowdown, not a decline, in the shares of GDP that welfare-state taxpayers put into such programs.81 If you put globalization up for a popular vote in the United States, I think it would lose 60/40.82

Such widespread change is bound to encourage hyperbole and, in the 1990s, many writers exaggerated the impact and extent of globalisation. The entrepreneurs of sensational publishing and true believers in global transformation argued that states would become less and less important and that, if not already, then soon, markets and multinational corporations would rule the world. Writers such as Kenichi Ohmae and Richard O’Brien argued that the end of the nation-state and geography were

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nigh and that the past no longer provided any meaningful clues for the future.83 Edward Luttwak argued that geo-economics had usurped geo-politics and that ‘as the relevance of military threats and military alliances wanes, geo-economic priorities and modalities are becoming dominant in state actions’.84 Walter Wriston argued that the ‘information revolution’ was leading to the ‘twilight of sovereignty’ and to the ‘relative decline in the value of material resources’.85 Susan Strange argued that US policy decisions, especially in finance, undermined US power and brought about a shift in structural power from states to markets: ‘The shift from state authority to market authority has been in large part the result of state policies. It was not that the TNCs stole or purloined power from the government of states. It was handed to them on a plate – and, moreover, for “reasons of state”.’86 Accordingly, states were no longer the most important source of change in the world economy as markets, transnational firms and other non-state authorities challenged state control. Instead, states were fundamentally in decline, struggling to deal with the challenges of global markets and technological change.87 Philip Cerny also focused on finance, arguing that the state had been both ‘an agent of its own transformation’ and a ‘major source of the development of globalization itself ’.88 States, he contended, ‘undermine and legislate away their own power, confronted by the imperatives of international competitiveness’.89 For Strange and Cerny, continuing state power and globalisation were exclusive possibilities. The twin thesis of state decline and economic ascendancy, so prevalent in the 1990s, exaggerated the past potency and hence contemporary decline of state power. Global financial markets are now extremely important in structuring political-economic developments, but this was also the case in the late nineteenth and early twentieth centuries.90 Financial collapse led to the Great Depression and reactions to the power of finance shaped the post-war economic order. The struggle to control and shape societal and economic forces has exercised states throughout history and capitalist states have never been unequivocal ‘masters of markets’, nor have they had this as their aim.91 Governments, particularly of the Left, have long faced structural economic

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constraints on programs of redistribution.92 Globalisation since the 1970s may have sharpened these pressures, but it did not create them. While analyses of democratic capitalism underestimated the structural constraints of capitalism during the 1960s and 1970s, they increasingly over-determined them under the rubric of interdependence and globalisation in the 1980s and 1990s. It should be obvious by now that my argument is that many writers have exaggerated globalisation’s impact on the state, mistaking tendencies for complete transformation. We should not go too far, however, in the opposite direction. Globalisation has led to many changes and challenges for both state policy and social priorities. States did allow finance to grow to become a destabilising, crisis-inducing force. Globalisation profoundly affected conceptualisations of state policy autonomy and capacity. In thinking about autonomy and capacity, it is always necessary to ask: Autonomy from whom? Who can be persuaded, ignored or marginalised in the policy process? Capacity to do what? And achieve what outcomes? In the 1980s and 1990s, analyses often equated state autonomy and capacity with the ability of governments to maintain past patterns of state regulation and intervention, especially those associated with Keynesianism.93 Policies that may have been indicative of state autonomy and capacity in earlier times ended up restricting the state’s ability to change policy directions in response to changing domestic and global circumstances.94 For Theda Skocpol, state autonomy is equated with the ability of the state to ‘formulate and pursue goals that are not simply reflective of the demands and interests of social groups, classes, or society’. Related, but distinct, is her conception of state capacity, which concerns the ability of the state to ‘implement official goals, especially over the actual or potential opposition of powerful social groups or in the face of recalcitrant socioeconomic circumstances’.95 States will often aim to be autonomous from dominant domestic forces such as sections of business, the labour movement or environmental pressure groups. They may also attempt to be autonomous from global forces such as financial markets or multinational corporations. The post-war Bretton

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Woods system allowed considerable autonomy from the financial sector, but with the expansion of finance from the 1970s, states increasingly sought autonomy from opponents of policy change. There is no continuing or absolute standard for assessing autonomy and capacity. State goals and policy methods change over time. There will also be value judgements about how capable states actually are and whether the achievement of limited goals shows capacity. Further, it is possible that state goals may be shaped in the first place by policymaker perceptions of a lack of autonomy from particular domestic and global forces. It is also possible that the state itself will be divided. In many cases, there will be multiple aims. Politicians and bureaucrats will not necessarily have the same goals and hence the same conception of what constitutes good policy. Central agencies in control of taxing and spending may have substantially different views on spending from government departments dealing with industry and welfare sectors. Environmental ministries will often oppose the agendas of agricultural and industry ministries. We can also assume that governments have re-election as their major underlying goal. Political parties are well aware that they can achieve little from opposition. Governments, then, may be deemed successful, at least on their own terms, simply by retaining office. This will especially be the case if they have done so during ‘difficult times’. Assessments of the success of governments during a crisis will be fundamentally different to assessments during boom times. But the base aim of governments remains the same: staying in office. We should not underestimate the role of politics and the electoral process in our analyses of the impact of globalisation and crisis. During the 1980s and 1990s, governments increasingly attempted to convince voters that economic difficulties or ‘new global realities’ meant that alternative political choices were unviable and that public expectations about the role of the state needed to be lowered. Policymakers aimed to globalise economies and move to more market-based regulatory structures. Given this aim, a better conception of capacity during the 1980s and 1990s would have equated it with the ability of a state, in Cox’s words, to ‘adjust national economic practices and

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policies to the perceived exigencies of the world political economy’.96 This was what policy-makers believed to be the solution to economic woes; what they needed was autonomy from opponents of globalisation. Different states, however, chose varying ways to globalise and to generate support and lessen opposition. Rather than signalling a weakening of government, the imposition of market mechanisms aimed to enhance state autonomy by allowing an apparently ‘neutral’ arbitrating mechanism to determine, and be held responsible for, socio-economic outcomes. The economic liberal aim was to naturalise or legitimise the market as the most appropriate ‘regulatory’ mechanism and to construct the world political economy as the market writ large. A further goal was to restrict political pressures on the state for policies that required increased spending or the insulation of domestic actors from competitive pressures. The invocation of global imperatives was a pivotal component of state attempts to restructure both domestic economies and polities. Arguments about policy constraints and global imperatives had political intentions and were integral components of the domestic political struggles to shape regulatory structures and distributive mechanisms. There were two main components of this globalisation ‘project’: persuasion – the rhetoric of globalisation – and coercion – the shift to economic liberal policies. Constant reference to the imperatives of globalisation and the idea that there really was no alternative, helped to marginalise alternative ideas and interests. For example, in Australia, the Hawke and Keating Labor governments reinforced three core messages about the need for Australia to adjust to globalisation: first, Australia’s economic structure and the policies of the past were no longer sustainable; second, if Australia embraced globalisation by liberalising the economy, Australians would benefit; and third, there was no choice anyway – globalisation would force adjustments on Australia. Liberalising policy changes gave substance to the rhetoric by facilitating and reinforcing globalisation, and coercing changing outcomes and expectations. It was one thing for policy-makers to tell workers that they needed to adapt but when protection or assistance was removed,

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workers had no choice and were forced to do so. These policy adjustments changed the distribution of advantages and disadvantages, forcing actors to adjust to altered circumstances. Certain industry sectors such as finance and business services flourished in the new policy environment in developed economies, whilst others, particularly manufacturing, languished. Both rhetoric and policy acted to make alternatives to liberalisation seem unviable.97 Bipartisanship on key liberalising reforms in the developed world was very important for the progress of globalisation. Two-party systems meant that citizens opposed to policy change were only able to vote for parties or candidates with no real impact on the policy process. Business groups also increasingly supported globalisation, although some key sectors such as the car industry were able to continue to receive state support. Continued support for sections of manufacturing and agriculture did not come at the expense of the general shift towards liberalisation and globalisation. While policy-makers succeeded in globalising and restructuring their economies, they were far less successful in cutting the size of the state and reducing expectations about state support for both business and its citizens. However, rather than hobbling the process of globalisation, an inability to downsize the state in the developedcapitalist world may have, in fact, supported globalisation during the 1990s and 2000s. While earlier analyses of the impact of globalisation have focused on external constraints on state autonomy and capacity, it has now become clearer that social constraints are also vital. In democracies, for example, governments continue to face periodic judgement by voters.98 Contemporary liberal democracies, therefore, are more constrained by domestic political pressures than they were a century ago. States expanded enormously over the twentieth century in response to popular demands, particularly after World War Two. As John Dunn points out, each of the three pivotal events of the twentieth century, the two world wars and the collapse of communism, ‘drastically extended the nation-state as a political format and strongly reinforced it as an ideological option’.99

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Although new challenges to state autonomy and capacity have emerged since 2000, especially the threat of terrorism, most writers have moved on from the simplistic equation that globalisation signals the decline of the state and the efficacy of government. In what is becoming a new orthodoxy, at least in academia, Nick Bisley contends that many state-decline arguments have misunderstood the modern state. Globalisation is not destroying the state. It is not doing so because its extent is often overstated and the capacity of the state to respond to changing circumstances – of which globalisation is clearly a form – has been a requirement from its emergence in the 17th century. The adaptability of the state has not only been a hallmark, but central to its success.100

Policy-makers have often been receptive to a strong globalisation thesis, promulgating arguments about state decline and the limits of welfare when it suits their purposes.101 The need to persuade reluctant sections of society about the benefits of liberalisation and globalisation (or in the absence of benefits, their inevitability), helps to explain why arguments about the overwhelming and constraining nature of external economic forces have retained their power. Despite this rhetoric, citizens and businesses have largely ignored efforts to persuade them that they need to decrease their demands on the state. Indeed, policymakers have disregarded their own rhetoric and have maintained levels of taxes; although they have changed the mix of taxes.102 The welfare state has been remarkably resilient. This should not necessarily be surprising because the association of economic openness − freer trade and capital flows − with the growth of the state has a long and varied intellectual pedigree. In a study of 18 capitalist economies in the 1970s, David Cameron argued that ‘a high degree of trade dependence is conducive to a relatively large expansion of the public economy’ and, further, that ‘a strong positive correlation … exists between the size of the increase in the public economy and a measure of economic equality’.103 In the mid-1980s, Peter Katzenstein pointed out that in

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the ‘neo-corporatist’ countries of Western Europe strong social democratic parties and powerful union movements had led to a strategy of social compensation and had underpinned openness and competitiveness.104 Economic openness did not lead to, nor did it require, a small state or increased inequality. Indeed, in the late 1980s, Francis Castles argued that ‘democratic capitalism is necessarily and unavoidably the progenitor of big government’.105 Into the 1990s, many argued that while these views may have once been relevant, recent globalisation had made them redundant.106 This pessimistic view, however, has increasingly come up against evidence to the contrary. Geoffrey Garrett pointed out that ‘partisanship’ – whether governments of the Left or the Right held office – continued to shape public spending, sound macroeconomic outcomes and levels of equality through the 1980s and early 1990s.107 Linda Weiss argued that the idea of the powerless state was ‘a myth’, and Dani Rodrik reconfirmed and extended Cameron’s thesis with a study of more than a 100 countries, contending that there is ‘a robust association between an economy’s exposure to foreign trade and the size of its government’.108 He concluded, ‘government expenditures have been and continue to be essential to provide social insurance against external risk’.109 Garrett criticised the static correlations of Cameron, Rodrik and others, arguing that it was necessary to consider changes in the level of globalisation over time and to analyse the impact of financial globalisation as well as trade.110 He found that increased trade globalisation over time had led to slower growth in government spending, but that higher levels of capital mobility had no effect on government spending.111 Responding to the need for a dynamic analysis of changes in the extent of globalisation, Cameron and Soo Yeon Kim considered fluctuations in a country’s level of trade. They found that the total level of trade was insignificant for year-to-year changes in the relative size of government. Large increases in the volume of trade were associated with only small increases in the level of government taxing and spending, but large and deteriorating trade deficits ‘exerted a significant expansionary impulse on government spending across the advanced capitalist

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world’.112 Axel Dreher, Jan-Egbert Sturm and Heinrich Ursprung investigated globalisation’s impact on the composition of government spending in a sample of 60 countries between 1971 and 2001 and the OECD since 1990. They conclude rather prosaically that ‘our results indicate that none of the investigated expenditure categories has been robustly affected by any of our globalisation indicators’.113 This, they argue, is because governments match the disciplining effects of globalisation with compensatory spending, or ‘the effects of globalisation might be exaggerated in the popular discussion and might simply not exist’.114 Colin Clark predicted in 1945 ‘that about 25 per cent of the national income, or possibly rather less’ was ‘the critical limit of taxation’.115 Subsequent developments proved Clark wrong as some countries in Europe went well over 50 per cent of GDP. Whether there is an upper limit for capitalism around the levels reached by Scandinavian countries in the 1990s remains to be seen. While the everexpanding state may have been slowed or even halted in some cases and while welfare institutions have been reshaped to bolster productivity, social spending remains pivotal in the first decade of the twentyfirst century.116 As Cameron and Kim summarise, ‘the fiscal role of the government remains significant in all [countries] and continues to increase in some’.117 What is considered to be the appropriate limit of state spending continues to vary throughout the world, based on a combination of partisanship, political institutions, historical legacies, culture and ideology. Changes to outcomes and the composition of spending need to be analysed on a comparative or individual basis to understand how states have adapted to the pressures from international and domestic domains. Although there are subtle but important differences in the various studies of the relationship between globalisation, taxing and spending, their broad thrust is that the retrenchment predicted has just not happened. This is particularly the case in the advanced capitalist countries and is true for both welfare and general government spending. Stephan Leibfried and Elmar Rieger turn traditional arguments

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about the limits of the welfare state by arguing that there are limits to globalisation. They contend, ‘Just as government freedom of action is dependent on “globalisation”, the fate of globalisation itself is decided by government action’. In ‘an ironic twist of world history’, the welfare state was a vital precondition for post-war globalisation.118 On this basis, it is possible to surmise that into the future liberal democratic support for globalisation may largely depend on redistribution. Globalisation does not mean the end of the state; rather, states have developed new ways to govern in their attempts to generate economic growth.119 Some states and societies have adapted better than others. The coming years will provide new challenges for the democratic state as it attempts to deal with a changing set of pressures from the world economy, interest groups and the electoral process. The global economic crisis and the belief that deficit spending will help to prevent recession from turning into depression will once again expand the role of the state. Constraints on states are now as intense as they have ever been, but not in the sense that state declinists would argue. Instead, the interaction of global and domestic pressures squeezes governments ever more intensely. A still significant role for the state does not mean that they will always and everywhere be strong or that regulation will always be effective. The financial crisis shows clearly that this is not the case. There was not only a lack of regulation, but regulators failed to enforce the regulations that did exist and financiers managed to develop innovative ways of avoiding them. Nevertheless, policy-makers increasingly believed that the strategy of ‘letting the market decide’ was preferable to tighter regulation. The financial meltdown shows that states were weak in their ability to avoid the crisis, but ultimately responsible for the financial mess that ensued. The continuation of government spending also has not meant that inequality has not increased as Chapter 8 outlines. But the foregoing discussion shows that states and societies are still able to choose more or less inequality in the face of globalisation.

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The globalisation debate has been especially important in the Anglo economies. Globalisation has been the dominant story since the end of the Cold War and a predominant narrative about inevitability reinforced its progress.120 The rapid pace of globalisation since the 1970s has spread the impact of the financial and economic crisis across the globe. There are three major questions for the trajectory of globalisation over the coming years. First, will the major states co-operate to regulate global capitalism, particularly global finance, more effectively? Second, will states develop policies that distribute the benefits of globalisation widely across their societies thus maintaining support for dynamic economic integration? And third, will the developed world see the economic challenge from developing countries through liberal or realist eyes – as an opportunity or a threat? Globalisation as a foreignpolicy issue will become increasingly important because the major developing states will seek to play a larger role in structuring the rules and regulations of the world economy, while developed states seek to maintain their privileged position. Ultimately, however, globalisation’s future will require domestic support in both liberal democracies and authoritarian regimes. This support will depend on globalisation producing more winners than losers or, at least, on the winners being able to convince the losers that they stand ultimately to benefit from short-term sacrifices to their welfare. Globalisation needs to be able to produce the goods – and the services. A liberal economic policy structure and support for globalisation is not set in stone. As the next few years will show, the imposition of more market-based regulation did not settle regulatory struggles for all time. The art of government will continue to involve trade-offs between economic and political pressures, and domestic and international arenas. The possibility remains that coalitions against globalisation and economic liberalism will emerge and that some groups within nation-states will continue to be amenable to protectionist rhetoric and policies.

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3

The World Economy in the Twenty-First Century

The global economic recession began in the United States, spread to Europe and then to Asia – and now impacts on all economies, including Australia. The distinctive feature of the current Global Financial Crisis, as George Soros himself has noted, is that it has emerged from inside ‘the system itself.’ The crisis has its roots in a long period of global imbalances, lax regulation and easy credit – all turbo-charged by greed out of control. Kevin Rudd1

We live today in a truly global capitalist economy. The present global financial crisis and recession have reminded us that global interconnections can have negative as well as positive effects. In both good times and bad, states and societies have to deal with the consequences of global flows of goods, services, investment, money, people, information, pollution, drugs, arms and much else. The next decade will test the current global policy consensus in favour of increasing globalisation. There is a certain irony in the fact that the globalisation of the world economy since the 1970s will make the effect of any shift away from globalisation over the coming years more severe as more countries have become dependent on global trade and finance! The global economic crisis is likely to restrict celebratory accounts

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of globalisation for quite some time, but its significance for economic global integration will depend on the depth of the downturn. A prolonged recession will undoubtedly lead policy-makers throughout the world, under pressure from business, labour and citizens, to attempt to protect domestic economic activity and jobs. The role of the United States will be pivotal. If the Obama administration eschews protectionism, it will be a powerful incentive for other countries to do the same. A shift towards protectionism by the United States would have a profound effect on the rise of Asia and, in turn, on Australia. The economic relationship between the United States and China will be particularly important. Both will need to manage their interdependent relationship – China’s dependence on US markets and the United States’ reliance on Chinese capital – carefully. Despite the crisis, US economic dominance continues. While Europe is the most important economic region, no single European country dominates like the United States, and none is a potential challenger like China. We should not mistake the relative economic decline of the United States for a decline in impact. The United States remains the indispensable political economy. While the Asian challenge to Western dominance will be the issue of the twenty-first century, we should be wary of substituting a possible future for the present. Asia still has a long way to go and many hurdles to negotiate before its global economic influence matches that of the West. Over the next generation, how the United States deals with challenges to its supremacy and counters the domestic consequences of globalisation will determine the future trajectory of the world political economy. This chapter outlines the current state of play in the world political economy, discusses the vital but arcane problem of the ‘global imbalances’, and analyses developments in global finance and trade. While the economic crisis unfolds as this book goes to press, this chapter outlines its present trajectory and considers possible outcomes.

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The state of play Others may worry that the recent bout of financial market volatility may begin to undermine the strong global growth that we envisage. But I do not believe that the financial tail is about to wag the economic dog. In our view, the cascade of selling in financial markets that we saw about a month ago represented a limited and largely temporary pullback from riskier assets including from emerging markets, after a long period of market buoyancy … I think we can sustain global growth around 5 per cent per year for some time to come.2 The stresses in the financial markets of the United States that first emerged in the summer of 2007 transformed themselves into a full-blown global financial crisis in the fall of 2008: credit markets froze; stock markets crashed; and a sequence of insolvencies threatened the entire international financial system … Virtually no country, developing or high income, has escaped the impact of the widening crisis.3

What a difference a year can make. The global economy went from boom to gloom quicker than virtually anyone could have imagined. Despite signs of looming economic problems, the outlook of most commentators in 2007 was that the world economy would continue to grow at a rapid pace, spurred by the rise of the developing world and, in particular, the runaway growth of China. While the US economy was obviously slowing down, the contagion effects of the US sub-prime crisis, its ratcheting up into a credit crisis, followed by a full-blown financial crisis and global recession, took many by surprise. By late 2008, worries about inflation were quickly dropped and subsumed by the financial meltdown. The rapidity of events, makes predicting where the world economy is heading over the next few years, a very difficult task, let alone predicting the state of things in ten, 20 or 50 years. A good way to start, however, is to assess the state of play.

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China emerged as an economic powerhouse in the 1990s and 2000s, and is another chapter in the Asian growth story, which began with Japan’s rise in the 1960s and 1970s, followed by the rapid development elsewhere in Asia during the 1980s and 1990s. The embrace of liberalisation by Vietnam and India also added depth to Asia’s dynamism. But China’s rise is more contentious than Japan’s because it is a large, strategically important country that sits outside of the Western sphere of interest. Japan is a stalwart democratic US ally while China is an authoritarian, potential challenger to US interests. Despite China’s meteoric rise, it is important to remember its economy is still a great deal smaller than the US economy. So how do we compare their economies? There are two major ways to measure the size of economies.4 We can convert the value of Chinese gross domestic product (GDP), for example, into US dollars and compare it to the GDP of other countries. The advantage of this method is that it provides a neat comparison of a particular country with any other country at any particular time. But the problem with this measure is that it varies with the dollar–renminbi exchange rate and doesn’t accurately reflect the cost of things within the Chinese economy. If the renminbi was revalued this would immediately increase the measured size of the Chinese economy. This is not completely spurious because a higher valued renminbi would enable the Chinese to buy more goods and services on the international market and would increase their ability to invest in other countries. When exchange rates do vary considerably over time, such as the dollar–yen exchange rate since the 1970s, this method may be a problem. For example compare the difference in size of the Australian economy when measured at a time when the Australian dollar was 47.75c against the US dollar in April 2001 to when it reached 98.49c against the US dollar in July 2008. Although for measuring purposes the exchange rate is averaged over a period, variation still poses obvious problems. Such discrepancies have led to the increased use of an alternative method of measuring the size of economies based on the concept of purchasing power parity (PPP).5 Statisticians measure purchasing power within individual economies and then make comparisons on

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that basis. PPP measures GDP adjusted to reflect different costs of living and production within different economies. Goods and services and production costs are considerably less in China than they are in the United States. We all know that our currency goes further in some countries and less in others. You can live, for example, much more cheaply in Indonesia than you can in Sweden! A popular representation of PPP values is the Economist magazine’s tongue-in-cheek Big Mac Index, which compares the price of Big Mac’s around the world. A Big Mac in Sweden ($4.58) will cost you a lot more than a Big Mac in Indonesia ($1.74) or even the United States itself ($3.45). According to PPP theory, the cost of Big Macs should be the same across countries once local currencies are converted to US dollars. In these February 2009 prices, the Index suggests that the Swedish Krona is overvalued against the dollar and the Indonesian rupiah is substantially undervalued. Big Macs are not really a good marker of PPP because they are generally considerably more expensive than local-food items in developing countries! There is also now an iPOD Index, which does the same thing, but with a high technology, tradeable item rather than a basic food item.6 This is significant because products that can be easily traded should, through the process of arbitrage, end up with the same price (allowing for exchange rates). If we compare what a given amount of dollars will buy in the Chinese economy and compare it to what a given amount of dollars buys in the US economy we can, according to advocates of this approach, get a better idea of the size of an economy. The problem with this method is calculating the different costs of production and living on an ongoing basis. To do a proper analysis of PPP, the World Bank compares a large range of goods and services. It is very difficult to get a comparable basket of goods for diverse countries with substantially different cultures and consumption norms. In December 2007, the International Comparison Program co-ordinated by the World Bank revised down its PPP estimate of China’s economy by 40 per cent making a considerable difference to the measured size of the Chinese economy in 2005.7 The best solution to the problem is the messy one of considering

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both measures together. Table 3.1 below shows that the United States accounted for 21.1 per cent of global GDP on a purchasing-powerparity basis in 2007, down from 23 per cent in 1995 and 24.5 per cent in 1980. China has rapidly caught up, accounting for 10.1 per cent in 2007 (revised down by the Bank by 6 per cent from earlier 2007 estimates!), up from 5.7 per cent in 1995 and 2.2 per cent in 1980. Measuring shares of global GDP by converting a country’s GDP to US dollars at market exchange rates produces very different results. On this basis, as Table 3.2 shows, in 2007 the United States was more than four times larger than China, accounting for nearly 25.3 per cent of global GDP, compared to 6.0 per cent for China. In 1995, according to this measure, the United States was ten times larger than China. On an exchange basis, Japan’s relative position increased significantly between 1980 and 1995, with the increased value of the yen in the mid-1990s improving Japan’s position. On an exchange basis, Japan’s share of the world economy declined by half between 1995 and 2007. On a PPP basis, Japan’s economy has declined by a much smaller amount. These tables show that US decline has been gradual and that China’s rise has been mainly at the expense of Japan. In 2006, the developing world accounted for more than 50 per cent of global GDP (measured on a PPP basis), signalling its growing importance. Developing countries grew at a faster rate between 1995 and 2005 than they did during the previous two decades and considerably faster than developed countries.8 In 2006, developing countries accounted for 43 per cent of world exports, up from 20 per cent in 1970; half of the energy consumption; and 70 per cent of currency reserves.9 Many see India as a major challenger to China’s mantle as the most important developing country. While China causes considerable anxiety in the developed world about its growing domination of manufacturing, India creates concerns because of its competitiveness in higher paid service and technology jobs. Outsourcing to India will increase in coming years and become even more important as a topic of debate. Predictions about an inevitable Chinese ascendancy rely on a faith

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Table 3.1

Share of world GDP on a purchasing power parity basis Country

1980

Country

1995

Country

2007

United States

24.5

United States

23.0

United States

21.1

Japan

9.1

Japan

8.7

China

10.8

Germany

6.6

China

5.7

Japan

6.6

France

4.7

Germany

5.6

India

4.6

Italy

4.5

France

3.8

Germany

4.3

United Kingdom

4.3

United Kingdom

3.7

United Kingdom

3.3

Brazil

3.9

Italy

3.6

Russia

3.2

Mexico

2.9

India

3.2

France

3.2

Spain

2.4

Brazil

3.2

Brazil

2.8

Canada

2.4

Russia

3.0

Italy

2.7

India

2.4

Mexico

2.3

Mexico

2.3

China

2.2

Spain

2.1

Spain

2.1

Saudi Arabia

1.4

Canada

2.1

Canada

1.9

Netherlands

1.3

Korea

1.7

Korea

1.8

Poland

1.3

Indonesia

1.4

Turkey

1.4

Australia

1.3

Australia

1.2

Indonesia

1.3

Argentina

1.2

Turkey

1.2

Australia

1.2

Turkey

1.0

Netherlands

1.1

Iran

1.2

Iran

1.0

Iran

1.0

Taiwan

1.1

South Africa

1.0

Taiwan

1.0

Netherlands

1.0

in its continuing and uninterrupted growth. Given China’s internal difficulties, this remains a precarious assumption.10 China has 1 billion poor people and as many as 150,000 civil disturbances a year.11 It also faces the possibility of environmental catastrophe. Despite its spectacular growth, China remains a poor country, as Table 3.3 shows, ranking only 108th in the world for GDP per capita on an exchange basis and 101st on a PPP basis. Another pertinent measure shown in Table 3.4 is the United Nations Development Program’s Human Development

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Table 3.2

Share of world GDP on a US dollar exchange basis, current prices Country

1980

Country

1995

Country

2007

United States

25.8

United States

25.0

United States

25.3

17.8

Japan

8.0

Japan

9.8

Japan

Germany

7.7

Germany

8.5

Germany

6.1

France

6.4

France

5.3

China

6.0

United Kingdom

5.0

United Kingdom

3.9

United Kingdom

5.1

Italy

4.3

Italy

3.8

France

4.7

China

2.9

Brazil

2.6

Italy

3.8

Canada

2.5

China

2.5

Spain

2.6

Spain

2.1

Spain

2.0

Canada

2.6

Argentina

1.9

Canada

2.0

Brazil

2.4

Mexico

1.9

Korea

1.7

Russia

2.4

Netherlands

1.7

Netherlands

1.4

India

2.0

India

1.6

Australia

1.3

Mexico

1.9

Saudi Arabia

1.5

India

1.2

Korea

1.8

Brazil

1.5

Switzerland

1.1

Australia

1.7

Australia

1.5

Mexico

1.1

Netherlands

1.4

Sweden

1.2

Russia

1.1

Turkey

1.2

Belgium

1.1

Belgium

0.9

Sweden

0.8

Switzerland

1.0

Taiwan

0.9

Belgium

0.8

Indonesia

0.9

Argentina

0.9

Indonesia

0.8

source IMF (2008) World Economic Outlook Database, October

Index (HDI). The HDI attempts to provide a broader measure of progress than GDP by including life expectancy, literacy, education and GDP per capita. Iceland, Norway, Canada and Australia lead the HDI. China ranks 94th, down from 81st in 2005 and just above Samoa. With the massive impact of the financial crisis on Iceland, it is doubtful that it will retain its position at the top of the HDI over the next few years.

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Table 3.3

GDP per capita, US dollar exchange basis and PPP, 2006 Exchange basis Country Luxembourg

2007 103,125

PPP basis Country

2007

Qatar

85,638

Norway

83,485

Luxembourg

79,660

Qatar

78,754

Norway

53,152

Iceland

64,548

Brunei Darussalam

50,790

Ireland

60,209

Singapore

49,754

Switzerland

58,513

United States

45,725

Denmark

57,137

Ireland

43,414

Sweden

49,603

Hong Kong

42,124

Finland

46,856

Switzerland

41,265

Netherlands

46,774

Kuwait

39,344

United Kingdom

46,099

Iceland

39,168

United States

45,725

Netherlands

38,995

Austria

44,852

Canada

38,614

Canada

43,674

Austria

38,181

Australia

43,163

United Arab Emirates

37,941

Belgium

42,618

Denmark

37,265

United Arab Emirates

42,501

Sweden

36,578

France

42,034

Australia

36,226

Germany

40,400

United Kingdom

35,634

source IMF (2008) World Economic Outlook Database, October

The growth of the Chinese manufacturing sector has also been meteoric, but most people would probably be surprised that the US manufacturing sector remains the world’s largest on a value-added basis.12 In 1990, China accounted for about 3 per cent of global manufacturing value-added, rising to 7 per cent in 2000. By 2007, China

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Table 3.4

Human development index, 2006 1

Iceland

0.968

2

Norway

0.968

3

Canada

0.967

4

Australia

0.965

5

Ireland

6

Netherlands

0.958

7

Sweden

0.958

8

Japan

0.956

9

Luxembourg

0.956

10

Switzerland

0.955

93

Georgia

0.763

94

China

0.762

95

Tunisia

0.762

96

Samoa

0.76

0.96

United Nations Development Program (2008) Human Development Indices

source

was the second largest manufacturer accounting for 13.2 compared to 20 per cent for the United States. When China eventually overtakes the United States it will return to a position it occupied for 1800 years until 1840 when it was replaced by the United Kingdom as the world’s largest manufacturer.13 In the meantime it is important to stress that in a globalising world economy, the expansion of manufacturing in one country does not automatically equate with a decline in the manufacturing sector of others: China’s manufacturing growth is not all bad news for the United States and other developed countries. As China becomes richer, partly based on its manufacturing prowess, it will open up opportunities for manufacturing in other countries. China

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dominates in ‘textiles, basic metals, computer equipment, appliances, and mineral products’, while the US is likely to continue to dominate in advanced manufactures ‘such as aerospace, pharmaceuticals, and specialized equipment’. Global manufacturing accounts for 17.5 per cent of global value-added and services about 65 per cent, although the manufacturing and resources sectors underpin a good deal of the services sector. In the services arena the United States reigns supreme accounting for 32 per cent of value-added compared to China’s 3.7 per cent (projected to rise to 8 per cent by 2015). Manufacturing only accounts for 12.5 per cent of US GDP, while for China it accounts for 36 per cent.

None of this should detract from the amazing rise of China since the 1980s. The development of the Chinese automotive sector has been particularly exceptional.14 In 1997, Chinese car production was 5 per cent of US output, but by 2006 China had overtaken the United States producing 5.4 million cars compared to 4.4 million in the United States.15 In January 2009, China also passed the United States in total car sales.16 To complicate the picture, however, US companies undertake a significant amount of their production (as do European, Korean and Japanese companies) within China, and Chinese automobile companies do not yet export cars to the United States. In 1994, Paul Krugman compared the growth of the newly industrialising countries of Asia to Soviet growth in the 1950s and 1960s, a period when it appeared that the Soviets were on the brink of challenging the United States economically as well as militarily. He argued that ‘perspiration not inspiration’ had been the major factor. He saw Japan, however, as different: ‘Japan, unlike the East Asian “tigers”, seems to have grown both through high rates of input growth and through high rates of efficiency growth. Today’s fast-growth economies are nowhere near converging on US efficiency levels, but Japan is staging an unmistakable technological catch-up’.17 Krugman argued that while Japan was experiencing an unmistakable ‘growth slowdown’, he

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Table 3.5

Top 15 manufacturing countries in 2007 and the future 2007

2025

1

US

1

China

2

Japan

2

US

3

China

3

Japan

4

Germany

4

Germany

5

France

5

South Korea

6

UK

6

France

7

South Korea

7

India

8

Italy

8

UK

9

Brazil

9

Italy

10

Canada

10

Brazil

11

Russia

11

Russia

12

India

12

Indonesia

13

Spain

13

Mexico

14

Mexico

14

Taiwan

15

Indonesia

15

Canada

Global Insight via Finfacts

source

underestimated the extent to which Japan would stagnate over the rest of the 1990s and early 2000s. If Japan had continued to grow at the rates achieved over the period, 1963–73, he predicted it would have overtaken ‘the United States in real per capita income by 1985, and total Japanese output would have exceeded that of the United States by 1998!’ Krugman also noted the differences of the Chinese growth story to that of the Asian tigers. Significantly, he pointed out that, ‘its population is so huge that it will become a major economic power if it achieves even a fraction of Western productivity levels’. By the early 1990s, it was clear that China’s shift in direction was leading to rapid and sustained economic growth, although there were (and continue to

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be) many concerns about Chinese statistics. Chinese growth in recent years has provided a considerable stimulus to growth in other countries, but ultimately Western demand supports the whole edifice. This is why export dependence is such a threat to growth in East Asia over the next few years. Breslin argues, ‘the majority of exports to China from other East Asian states are actually disguised exports to Japan, Europe and the United States’. China is a ‘manufacturing conduit’ for the region.18 As the early months of 2009 revealed, China’s (and Asia’s) ability to go it alone was limited indeed. Both GDP and exports fell precipitously in the fourth quarter of 2008. Not only has trade with the West dropped, but trade within Asia as well. This makes sense because of the regional nature of Asian production, with the developed world as the final destination. In early 2009, some analysts tipped Chinese growth to slow to 6 per cent, which they categorised as a ‘hard landing’ because China needs a sustained growth rate of 8 per cent to avoid rising unemployment and social unrest.19 The bad news for the West is that imports have dropped even more, which means a decline in domestic demand in Asian economies.

Global imbalances Many commentators argued during 2007 and 2008 that the effect of a US recession would not have the global impact it once did.20 They argued that China and Asia had ‘decoupled’ from the United States and the West more generally. However, from late 2008 it was clear that this was simply wrong. Although export exposure to the United States has declined for most regions as a percentage of their total trade, because of their greater trade openness the share of exports to the United States as a percentage of GDP has actually increased.21 US financial markets are the world’s largest, with its stock market accounting for 40 per cent of global stock market capitalisation and the United States accounting for half of total global private debt outstanding.22 Consumer spending in the United States accounted for 71 per cent of US GDP in 2006 and 40 per cent of ‘total consumer spending in

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the world’s advanced economies’. US consumer spending amounted to $US8.7 trillion in 2005 compared to $US8.1 trillion in the Eurozone and Japan combined.23 If US consumer spending is 71 per cent of US GDP and US GDP is 25.3 per cent of global GDP, then US consumer spending is 18 per cent of global GDP! More revealing is that the wealthiest 20 per cent of Americans accounts for 39 per cent of US consumer spending. This means the spending of the wealthiest 20 per cent of the US population accounts for about 7 per cent of global GDP.24 How then could a downturn in the US not have a major impact on the global economy and particularly on export-dependent Asian countries? There were several major contentions about the global imbalances between deficit and surplus countries before the financial crisis hit.25 A common theme was that US profligacy – high levels of spending and low levels of saving – led to a high current account deficit (CAD). Deficits, however, are only one side of the global economic ledger. Matching the deficits of the United States, Spain, the United Kingdom, Australia, Italy and Greece were the surpluses of China, Germany, Japan, Saudi Arabia and Russia. Figure 3.1 shows the top ten deficit countries in 2007 and illustrates the significance of the United States – with nearly 50 per cent of total global deficits – for supporting demand in the world economy. The US CAD, which is predominantly a trade deficit rather than an income deficit – is five times the next largest CAD. In 2007, Australia had the fourth largest deficit in the world (up from sixth in 2006) comprising 3.8 per cent of total world deficits (compared to its 1.7 per cent share of global GDP). On the surplus side of the ledger, shown in Figure 3.2, China comprised 21.4 per cent of total surpluses. The world’s largest exporter of goods, Germany, came next with just under 15 per cent of the total. Oil exporters also accounted for a large percentage of the global surplus. The need for the United States to act as a ‘buyer of last resort’ is, as Palley explains, a result of the inability of surplus countries to generate sufficient domestic consumption.26 Add the Middle Eastern and Russian surpluses to the Asian ones and the problem becomes clear. Large US deficits were necessary to underpin global growth. A shift away from reliance on the United States for

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Figure 3.1

Deficit countries percentage of world current account deficits, 2007 ($US) 60

50

40

30

20

10

0 US

Spain

UK

Australia

Italy

Greece

Turkey

France

Romania Portugal

IMF (2008) World Economic Outlook Database, October

source

spurring global demand would require a sustained increase in consumer spending in surplus countries. While the initial focus of most analyses of the global financial crisis was on the absence of suitable regulation, it is necessary to consider both micro (regulatory) and macro (global capital flows) factors behind the crisis. The absence of effective regulation was ultimately responsible, but the huge and unsustainable global imbalances between deficit and surplus countries, and particularly the imbalances between the United States and China played a fundamental role. China bought US dollars to maintain the low value of the renminbi against the US dollar to sustain the competitiveness of its export industries. Between 2003 and 2008, China ‘spent as much as one-seventh of its economic output buying foreign debt, mostly American’.27 It would be wrong, however, to see the creation of surpluses as just a Chinese problem as Figure 3.2 shows.

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Figure 3.2

Surplus countries percentage of world current account surpluses, 2007 ($US) 25

20

15

10

5

0 China

Germany

Japan

S Arabia

Russia

Switz

Norway

N'lands

Kuwait

Singapore

IMF (2008) World Economic Outlook Database, October

source

The United States, of course, was also complicit; gleefully accepting the largesse to fund spending and develop elaborate financial engineering through the production of increasingly exotic financial derivative products that eventually led to the global financial meltdown. The flow of funds from China to the United States has been a major component of a more generalised picture of a perverse net capital flow from the developing to the developed world. Developing countries had a combined current account surplus of $US640 billion in 2006, which represented an equivalent outflow of capital to the developed world.28 Between 2000 and 2008, the United States received $US 5.7 trillion from other countries. US saving fell from 10 per cent of disposable income in the 1970s to less than one per cent in the latter part of the 2000s.29 The shift in direction of net capital flows from developing to developed countries is a remarkable turnaround from the situation before the

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Asian crisis in 1997. In 1996, ‘the combined current account balance of the developing economies was a deficit of $80 billion, representing a capital inflow of that amount from the industrial world’.30 This effectively means that the poor in the developing world have been subsidising the consumer spending of developed countries by lending them money at extremely low rates of interest. Rogoff calls the two trillion dollars worth of low-interest bonds (mostly US Treasury bonds and mortgages) that Japanese and Chinese central banks hold ‘the world’s largest foreign aid program’.31 Michael Pettis argues that ‘while triggers for financial crises throughout history have been different, the underlying causes have been the same. Every financial crisis in history has been preceded by a long period of excess liquidity growth’.32 He argues that the path to the crisis originated with the development of securitisation in the 1980s as banks sought to make illiquid assets (mortgages) liquid by bundling them up and selling them to investors, both US and foreign. These mortgages were then converted into other investment products, such as collateralised debt obligations, which will be discussed below. As Japan generated a large trade surplus with the United States, huge flows of Japanese capital flowed into the United States in the mid-1980s, which added to the increased liquidity made available through securitisation In the late 1990s, after the Asian financial crisis, more Asian economies generated large trade surpluses and accumulated large currency reserves to avoid ever having to rely again on the IMF for assistance.33 The most important relationship was between the United States and China, but Japan also continued to invest huge sums in US Treasury securities further boosting liquidity growth. A problem for China and other developing countries is that they invested much of their reserves (official capital flows) in low-yield government securities, which meant foregoing the possibility of greater returns from other investments. The poor returns China and other countries received worsened as the US dollar fell. The official inflow from foreign central banks has been nearly enough to fund the entire US CAD, which has meant that US compa-

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nies and investors, in turn, have had cheap funds to invest outside of the United States, often in China and the rest of the developing world, where they received higher returns.34 When in early 2007, the Chinese government switched tactics and attempted to get a higher return for a portion of its reserves, it did so at precisely the wrong time.35 The losses China has realised from this switch of investments to US financial companies have been substantial. It has lost $US5 billion on $US10.5 billion invested, including an 86 per cent loss on $US3 billion invested in the private equity firm Blackstone.36 Some analysts argue that these losses will make the Chinese wary of straying from the relative safety of US Treasury securities in the future, which will benefit the United States given the amount of debt they need to fund bailouts and stimulus packages. In her trip to Asia in February 2009, Secretary of State Hillary Clinton encouraged the Chinese to keep buying US debt: It would not be in China’s interests if we were unable to get our economy moving … So by continuing to support American treasury instruments, the Chinese are recognising our interconnection … We are truly going to rise or fall together. We are in the same boat and, thankfully, we are rowing in the same direction.37

Chinese capital invested in the United States, however, is capital not invested in China. Nevertheless, Clinton is undoubtedly correct: rapid Chinese divestment from US-dollar holdings would lead to a collapse of the dollar and a collapse in the value of China’s remaining investments. This would also make the Chinese manufacturing sector less competitive and lead to a decline in US demand for Chinese goods. The great tragedy of the current economic crisis is that money continues to flow into the safe haven of US Treasury securities, which means that there is less capital available for the developing world. This will exacerbate the effect of the crisis in developing countries and will provide cushioning for the huge public debt the US government is building up to ameliorate the crisis. Heads the United States wins, tails the developing world loses.

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What is required is a gradual rebalancing of global capital flows with the United States saving more and consuming less, and becoming less reliant on foreign investors to fund its CAD; and China and other surplus countries taking action to stimulate demand within their own economies. For the Chinese people to spend more requires them to save less. But this will not happen unless the Chinese government provides more certainty for the population through spending on public health and welfare. Both deficit and surplus countries will need to make adjustments and this will require deft negotiations.38 It is likely that global recession will force some changes. The United States is reducing both consumption and debt, and China through increased government spending is increasing consumption and lowering its surplus with the rest of the world. The danger is that a rapid unwinding of the global imbalances will severely exacerbate the current crisis. But even a more prosaic unwinding of debt in the United States and other economies is likely to see a prolonged recession. Increased consumption in China is likely to be beneficial over the long term for the Chinese people but as the West buys fewer Chinese goods it will also mean a period of adjustment for the Chinese economy.

Global trade Trade is another area of the global economy that will require skilful negotiations. Since World War Two, states have played a major role in encouraging the growth of trade. Multilateral and regional negotiations and unilateral policy decisions to reduce barriers and increase market access have provided a generally conducive international environment for trade expansion, although non-tariff barriers and subsidies have become more important since the 1970s. The various rounds of the General Agreement of Tariffs and Trade (GATT) in the post-war period reduced tariff levels significantly in the developed world and many developing countries also embraced trade liberalisation. Mercantilist policies, however, continue to be attractive to developing countries in Asia and those wanting to emulate Asian success.

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The replacement of the GATT by the World Trade Organization (WTO) in 1995 bolstered the freer trade cause, with the disputesettlement system an important new development. In theory, dispute settlement underscores the rule of law and helps to make the trading system more secure and predictable.39 Critics argue, however, that the process takes too long.40 States may be well aware that they are transgressing WTO rules, but they also know that by the time a dispute is settled, they will have provided critical leeway for their businesses. Power politics still shapes the system. The potential animosity generated by disputes also runs the risk of undermining the whole system, although the WTO leaves it up to the victor of a settlement to impose sanctions. There is no provision for enforcement if the aggrieved party declines to act. Difficult and acrimonious negotiations continue to plague the WTO system, partly because the scope of international trade negotiations has expanded enormously since the 1980s and partly because of the newly found assertiveness of the major developing countries.41 The very success of past trade negotiations is also a factor: as trade barriers came down, the trade agenda shifted from reductions in tariffs and quotas into sensitive areas of economies, not as amenable to easy negotiation. The multilateral trade agenda has gone beyond trade liberalisation to ‘global market integration through the convergence of national market regulation’.42 This has a major impact on developing countries because as they seek to catch up to the developed world they find that restrictions on industry policies, which have been foisted on them by the WTO, limit their development options.43 Developed countries have pushed hard for the liberalisation of trade in services and investment. Nevertheless, most countries still generally seek to give advantage to domestic firms over foreign firms, and many countries still use subsidies to attract investment. Such pressures are likely to increase in coming years. The ‘Buy American’ clause attached to the US stimulus package of early 2009 aimed to ensure that stimulus money was used to buy American goods. It was roundly condemned by US trading partners and shows the possibilities of tit-for-tat retaliation in the trade arena.

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The current Doha Round, which began in 2001 in Doha Qatar, with the aim of incorporating development into the WTO agenda, continues to be deadlocked over agricultural trade. Agriculture, which had been excluded for all of the post-war negotiations, was finally included in the Uruguay Round and has caused considerable conflict between Europe and the United States, and between the developed and the developing world. Agriculture is still subject to protectionism and subsidies and the costs of these are generally borne by developing countries (and Australia) and consumers in the developed world who must pay higher prices. Many believe that a reinvigoration of trade liberalisation will be crucial to stimulating recovery from the global recession but in fact it is more likely that countries will be less willing to liberalise fearing increased competition to their vulnerable domestic industries. As WTO negotiations have faltered, regional trade agreements (RTAs) have proliferated.44 While the multilateral system spreads the benefits of liberalisation on a non-discriminatory basis, RTAs generally restrict the benefits to participants. As of December 2008, contracting parties had notified the WTO/GATT of 421 RTAs, with 230 still operating. By 2010, the WTO estimates there will be 400 RTAs in operation.45 According to the WTO guidelines, RTAs are ‘to facilitate trade between the parties and not to “raise barriers to the trade” for other WTO members’.46 A major concern is that RTAs make states less willing to spend time and effort on multilateral negotiations. Many liberal supporters of freer trade are also critical, arguing that RTAs lead to a ‘spaghetti-bowl-like’ confusion of trade agreements with different standards.47 Others argue that RTAs are a component of globalisation: as trade is liberalised between members, pressures emerge to extend liberalisation to outsiders. Richard Baldwin contends that regional agreements are ‘here to stay’ and that they must be ‘multilateralised’.48 Table 3.6 shows intra- and inter-regional trade. Regional trade is most important in Europe, but increasingly in Asia as well. This means that Europe is less dependent on the world beyond its own region than are North America and Asia on the world beyond their regions. Africa

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Table 3.6

Intra- and inter-regional trade showing share of regional trade flows in each region’s total merchandise exports Destination North America

South & Central America

Europe

CIS*

Africa

Middle East

Asia**

Percentage of world trade

18.5

3.3

43.7

2.9

2.6

3.5

24.2

North America

51.3

7.0

17.7

0.7

1.5

2.7

19

South & Central America

30.3

24.4

21.2

1.3

2.7

1.8

16.1

Europe

7.9

1.4

73.5

3.3

2.6

2.6

7.5

CIS

4.6

1.2

56.3

20.2

1.3

3.2

11.7

Africa

21.7

3.4

39.5

0.2

9.5

2.5

19.1

Middle East

11.0

0.6

14.3

0.6

3.6

12.3

52.3

Asia

19.9

2.4

18.8

2.1

2.4

4.0

49.7

Origin

WTO (2008) International Trade Statistics

source

*CIS is the Commonwealth of Independent States, which includes Armenia, Georgia, Moldova, Turkmenistan, Azerbaijan, Kazakhstan, Russian Federation, Ukraine, Belarus, Kyrgyz Republic, Tajikistan, Uzbekistan. **Australia and New Zealand are included in Asia.

has the lowest level of regional trade. Chortareas and Pelagidis argue that regionalisation better describes world trade than globalisation because regional-trade flows have increased at a greater rate than global flows.49 However, as Table 3.6 also shows, inter-regional trade is still vital, helping to militate against the development of a three-bloc world. It is unlikely that states and firms will want to restrict their trade to only their own regions. Total world trade has continually increased at a faster rate than world output, which means that trade has become relatively more

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important over time. In the nineteenth and early twentieth century, world trade grew significantly faster than world output under the hegemony of Britain, which aimed to exploit its industrial and financial might through freer trade. World War One, the Great Depression and World War Two damaged trade relations and, by the late 1940s, world trade had significantly declined in importance compared to its position in 1913.50 In the post-World War Two period, however, the US-dominated world economy provided a supportive environment for the expansion of world trade. World trade grew quickly between 1950 and 1973, considerably faster than world output, but with the end of the long boom in the 1970s, the growth of trade slowed dramatically. By resorting to non-tariff barriers (such as subsidies, export incentives, procurement policies, complex import procedures, health and safety regulations etc) and voluntary export restraints, states attempted to shield their economies from the global recession and increased competition.51 In the 1980s, for example, France understaffed a VCR inspection office that was located far from where imports would arrive. Imports of VCRs were effectively restricted, which helped to protect the struggling French industry, at least for a while until VCRs were superseded by DVD players. ‘Voluntary’ export restraints imposed on Japan by the United States in the 1980s and 1990s were anything but voluntary. Their aim was to engineer a reduction in Japanese exports to the United States and to encourage Japanese production within the US market. The shift into the US market has been a major success for the Japanese car companies who now produce more cars outside Japan than they do at home. International trade in the 1980s involved contradictions and uncertainties similar to those of the late nineteenth century: shifts towards protectionism but with a continuation of trade growth. Many policy-makers and commentators feared a return to protectionism, but by the late 1980s and 1990s trade expanded considerably. Since 1970, world trade as percentage of global output has more than doubled to over 25 per cent of world GDP. There has been a significant transformation in the composition of world trade since the 1950s. Agriculture has declined in importance

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from an average of 37 per cent of merchandise trade in the 1950s to 8.3 per cent in 2007. After declining from 1980 to 1998, fuels (15 per cent) and mining products (4.5 per cent) have risen to 19.5 per cent of merchandise trade in 2007. Manufactures remain the most important component of world trade, accounting for nearly 69.1 per cent of merchandise trade.52 Services trade (measured separately from merchandise trade) has remained stable at just under 20 per cent of total world trade (merchandise and services trade combined) since the early 1990s. This stagnation in growth is because of continuing trade barriers and the non-tradability of many services. Non-tradability accounts for the increase in services in foreign investment figures because, while foreign companies may not be able to export many services, they can still provide them through foreign direct investment (FDI). The services share of global FDI increased from 42 per cent of FDI stock in 1988 to 66 per cent in 2002.53 Trade dependence (the sum of exports and imports as a percentage of GDP) varies considerably between countries and is an indicator of how reliant a country is on the world economy. Virtually all countries have increased their trade dependency since the 1980s. The United States (27.2 per cent) and Japan (31.5 per cent) have low trade dependency. Most of Japan’s growth in recent years, however, has still come from exports. Germany (83.3 per cent) and China (71.3 per cent) have relatively high dependency. The dynamic East Asian economies are generally trade dependent, ranging from 60.4 per cent for Indonesia to 443.7 per cent for Singapore.54 Australia (44.7 per cent) has a low dependence ratio compared to similar sized economies. Just as globalisation had positive effects on countries on the way up, as growth expanded opportunities to trade, the impact on the way down is likely to be severe. Prime Minster Kevin Rudd likes to say that ‘we’re all in this together’ and because of the globalisation of trade and finance this is now more the case than ever before. Analysts expect trade growth in 2009 to be negative for the first time since 1982 as exports decline in virtually every country in the world. Export volumes began to fall in the middle of 2008, gaining momentum after the

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collapse of US financial firm Lehman Brothers in September. The flipside of exports is of course imports and, most importantly for Australia, imports have dropped precipitously in China, Japan and other Asian countries. The problem is not just declining demand but the inability of many companies to access trade finance. The possibility that the downturn will be severe and prolonged raises the frightening prospect of a return to protectionism. Not all countries can export their way out of recession. Exports have powered China’s rise since the 1980s and the temptation to maintain its trade surplus by lowering the value of the renminbi or restricting imports would have a disastrous flow on effect. A recessionary United States probably does not need too many reasons to respond negatively to any Chinese attempts to maintain or increase its trade surplus. Trade is an easy target during recessions as companies lay off workers and go out of business. At the same time, it will be understandable that governments attempt to support domestic interests. The issue is how far will states go in undermining international trade and restricting growth opportunities.

Global finance and investment An explosion in global finance has accompanied the considerable growth of global trade since the 1980s. It was once common for commentators to celebrate this growth, but the financial crisis has put a sudden end to the revelry. It is worthwhile noting just how oversized the financial sector has become. The total value of the world’s financial assets (bank deposits, government and corporate debt securities and equity securities) reached $US167 trillion in 2006, up from $US53 trillion in 1993 and $US12 trillion in 1980.55 Since the 1970s, financial growth has been considerably faster than GDP growth, signalling the increased importance of finance in the economy. Global financial stock was approximately equal to global GDP in 1980, but had expanded to 346 per cent of global GDP by 2006. At this time, the United States was the world’s largest financial market with $US56.1 trillion of assets, that

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is about one-third of the world total. Europe accounted for $US53.2 trillion. Emerging markets accounted for 14 per cent of assets in 2006, up from 7 per cent in 1995. In the United States, the financial sector’s share of corporate profits increased from 10 per cent in the early 1980s to 40 per cent in 2007, and its share of the stock market increased from 6 per cent to 23 per cent – levels that probably won’t be reached again for quite some time.56 This ‘financialisation’ occurred despite the fact that the financial sector accounted for only 14 per cent of US GDP and 5 per cent of US employment.57 The next few years will also see a retrenchment in capital flows as investors attempt to make sense of the financial crisis. According to Diana Farrell and her co-authors, global cross-border capital flows (foreign purchases of equity and debt securities, cross-border lending and FDI) reached over $US8.2 trillion in 2006.58 There are four main types of global capital flows: direct investment, portfolio equity flows, debt flows, and bank and money market transactions.59 The fastest growth has been in short-term or portfolio investment flows. Until the recent massive destruction of financial wealth, a general expansion in financial assets had underpinned cross-border flows. Foreign ownership of financial assets reached $US74.5 trillion in 2006. Farrell writes that this meant the ‘world is more financially intertwined than ever before: foreign investors own one in three government bonds around the world, up from just one in nine in 1990. One in four equities and one in five private debt securities is now held by a foreign investor, triple the level of 1990’.60 The global foreign exchange market is the most globalised of all markets, operating continuously across the globe. In 2007, foreign exchange markets turned over $US3.2 trillion a day, up 71 per cent from 2004 figures.61 As Figure 3.3 shows, this is a huge increase from the $US10–20 billion traded daily in the early 1970s or the $US60 billion a day in 1983. The growth is due to the growing role of foreign exchange as an investment distinct from equities and fixed interest, and the increasingly active role of asset managers and hedge funds.62 The US dollar continues to be the most actively traded currency, being on

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Figure 3.3

Average daily turnover in foreign exchange markets (billions of $US) 3500 3000 2500 2000 1500 1000 500 0 1980

source

1989

1992

1995

1998

2001

2004

2007

BIS

one side of 89 per cent of all transactions world-wide. The euro is a distant second with 37 per cent of all transactions, followed by the yen with 20 per cent and the pound with 17 per cent. There has also been spectacular growth in financial derivative products and markets. Derivatives are financial instruments based on underlying entities such as equities, bonds, currencies, interest rates, stock indexes, mortgages or various combinations of these. Derivatives allow parties to offset or exchange risk. They include futures, swaps, options, ‘swaptions’, warrants, collateralised debt obligations, and many others. The increased use of derivatives as speculative instruments was a fundamental cause of the global financial crisis.63 The continuing growth of institutional investors – pension funds, mutual funds and insurance companies – provided an important spur to financial globalisation up until 2008. The shift to compulsory pensions (superannuation in Australia) and the desire of investors to

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access higher-return investment possibilities increased institutional investment. The increase in assets controlled by institutions led to a search for higher and riskier returns. US pension funds doubled their allocation to international bonds and equities between 1994 and 2005 to 15 per cent and Australian funds increased their overseas allocation to 32 per cent up from 15 per cent.64 These international weightings will now decline as investors refrain from overseas investment. Up until recently, ‘hedge funds’ have been major vehicles for individual and institutional investors seeking higher returns. Hedge funds are investment funds that generally take high risk positions in financial markets through the use of leverage (debt). They are more loosely regulated than other investment funds and are open only to those with large amounts of capital, willing to pay high fees to investment managers. Ironically, the term ‘hedge’ relates to investment strategies that offset risk. The number of hedge funds increased from 530 in 1990 to 6500 in 2005 and their assets increased from $US30 billion to more than $US1.4 trillion.65 Analysts argue that as many as half of all funds could go out of business because of the financial crisis.66 Some hedge funds took on the riskiest components of collateralised debt obligation derivatives related to sub-prime housing debt in the United States; consequently, they lost huge sums of money and were major carriers of financial contagion across the global financial system. The build-up of official foreign exchange reserves and the creation of sovereign wealth funds (SWFs) have also had a major impact on world financial markets. Foreign reserve assets reached over $US7.3 trillion at the end of 2008 with Asian countries building up their reserves to highest ever levels. China’s reserves reached $US1.95 trillion in December 2008 and Japan had a little over $US1 trillion of reserves in February 2009.67 The United States has very small foreign reserves because it has the luxury of having the world’s most important currency. SWFs are state controlled investment companies that invest national financial assets or savings to make a profit. Most of the assets come from accumulated foreign exchange reserves and many of the major oil exporting countries have SWFs to reinvest earnings.

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The largest SWF is based in the United Arab Emirates and had assets of about $US875 million in 2008. The most active funds are the two Singaporean SWFs. China developed a $US200 billion SWF in 2007 to diversify its international investment.68 Australia’s Future Fund is a SWF. Virtually all SWFs have lost considerable capital since late 2007. According to Morgan Stanley, SWF assets exceeded $US2 trillion in 2007 and estimated that they could reach $US12 trillion by 2015.69 Like most other components of global finance, analysts are likely to revise these figures downwards over the coming years. If foreign exchange and derivative markets have been the most spectacular aspect of globalisation, more important over the longer term are the roles of multinational companies (MNCs) and foreign investment. Foreign investment is more important for the globalisation process because it fosters a deeper form of global integration than international trade and a more lasting form of integration than shortterm financial movements.70 The global financial crisis will severely affect international investment, which is of particular concern because the increased receptivity to and active pursuit of foreign investment by governments in both developed and developing countries has bolstered growth over the past 30 years. Rejected by governments as foreign exploitation in the 1960s and 1970s, governments abandoned their suspicions of foreign investment during the 1980s. There are two main types of foreign investment: foreign direct investment (FDI) and foreign portfolio investment (FPI). FDI involves an equity investment of greater than 10 per cent in a company and entitles investors to management rights and a degree of control.71 FDI can be further divided into two types: ‘the creation of new productive assets by foreigners, which is referred to as greenfield investment; and the purchase of stocks in an existing firm by foreigners with the purpose of participating in its management’.72 FPI does not entail control, but significant shareholdings may still be very important. FPI provides greater liquidity for the investor as they can more easily cash out their holdings. FPI has become increasingly important since the 1970s. High levels of FDI have significant precedents in the period before

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World War One. Measuring foreign investment requires a distinction between stocks and flows. Flows are the amount of investment coming into or going out of a country over a particular period; stocks are the total amount of accumulated investment at any point in time. As a percentage of world output, FDI stocks were 9 per cent in 1913, a figure not reached again until the mid-1990s.73 Since that time, world stocks of FDI, as a percentage of world GDP, have more than doubled to nearly 23 per cent. The United States has generally been both the biggest investor and the biggest recipient of foreign direct investment, although China challenged for the latter mantle in 2003. While investment increased in manufacturing, services and primary commodities sectors, MNCs have expanded investment in the resources sector in recent years. Around 90 per cent of the inflow into developed countries comes from other developed countries. Figures 3.4 and 3.5 show the substantial growth of FDI since the 1980s. Measuring in relation to GDP gives a much clearer picture of relative increases or declines than absolute figures, which do not take into account the increase in the size of economies. Outward FDI stock increased from 5.5 per cent of global GDP in 1980 to 28.5 per cent in 2007. It grew from 6 per cent to 34 per cent of GDP in the developed world and from 3.5 per cent to 14.9 in the developing world. The US increased its outward stock from 7.7 per cent of GDP in 1980 to 20.2 in 2007. Japan increased its stocks from 1.9 per cent to 12.4 per cent of GDP. China increased from 0.01 per cent to 2.9 per cent of GDP. Australia massively increased its outward investment between 1980 and 2007, from 3 per cent to 30 per cent of GDP. US inward stock increased from 3 per cent of global GDP in 1980 to 15.2 per cent in 2007. Japan’s inward stocks increased from 0.3 per cent to 3 per cent of GDP, and China’s increased from 0.4 per cent to 10 per cent, after reaching a high of 16.9 per cent in 1999. The Chinese economy is about twice as big in 2007 as it was in 1999, but it also shows the massive investment by the developed world in China in the 1990s. Australia’s inward investment increased from 15 to 34 per

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figure 3.4

Outward FDI stocks, 1980–2007 (% of GDP) 40 35 30 25 20 15 10 5 0 1980

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figure 3.5

Inward FDI stocks, 1980–2007 (% of GDP) 40 35 30 25 20 15 10 5 0 1980

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cent of GDP between 1980 and 2007. After reaching an historic high of $US1.8 trillion in 2007, foreign investment is likely to have declined significantly over 2008 and will decline even further over 2009. Credit restrictions, falling profits and the economic downturn will reduce incentives for new investment.74 While most countries have continued to liberalise foreign investment regulations during the 2000s, ‘others took steps to protect their economies from foreign competition or to increase state influence in certain industries’.75 Overall, while the direction of change has been overwhelmingly towards liberalisation, unfavourable changes have increased in recent years. Between 1992 and 1999, there were 888 (93.8 per cent) regulatory changes favourable to FDI and 59 (6.2 per cent) unfavourable changes throughout the world. Between 2000 and 2007 there were 1404 (88.1 per cent) regulatory changes favourable to FDI and 189 (11.9 per cent) unfavourable changes.76 International investment agreements have also continued to grow in recent years, with the total number reaching 5600 at the end of 2007, comprising 2608 bilateral investment treaties (BITs), 2730 double taxation treaties, and 254 free trade agreements and economic cooperation arrangements. Free trade agreements with investment provisions have been growing in importance and many BITs were renegotiated in recent years.77

The global financial crisis W Max Corden argues that there are four components to understanding the global financial crisis.78 The first component was the creation of excessive credit resulting from the global imbalances between surplus and deficit countries. These imbalances helped to fund housing booms in the United States and other deficit countries like the United Kingdom, Spain and Australia. The second component of the crisis was the pursuit of risky investments – the so-called search for yield or greed – which was a reaction to low interest rates. As growth continued and the housing and stock markets continued onwards and upwards, investors took more and more risks. Associated with the increase in risk

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was the principal-agent problem. Increased risk-taking brought shortterm rewards for those taking them, which then encouraged further risk-taking. Those rewarded by short-term profits don’t necessarily care about the long-term interests of firms, and they certainly do not care about financial stability. The third component, which was the development of new financial instruments or structured finance, was the ‘fatal flaw’ according to Corden. Finally, the fourth component was panic, which ‘converted a US housing market crisis into a world-wide banking crisis’.79 The financial crisis began in the sub-prime sector of the US home mortgage market. The term ‘sub-prime’ is a euphemism for high-risk borrowers. The sub-prime sector – which also includes credit cards – developed because of investor demand for higher yielding securities. Market participants even referred to some of these loans as NINJAs (these were loans taken out by people with No Income, No Job and no Assets). Take this as one example: ‘In Bakersfield, California, a Mexican strawberry picker with an income of $US14,000 and no English was lent every penny he needed to buy a house for $US720,000’.80 Traditionally, mortgages involved one-to-one transactions between banks and borrowers, and banks only gave loans to people who were carefully assessed as being creditworthy. In recent years, securitisation of mortgages has become increasingly common, that is loans are bundled together and then repackaged into securities (bonds). For sub-prime mortgages, the securities were bundled into collateralised debt obligations (CDOs). The creators of CDOs divided the securities into three investment grades – senior, junior and equity – ranging from AAA to unrated. This meant that financiers generated investment grade securities, based on sub-prime loans – a dangerous combination. Lower tranches of the CDOs – with the lowest designated as ‘toxic waste’ – earned higher rates of return but were the first to take losses. One of the big problems with securitisation, particularly in the mortgage market, was that mortgage originators, who made the original loans, took no responsibility for the loans after they had been set. This incentive structure proved volatile when mixed with Bill Clin-

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ton’s admirable desire to increase housing loans to the poor through his extension of the 1977 Community Reinvestment Act. Many of the originators – the model is known as the ‘originate to distribute’ model – pushed people into taking loans they could not afford on initially favourable terms. But the terms soon changed after a relatively short time, making it impossible for the mortgagee to continue servicing the loan. While house prices kept going up and interest rates stayed low, the unsustainability of the sub-prime sector remained hidden. This model differs from the traditional model of ‘originate to hold’. Banks liked the new model because it allowed them to push the loans off their balance sheets and expand their businesses without transgressing lending limits. Banks did not have to expand their capital base to keep making loans, which, of course, made them riskier propositions. Sometimes the banks did not fully offload the loans but created structured investment vehicles (SIVs). These SIVs were separate entities for regulatory purposes, but the banks were, ultimately, still responsible for them. SIVs funded themselves through the issue of short-term debt, which they used to ‘search for yield’, taking higher risks with leveraged capital. For hedge funds buying CDOs, typical leverage in the ‘purchase of high-yield tranches was 500 per cent. That means that $100 million of capital would be added to $500 million in borrowed funds for a $600 million investment’.81 The regulatory authorities did nothing to stop these practices. The crisis developed when the number of housing foreclosures in the United States increased rapidly. Many of the borrowers defaulted after interest rates increased and house prices declined after booming for many years. The massive increase in mortgage defaults led to the bankruptcy of many sub-prime lenders, which then undermined the collateral base of the CDOs and led to a decline in asset values. Rather than just the banks taking a hit from the mortgage defaults, CDOs had spread the damage throughout the global financial system. When the credit markets dried up in late 2007 and effectively froze after the collapse of Lehman Brothers in September 2008, it became very difficult and, for some, impossible to rollover short-term debt. As investors

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found it more difficult to get credit, they were forced to sell assets to service obligations, which then exacerbated the fall of asset prices. The consequence has been a continuing crisis of credit and increasingly expensive bailouts. As of early February 2009, the US government had made potential bailout commitments of nearly $8.8 trillion and had spent $2 trillion.82 The next stage of the crisis brought another financial product to the fore – the credit default swap (CDS). CDSs represent another layer of complexity in the development of financial derivatives. With the expansion of global finance from the 1970s, financial academics became involved in the process of unpicking ‘the various components of risk and trading them separately’.83 The first major development was in ‘options’, which are basically a form of insurance. Financiers then developed the ‘swap’ – first currency swaps, followed by interest-rate swaps – which allowed borrowers to swap fixed rate payments to variable rate payments. A CDS ‘allows investors to separate the risk of interest-rate movements from the risk that a borrower will not repay. For a premium, one party to a CDS can insure against default’.84 The problem eventuated when CDSs became a major tool of speculation. Notional amounts outstanding reached $US62.2 trillion in early 2008. To put this in perspective, total world GDP was $US54.3 trillion at the end of 2007. According to Varchaver and Benner, the market expanded so quickly because ‘you don’t have to own a bond to buy a CDS on it – anyone can place a bet on whether a bond will fail. Indeed the majority of CDS now consists of bets on other people’s debt’.85 CDSs then provided an avenue for betting on virtually anything bad that could happen on financial markets. One hedge fund, for example, made $US15 billion in 2007 using CDSs to bet against sub-prime mortgage bonds! During the good years, the numbers of CDS just kept rising with sellers unconcerned about the possibilities of widespread defaults. Regulators simply ignored the market until it was too late. Many of the bailouts have been due to unchecked CDS contracts. The $US100 billion bailout of Bank of America had much to do with CDSs, as did the $US150 billion bailout of the insurance company American

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International Group (AIG). The failure of AIG undermined the whole notion of insurance. Banks used AIG to insure them against risk that their assets would default, which meant that they didn’t have to put capital aside, allowing the banks to make even more gambles. The problem the global financial system faces in 2009 is the continuing overhang of CDSs written on companies that could fail during the recession. Until this problem is dealt with the credit system will remain impaired.86 Despite a larger notional figure, there are about $US30 trillion of contracts outstanding. We can remove about $US15 trillion from the equation because ‘winning and losing stakes offset each other’, but that still leaves $US15 trillion of contracts that could cause major problems. It is likely that the sellers of these CDSs will default if the contracts are honoured, which could mean more bailouts will be required. If the Obama administration does not remove the toxic debt in the US financial system, the financial crisis will continue to undermine economic activity. Hyman Minsky argued that financial crises are difficult to avoid because financial and economic stability eventually encourages increased risk-taking, as investors believe that ‘this time it’s different’. Those warning about the dangers of financial collapse were largely seen as doomsayers and were ignored. The danger now is a complete collapse of confidence. The financial system relies on confidence and trust. While the financial crisis has now turned into an economic crisis, fixing the economic crisis will require fixing the financial crisis. Policymakers know that this is true and will need to deal with rising popular resentment against financial-sector bailouts. According to an IMF analysis of 122 financial crises, ‘until all the losses have been recognised – not only from real estate, but also [others] resulting from the downturn in the economy – not until all the banks have been cleaned up can we find any way for recovery’.87 Other studies of financial stress show that prolonged banking crises are associated with high levels of economic disruption. Many policy-makers, investors and commentators believed that an increasingly globalised financial system would spread the risks. Instead,

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it spread the losses. The property collapse turned into a general stock market rout with the US share market suffering its second worst year since 1825.88 The causes are many and varied but in the final analysis, a lack of effective regulation and a lack of desire to do anything about the build up of debt and liquidity must take a major part of the blame for the crisis. One fund manager has called the crisis ‘the first truly global bubble’.89 At the end of 2008, the US stock market was below the level of 1997. While most financial advisers will encourage investors to stay in the market, an extended bear market is possible.90 There are ominous precedents. In 1964, the Dow Jones Industrial Average (DJIA) finished at 874.1, 17 years later it finished at 875! If we divide the twentieth century into phases, bear markets ran from 1901–21, 1929–49 and 1965–82, and bull markets from 1921–29, 1949–65 and 1982–2000.91 In the 2000s, the DJIA fell from a high point of 11908.5 in January 2000 to a low point of 7397.3 in March 2003. It rose again to a high of 13059.3 in December 2007 but in December 2008, it had fallen to a low of 8072.5.92

Moving forward The financial crisis has shown that ultimately states are responsible for financial stability. Normally, central banks are lenders of last resort, but during this crisis they have become ‘lenders of first and only resort’.93 Taxpayers have had to bear the costs. It is unlikely that policy-makers will soon revert to the belief prevalent from the 1980s that the best approach was to ‘leave it to the market’. The amount of money that has been spent by states bailing out financial institutions during late 2008 would have been unthinkable before the crisis. While some commentators believe that financial authorities should have allowed financial institutions to fail, if this had happened and governments had not intervened, the world banking system would have frozen, leading to total financial collapse. Heavily indebted countries would not have been able to rollover debt and the world economy would have sunk into a depression perhaps as severe as the Great Depression. Doing

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nothing was not really an option, and was espoused only by the most radical of economic liberals. The decisions taken by the Obama administration will profoundly affect the trajectory of global finance and the world economy generally. The United States should not go it alone because solutions to the crisis will require doing something about the global imbalances and international financial regulations. Surplus countries will need to reduce their surpluses by expanding their domestic demand, and deficit countries, including Australia, which has the fourth biggest deficit in the world, will have to save more. This is the macro level action required. At the micro level, financial authorities will need to devise new regulatory rules to limit the ability of increased liquidity to cause financial problems. When developing these new rules, policy-makers will need to be careful to restrict the development of new sources of instability as investors seek new ways to get around the rules. The world is now going through a period of intense de-leveraging, which is another way of saying that households and corporations are paying off debt and saving more. Leverage has the advantage of making existing capital go further (at least until there is a bust) and encourages investment and spending. The opposite happens during a period of de-leveraging, which of course increases the likelihood of recession and the need for more de-leveraging, and so on. Keynes called this process the ‘paradox of thrift’, wherein the prudent actions of individuals or companies to save more (and pay off debt) has the collective impact of increasing unemployment and company failure, which further induces those that can to save more, and so on. The omens are here for a long and severe downturn.

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4

Australia in Boom and Gloom

Australia is a lucky country run mainly by second-rate people who share its luck. It lives on other people’s ideas. Donald Horne1

Natural resource abundance appears to have been a blessing (as in the USA), rather than the curse portrayed in much of the growth literature. Ian W McLean2

When Donald Horne wrote The Lucky Country in 1964 he could not have imagined how widely used and defining of Australia the phrase would become, although most Australians today are probably unfamiliar with the thesis of Horne’s classic book or the ironic intent of its title. His argument that Australia had succeeded because of its luck rather than its industriousness or innovation could not deny the fact that Australia was, indeed, lucky, so it is not surprising that the irony soon disappeared from the epithet. What was surprising was how soon the luck appeared to run out when the stagflation and poor economic management of the 1970s ended in severe recession in the early 1980s. By the middle of that decade, it was common for commentators to pronounce the lucky country well and truly dead. Labor government minister Barry Jones argued in 1985 that, ‘we can no longer assume

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that minerals, wheat and wool alone will carry the “Lucky Country” towards higher living standards … We have to diversify and extend our skills base’.3 Labor Treasurer, Paul Keating, gave this new view dramatic emphasis with his infamous ‘banana republic’ warning in May 1986. The growing consensus was that Australia’s decline was a fundamental outcome of the prevalence of protectionist attitudes in Australia. Resource pessimism, based on a long-term decline in Australia’s terms of trade and a concomitant conviction about the need for a more diversified economy, played a pivotal role in justifying wide-ranging changes to Australia’s political economy in the 1980s and 1990s. It is worthwhile defining the terms of trade because it has been and remains a vital concept to grasp the condition of the Australian economy. It might be an esoteric economic term but it is a fundamental measure of boom and gloom. The terms of trade is the index-measure ratio of the average price level of exports to the average price level of imports. It effectively reflects the capacity of a given quantity of exports to pay for a given quantity of imports, and provides an important indication of the strengths and weaknesses of the economic structure. A rising or falling terms of trade indicates the possibility of improving or declining living standards, because if what we sell earns relatively more than what we buy, we will be relatively wealthier. Because the terms of trade is a ratio, increases can be a result of export prices increasing at a greater rate than import prices, or export prices increasing while import prices are declining, or export prices declining at a slower rate than import prices. Of course, a rising terms of trade doesn’t stop us from buying more things than we sell, which we have made a habit of for much of our history! Improvements in the terms of trade are not reflected directly in GDP figures, but improvements do contribute significantly to increases in national disposable income. From 1999, the terms of trade went on an almost continuous upward trajectory as a result of the resources boom. With Australia experiencing the longest period of growth in its history up until 2008, the argument that Australia needed a more diversified economy if it were to prosper in the twenty-first century was hard to sustain and

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was put to one side. But the boom has left Australia unprepared for the inevitable downturn and it has disguised the fact that the boom did not benefit everyone and helped to conceal continuing Australian vulnerabilities. Booms inevitably lead to complacency and greater risktaking; they also lead to less concern about those who are missing out. An historically informed analysis of the ups and downs of Australian capitalism – periods of boom and gloom – should make us wary of being complacent and provide us with a warning against any return to a boom-time mentality in the future. Booms do not solve, indeed they exacerbate, the fundamental recurring problem of Australian economic history, which is Australia’s vulnerability to changes in international demand and international financial sentiment. Resource booms and their aftermaths have continuously shaped economic development in Australia. All of Australia’s resource booms since World War Two have ended badly. An over reliance on resource wealth is still a precarious path for Australia’s future. Indeed, with rising concern about global warming, it is perhaps more urgent than ever to increase the diversity of Australia’s productive capacity and export profile. If the more dire consequences of warming occur, Australia needs to be prepared. Australia in the twenty-first century is perhaps more vulnerable to global forces because exposure to the outside world is the very essence of the policy structure Australia has chosen since the mid-1980s. First, however, to understand why there should have been more concern about the boom, it is pertinent to consider periods of both boom and gloom in the history of Australian capitalism.

A short history of boom and gloom Since white settlement and long before globalisation dominated the vocabularies of policy-makers and commentators, the world political economy has shaped Australia’s destiny. Australia’s reliance on foreign labour, capital and markets for exports – ‘men, money, markets’ – has shaped the cycle of boom and bust in Australian economic history. The

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establishment of a natural resource-based economy in the first half of the nineteenth century, through state support for private initiative, set the scene for Australia’s future economic development. As WA Sinclair puts it, ‘From quite early in the history of white settlement, therefore, economic life in Australia was plugged into the world circuit of economic development’.4 Australia had an abundance of land and this fitted well with an emerging global trade system wherein industrialising countries in Europe, which were population rich but land poor, increased their manufacturing output and imported raw materials and foodstuffs from Latin America, Africa, Asia and Australia.5 From the first pastoral boom in the 1820s and 1830s, through the gold rushes of the 1850s, Australia’s natural resources were a significant factor in the generation of export wealth.6 Wool and gold provided Australia with the income necessary for increasing the capacity to import and service developmental loans. Together, wool and gold accounted for between 55 and 75 per cent of Australia’s exports before 1913. After World War One, gold declined in importance, ‘whereas wool continued to dominate Australia’s export trade right up to the 1960s when it still accounted for between one-third and one-quarter of the country’s export trade by value’.7 The boom times between 1861 and 1891, like all boom times, disguised Australia’s vulnerability. GDP grew at an annual rate of 4.9 per cent (1.5 per cent per capita).8 The end of the boom was a fortuitous time to measure Australia’s fortunes, leading to the claim from Australian statisticians ‘that Australia was the wealthiest place in the world per head of population’.9 The development of statistics in Australia was the most advanced in the world, but there may have been a bit of propaganda surrounding the claim as well. Doomers in the 1980s regularly used to trot out the declaration to show how far Australia had fallen in the past 100 years.10 Undoubtedly, Australia had prospered from a combination of international demand and capital and domestic-led development, but the ensuing depression of the 1890s revealed how external developments could exacerbate domestic economic problems. During the 1880s, servicing Australia’s debt increased from 15 to 40 per

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cent of export earnings.11 An unsustainable lending and property boom in Victoria, left Australia vulnerable when the boom ended.12 When the British bank Barings nearly went bankrupt through bad deals in Argentina, British investors did the sort of wholesale reassessment of developing-country investments that has been common in recent years at times of crisis. Between 1887 and 1894, Australian terms of trade declined by 21.5 per cent.13 The substantial decline in the demand and price of commodities, and the decline in foreign sources of capital, intensified the problems caused by over-expansion in the wool industry, property speculation, banking collapse and over-investment by colonial governments in infrastructure.14 The severe drought from 1895–1903 added to the colonies’ woes and delayed their recovery. Despite the depression, the view remained that Australia was ‘a fundamentally prosperous economy’.15 In their attempts to establish the policy principles for the new Federation, Francis Castles maintains that policy-makers: set out to defend the economic structure as it presently existed … by offering all major economic sectors institutional guarantees that the economic prosperity that they now enjoyed, or rather had enjoyed before the onset of the depression, would be the first priority of public policy.16

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, which he calls ‘domestic defence’: 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.17 Protectionism underpinned the creation of a manufacturing sector of greater size and importance than would have been possible if Australia had adopted a policy of free trade, providing a fundamental source of employment and helping to establish a more diversified capitalist economy.18 High wages and controlled white immigration provided a compromise between the demands of labour and the desires for a

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larger population. High levels of male employment meant that policymakers deemed only a residual welfare state was necessary. There was little provision for those who were unlucky enough to fall by the wayside. Single women with children were particularly disadvantaged. Kelly designates this policy structure the ‘Australian settlement’ and adds Imperial benevolence – Australia’s reliance on ‘great and powerful friends’ – as integral to the structure.19 In the period from 1900 to 1914, increasing demand for Australia’s exports underpinned economic growth, the repayment of foreign debt and rising living standards.20 The recovery was not dependent on foreign investment and immigration,21 rather it was bolstered by gold discoveries in Coolgardie and Kalgoorlie, and Western Australian development generally.22 Australia maintained a trade surplus for most of the period and capital flowed out of the economy to repay the debts incurred in the 1880s.23 Alan Lougheed argues that during these years and ‘given the favourable conditions persisting in the outside world, Australia was able to experience prosperity based predominantly on her own resources, productive effort and expertise’.24 State and federal governments made efforts to diversify the economy by encouraging manufacturing, mining, the service sectors and non-pastoral land use.25 Policy-makers also established ‘home consumption pricing’ – the maintenance of higher prices in the domestic market than in export markets – in the first decade of Federation. Queensland only agreed to join the Commonwealth if the Commonwealth guaranteed a home market for sugar. The Queensland sugar industry’s demand for industry protection was linked with the White Australia Policy as a payoff in return for abandoning lower paid Melanesian labourers in favour of whites. ‘The principle of a high domestic price for farm products as compensation for a wage cost disadvantage’, AG Kenwood argues, ‘closely resembled the main argument being advanced for tariff protection for manufacturers’. Throughout the twentieth century, governments would build upon this initial agricultural protectionism by assisting rural industries through price control and stabilising prices through quotas and restricting imports.

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Higher wages paid in protected industries provided an additional incentive for British migrants. Protectionism and immigration were self-reinforcing, in that Australians saw controlled increases in the (white) population as providing domestic markets for rural and manufactured goods. An enlarged population necessitated increased employment opportunities, making a larger manufacturing sector vital. As Prime Minister, Stanley M Bruce, put it in 1926, ‘We cannot develop unless we have more population, and we cannot absorb more migrants unless we develop’.26 Once again, good times were not to last as the world descended into depression during the early 1930s, exposing Australia’s dependence on primary commodity exports and reliance on foreign capital. Rising agricultural protectionism, falling population in Europe and surplus production caused lower demand and lower prices for Australian exports in the mid-to-late 1920s. While the 1890s depression had been vastly more severe in Australia than in the United States, Canada or the United Kingdom, the 1930s Great Depression was severe everywhere. ‘Between 1929 and 1932, world imports fell by 61 per cent in value and 27 per cent in volume. Primary producers were the hardest hit as prices for their exports fell much more than those of manufactures – by over 60 per cent (and 75 per cent from 1925 to 1932).’27 Still, Australia was one of the worst affected countries. Australia’s terms of trade deteriorated by 39 per cent between 1929 and 1933, after falling by 20 per cent between 1925 and 1929.28 Increased recourse to foreign borrowing in the late 1920s accompanied the decline of Australian exports. Public debt during this period was high – about 128 per cent of GDP – because of government efforts to develop the economy through the provision of infrastructure and support.29 As EA Boehm points out, from 1929 ‘private capital began to flow out instead of in’ and this led to ‘corresponding structural adjustments in production and expenditure’.30 Rolling over debt was no longer possible after the crash of 1929. Debt servicing as a percentage of exports had once again grown steadily during the 1920s, reaching a peak of 50 per cent in 1931 and remaining over 30 per cent for most of the 1930s.31 Unemployment

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figure 4.1

Indices of Australia’s manufacturing tariff levels, 1907–40 (1919–20 = 100) (© Commonwealth of Australia reproduced by permission) 250 230 210 190 170 150 130 110 90 70

source

39 19

37

35

19

33

19

19

31

29

19

19

27 19

25

23

General Tariff

19

19

21

19

19

17

19

19

15

11

13

19

19

19

09 19

19

07

50

British Preferential Tariff

Pinkstone, Global Connections, p. 361.

reached nearly 30 per cent in Australia and governments were unable to find a way out of the downward spiral, or to alleviate the desperate circumstances of so many of their citizens. Australia, however, did recover slightly after 1932, doing better than other primary producers around the world because of its more developed manufacturing and services sectors, and superior infrastructure and education levels.32 The slide into depression led to a large increase in protection with James Scullin, the Labor Prime Minister from 1929 to 1935, bypassing the Tariff Board with a series of tariff rises. Combined with a 25 per cent devaluation of the Australian pound against sterling, the tariffrises substantially strengthened the competitive position of manufacturers against imports (see Figure 4.1). Although policy-makers lowered tariff levels after the worst of the depression was over, the depression

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confirmed the perception of the usefulness of protectionism in a time of vulnerability. Fear of mass unemployment was one of the most important legacies of the Great Depression and the need to maintain full employment dominated Australian policy concerns in the 1940s.33 World War Two showed how state planning could deliver beneficial economic results: full employment with low inflation. As the head of the Department of Post-War Reconstruction, HC (Nugget) Coombs, stated in 1944: ‘It did not take us long to discover that the working of the economic system was something within our capacity to control’.34 The desire for continuing full employment was enshrined in the 1945 White Paper on Full Employment, which stated in its opening sentence that: ‘Full employment is a fundamental aim of the Commonwealth government’.35 Though the White Paper signalled a shift in macroeconomic management away from ‘sound finance’ to Keynesian demand management, the faith in the protectionist policy structure remained constant. The war also allowed for an increase in Commonwealth power − the Reserve Bank powers became entrenched in the Commonwealth Bank Act 1945 and the Banking Act 1945; and, most notably, the Uniform Tax Agreement of 1942 transferred income taxing powers to the Commonwealth.36 World War Two provided an impetus to the development of the manufacturing sector when supply lines were cut by the Axis Powers. Australian manufacturing benefited enormously from US technology during the war, but afterwards the sector became increasingly labour intensive and inwardly focused. Nevertheless, manufacturing growth was extensive, and between 1934 and 1950, the sector’s share of GDP increased from 15.5 per cent to 25.2 per cent.37 Given the protection of the sector, this growth is not surprising, but neither policy-makers, nor business people or the unions made any real effort to develop an export-oriented manufacturing industry policy.38 In the late 1940s, Australia once again boomed because of international demand. The Korean War sparked massive US demand for wool, and by mid-1950, its price had increased by 50 per cent over

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the previous year. Combined with greater demand for metals, exports rose to 30 per cent of GDP. The boom involved the largest increase in the terms of trade in Australian history and the subsequent fall was just as spectacular. A massive increase in currency reserves and money supply led to a 25 per cent increase in prices. The Menzies Government loosened import restrictions and then, fearing a balance of payments crisis, hastened to re-impose controls. The volume of imports doubled between 1948 and 1952.39 EA Boehm reports that the recession of 1952–53 involved a decline in real GDP of 7 per cent (compared to 3.2 per cent in 1982–83 and 2.5 per cent in 1990–91).40 Despite the boom and bust, Pinkstone argues that the gains from the postwar improvement in the terms of trade combined with the larger export volumes greatly increased the country’s capacity to import, and given that producer goods accounted for around 80 per cent of visible imports in the late 1940s this considerably assisted the process of urban and industrial expansion which was taking place.41

The reinvigorated protectionist policy structure did not just apply to manufacturing and weaker rural industries, but to the financial sector as well. Despite the defeat of Chifley’s Labor government’s bank nationalisation policy in 1949, the Menzies Government when it came to power maintained the tightly regulated financial sector that had been established during the war and entrenched in the Acts of 1945. In addition to efforts to control liquidity, there were regulated interest rates, quantity and quality restrictions on loans, segmented markets, subsidised housing loans, heavily regulated access to international money markets for Australian companies and a ban on foreign banks entering the Australian market.42 Developments in the late 1940s and the early 1950s reinforced the belief that Australia’s traditional export structure was sufficient to ensure continuing prosperity. Overall, the 1960s were a time of growing prosperity for Australia, as they were for most of the developed world. Comparatively, however, Australia’s performance was poor: growth of

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GDP and GDP per capita were well below the average for the OECD.43 Much of the stimulus for economic growth in Australia came from the international arena, not only from international demand, but also from immigrant labour and the inflow of capital. Manufacturing became a significant export earner for the first time in Australian history. Exports of manufactures increased from 7 per cent of merchandise exports in 1950 to a peak of 26 per cent in 1973.44 Many of these exports, however, were in the ‘simply transformed manufactures’ category – resources that require minimal processing, such as pig iron, paper, clay bricks and plaster. A series of technological and competitive pressures undermined the post-war expansion of the manufacturing sector.45 Mineral and fuel exports increased from 3 per cent of merchandise exports in the early 1950s to over 30 per cent by the mid-1970s.46 An over-valued dollar, resulting from increases in foreign earnings from the mining sector and foreign investment in mining company shares, also undermined manufacturing. Policy-makers were often ambivalent about the future of manufacturing, given mining’s meteoric rise.47 Capital inflow fuelled the share market boom of the early 1980s and caused considerable problems for macroeconomic management. The growth of mineral exports helped reduce Australia’s reliance on agricultural exports, although agricultural exports still averaged around 50 per cent of merchandise exports between 1970 and 1975. Accompanying the shift in composition was a shift in direction. Australian trade shifted away from Britain and Europe to Japan and the United States. By the early 1970s, Asia accounted for half of Australia’s exports.48 Australia achieved a trade surplus between 1973 and 1980, but this was insufficient to reduce the worsening current account deficit (CAD).49 The 1970s were a time of turmoil for both Australian politics and the Australian economy. The Whitlam Government’s ambitious social democratic program assumed continuing prosperity, but as the mid-1970s mining boom turned to gloom and as stagflation beset the global economy, conditions for social reform became less than propitious.50 The world economic downturn would have made managing

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the economy difficult for even the most economically competent and politically united government. Unfortunately, the Whitlam Government was neither. Loose fiscal policy and a wages explosion (average wages increased by 30 per cent in 1974) exacerbated international inflationary pressures.51 Whitlam’s successor, Malcolm Fraser, continued to believe that the rural and resources industries would provide for Australia’s future.52 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 argued: In my policy speech of 1977, I said Australia could look forward to $6000 million in development. Some amazement was expressed in this – even disbelief … And now prospective development is $29000 million. This development promises to be as important to Australia and individual Australians as anything in the last 35 years. Already new aluminium smelters and mines are being established in Australia along with the associated new towns, railways and port facilities. The benefits of this will be felt nationwide.53

Unfortunately, the mooted boom failed to bring the economic windfall that some believed would present Australian policy-makers with the ‘problem’ of working out what to do with excessive trade surpluses!54 John Stone, Secretary to the Treasury, suggested that, faced with an appreciating currency because of the boom, Australia would need to lower protection levels so that the burden of adjusting to the boom would fall on the inefficient manufacturing industries. This would allow imports to flow into the Australian economy, lower the trade surplus and reduce pressure on the currency. The obvious political difficulty of this strategy was evident in Fraser’s equivocations over reducing protection. The failure of the boom to eventuate rendered the debate meaningless.55 Fraser and Stone, as well as many other policymakers, failed to realise the extent of Australia’s structural economic problems and were lulled into a false sense of security by the resource imaginary.

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The impetus for structural change The economic crises of the 1970s and early 1980s accelerated the sense of malaise and led to dire predictions for the Australian economy.56 While some commentators wanted a more market-oriented economy,57 others emphasised the need for a diversified, export-oriented manufacturing sector.58 Mining and service industries strongly supported arguments for a major policy shift away from protection. By the time of the recession of the early 1980s, the economic policy community began to envisage widespread structural change, although many wondered out loud whether Australia was up to the task.59 The situation facing the incoming Hawke Labor Government in 1983 was bleak. Inflation was high and the recession of 1982–83 was severe, with unemployment reaching 9.9 per cent. Australia’s net foreign debt more than doubled between 1980–81 and 1982–83. The early 1980s also saw the trade balance worsen as imports surged and Australia’s CAD reached 5.5 per cent of GDP, its highest level since the Korean War.60 One of the Hawke Government’s first major policy decisions – to float the dollar and abandon exchange controls – was also probably its most important. Financial liberalisation exposed the Australian political economy to the market disciplines of international finance.61 It also provided a useful rhetorical device to persuade Australians about the urgency of change. The government increasingly asserted that protectionism was preventing necessary adjustment to global changes and exacerbating Australia’s vulnerability.62 After three years in office and the restoration of growth, the Hawke Government faced a terms-of-trade crisis and the accompanying dilemmas of an expanding CAD, increased foreign indebtedness and currency depreciation. On 14 May 1986, in reaction to another poor balance of payments outcome, Treasurer Keating told Australians: We took the view in the 1970s – it’s the old cargo cult mentality of Australia that she’ll be right. 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

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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 problems … the only thing to do is to slow the growth down to a canter. Once you slow the growth under 3 per cent, unemployment starts to rise … Then you are gone. You are a banana republic.63

Although Keating was talking hypothetically, the mere use of the label shocked the financial markets and the Australian population.64 As Figure 4.2 shows, Australia’s terms of trade went into freefall after the short-lived mineral booms of the mid-1970s and early-1980s. After gradually climbing from late 1982, it again plummeted over 1985 and early 1986. The current account deficit went from a small surplus in 1973 to a deficit in 1974 from which it continued to worsen until the crisis of 1986 (see Figure 4.3). From this point, the deficit became the fundamental economic policy problem for policy-makers for the rest of Labor’s period of office. The implications seemed clear: Australia was in almost terminal decline, and external vulnerability was once again the fundamental issue of public policy. The sense of crisis framed economic policy for the rest of the 1980s, reinforcing the government’s belief that fundamental economic restructuring was unavoidable and that widespread liberalisation – beyond the financial sector – was the only realistic policy response.65

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FIGURE 4.2

Terms of trade, 1974–86 (2006–07=100) 100 95 90 85 80 75 70 65 60 55 50 1972

sourCe

1974

1976

1978

1980

1982

1984

1986

Treasury

FIGURE 4.3

Current account deficit, 1973–86 1 0 -1 -2 -3 -4 -5 -6 -7 1973

sourCe

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

ABS 5302.0 Table 85

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The recession ‘we had to have’ and its aftermath The inability to fix the current account deficit provided a continuing indication of Labor’s policy failure on terms that it set for itself. The deficit gradually improved in 1987, but the loosening of monetary policy in response to the stock market crash of October 1987 led to a lending boom, an expansion of demand and a substantial worsening of the deficit over 1988 and 1989. As the high interest-rate policy began to bite, many members of Cabinet became alarmed at the government’s policy stance. In hindsight, Keating argued that all the bureaucratic advice he received downplayed the possibility of recession, but he was steadfast in his determination to maintain policy discipline.66 With news of the recession, Keating made possibly one of the most politically stupid remarks in Australian history when he said: It is a recession that Australia had to have. The Government would not have inflicted this pain on itself, or the community, unnecessarily. The unsustainability of spending in the economy over the past couple of years had to be slowed … while the slowdown will inevitably affect the labour market and growth in the short-term, it will set Australia up for much longer-run success.67

Keating and his advisers truly believed that a recession would be good for the economy because it would help to ‘fix’ the CAD, kill inflation and set up Australia for long-term growth. In one revealing television interview, Keating adviser Don Russell cheerfully recalls how, with the final increase in interest rates, the economy finally went into recession. ‘You could feel it’, he says, ‘something snapped’.68 The following year Keating noted that, ‘frankly, the only difficulty for the government is being around long enough to see [the growth]’. To much mirth from the Opposition, he added, ‘Australia will be a low inflation and productive country with a huge merchandise trade surplus right through the 1990s. As sure as I stand here’.69 Ironically, Keating had argued in 1986 that dealing with the CAD and the increased levels of foreign debt

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did not require putting Australia into recession. ‘The no growth solution’, he had stressed, was no answer to the CAD because ‘as soon as the economy was allowed to recover the problem bounced up again’.70 Wise words, indeed. Pity he didn’t follow them.71 The government attempted to justify its harsh policy stance by focusing on the ongoing need to restructure the Australian economy in the face of global ‘imperatives’. In an all-out assault on the ‘lucky country’ mentality, Hawke stressed that the world did not owe Australians a living: This tough, increasingly competitive world of five and a half billion people does not owe, and will not give, seventeen million Australians an easy prosperity. The days of our being able to hitch a free ride in a world clamouring, and prepared to pay high prices, for our rural and mineral products, are behind us. From this fact flows everything else.72

In March 1991, the Labor government released one of the most significant policy statements of its 13 years of office. Labor significantly cut tariffs, even in the sensitive car, textiles, clothing and footwear industries. The tariff cuts broke the back of protectionism because they showed that both boom and gloom now required globalisation.73 Keating claimed, ‘with these measures we complete our transition to an open economy’.74 The 1991 recession was deep but not as severe as the recession of the early 1980s (despite much comment to the contrary). The government resisted pump priming the economy until it was already on the road to recovery. In the lead-up to the 1996 election, the Coalition increasingly 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 government.75 Yet, after the recession, the Australian economy went from strength to strength, with the exception of negative growth of 0.1 per cent in the December quarter of 2000. The Howard Government may have taken office at the most economically opportune time in Australian history, but, in

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the lead up to the 1996 election, it could argue that growth was fragile. Howard mocked Keating in 1995 by arguing: The new Coalition Government will have one unswerving, over-riding, national goal, G-R-O-W-T-H – growth – real growth, sustainable growth. Not five minutes of economic sunshine – but the solid, sustainable, long-term recovery of the national economy in which all Australians will share.76

The phrase stuck and was an elegant counter to Keating’s promises of future growth. In the lead up to the 2007 election, no one could make the same claim about what became the longest period of growth in Australian history. It was not all plain sailing for the Howard Government. In the late 1990s, Australia had to deal with the Asian financial crisis. 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.77 These statements were the residue of the mid-1980s anxiety about Australia’s primary commodity dependency because, soon after, commodity prices went on to rise almost continuously until 2008. In hindsight, the lack of a widespread technology boom in Australia was an advantage because, as Macfarlane points out, ‘We didn’t have the boom, so we did not have the bust’.78 While the technology boom and bust led to a recession in many OECD countries, in Australia a housing boom turned into a resources boom. China changed everything. While China’s voracious appetite for resources had been growing for some time, prices for Australian exports increased enormously between 2002 and 2008. As growth glided through its 17th year, many commentators argued that this boom was different because Chinese demand would continue to underpin Australian prosperity into the future.79 Once again, Australians believed that their resource endowment was a blessing rather than a curse.80

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From doom to boom to gloom Between June 1991 and June 2008 the economy expanded by just under 80 per cent, with the Howard Government presiding over a housing and consumption boom, followed fortuitously by a mining boom.81 This continuous growth had, of course, a beneficial effect on employment growth and government finances. Figure 4.4, which plots quarter-byquarter GDP growth from 1960, shows that the recession of the early 1980s was deeper than the recession of the early 1990s. It also shows the poor performance of the economy from the early 1970s to the early 1990s. From that point until 2008, the Australian economy entered its record 17-year expansion. The figure also shows that the variability of FIGURE 4.4

GDP and GDP per capita growth quarterly changes, 1960–2008 (chain volume measures) 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 GDP

GDP per capita

ABS (2008) 5206.0 Australian National Accounts: National Income, Expenditure and Product

sourCe

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growth moderated over the 1990s and 2000s. The downturn of 2001 avoided a two-quarter slip into negative territory, making this the first international recession that Australia has managed to avoid. While the Australian economy underperformed during the 1950s and 1960s and between 1981 and 1991 compared to the rest of the developed world, after the 1991 recession Australia has consistently outperformed the OECD average, as Figure 4.5 shows. Over the period 1992–2007, Australia averaged a growth rate of 3.7 per cent compared with an OECD average of 2.6 per cent. Australia’s shift down the ranks of per capita income over the 1970s and 1980s also turned around remarkably during the 1990s and 2000s. Demand from China bolstered growth, particularly in the mining sector, but also in construction and services. The mining boom and the associated increase in the terms of trade had a significant effect

figure 4.5

GDP growth Australia and the OECD 6

5

4

3

2

1

0 1981-91 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1992-2007 Australia

source

Total OECD

OECD Economic Outlook, various editions

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on Australia’s economic structure. Head of Treasury, Ken Henry, contended that policy should not attempt to resist the market signals from increased resource demand. Henry was keen to disavow concerns about increased resource dependency and associated demands for a more active industry policy.82 In some ways, the end of the mining boom lessens the urgency of the debate about economic structure. But it also shows the danger of a continuing belief that resource-sector growth is sufficient to ensure long-term Australian prosperity.

Economic structure Table 4.1 provides a picture of the contribution of various industry sectors to the GDP. The Australian economy has changed significantly since 1990. The small percentage contribution of agriculture and mining to GDP would probably surprise most Australians. Such perceptions have their origins in the more substantial contributions of both for much of Australia’s history.83 In 1901, the agriculture, forestry and fishing sector was the largest, contributing nearly 20 per cent to GDP. Next most important sectors at Federation were manufacturing, mining and dwelling rent industries, which contributed between 10 and 12 per cent. Construction and other industries each contributed 7 per cent to GDP, and services as a group contributed 31 per cent. In 1950–51, boosted by demand associated with the Korean War, agriculture contributed 30 per cent to GDP. Since its post-war high point, agriculture’s contribution has been in continuous decline. Manufacturing’s contribution doubled over the first 50 years of Federation, while mining’s share fell to 2.6 per cent. Manufacturing peaked in the late 1950s and early 1960s at just under 30 per cent of GDP and its decline since then has been considerable. The percentage of output of both agriculture and manufacturing has declined, but the value of output has not diminished. Rather, the output of other sectors has simply grown at a faster rate since the early-1960s. The services group has seen its percentage continually increase since the middle of the twentieth century to about 50 per cent of GDP.

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In 2008, property and business services was the most important industry category contributing 13 per cent to GDP, passing manufacturing at 10.5 per cent, down from 15.8 per cent in 1990. Between 1990 and 2008, agriculture declined from 4.9 per cent to 2.5 per cent and mining’s contribution rose from 4.9 per cent to 8.3 per cent, improving its percentage of GDP by a remarkable 57 per cent between 2002 and 2008. Construction also increased in importance. The role of agriculture, manufacturing and mining may be more important than these figures suggest, however, because of the dependence of many of the service industries – finance, construction, transport, and electricity, gas and water supply – on them. Ed Shann argues that if we include investment, processing and other related activities, mining is much bigger than the raw figure listed here. Up until recently, mining has contributed to rising consumption, boosted construction and spurred growth in mineral processing (classified under manufacturing).84 The resources boom also significantly increased government revenue and allowed reductions in taxation, which supported consumption.85 The same caveat also applies to employment. Mining contributed 1.2 per cent to Australian employment in 2007, with agriculture contributing 3.5 per cent and manufacturing 9.9 per cent (down from 20 per cent in 1980).86 While the contribution of mining and agriculture to GDP may be smaller than most people commonly imagine, both sectors are vastly more important when it comes to exports, as Figure 4.6 shows. Australia has always been reliant on exports of primary commodities, but part of the success story of the 1990s was the significant increase in exports of elaborately transformed manufactures (ETMs), such as cars, machinery or clothing. This improvement has ceased in recent years. Between 2001 and 2006, total manufactures declined from 31.2 per cent of merchandise exports to 25.6 per cent. ETMs declined from 21.1 per cent of merchandise exports to 16.7 per cent. Even simply transformed manufactures declined from 10.2 per cent to 9 per cent. Primary products, not surprisingly increased from 59.7 to 62.2 per cent of merchandise exports.87 In 2006, manufactures comprised 77.5 per cent of merchandise imports.

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table 4.1

The structure of the Australian economy (industry sector contribution to GDP) Industry

1990

1996

2002

2008

Percentage of gross value added at basic prices

Agriculture, forestry and fishing

4.9

3.8

4.4

2.5

Mining

4.9

5.0

5.3

8.3

15.8

14.6

12.1

10.5

Electricity, gas and water supply

3.5

2.8

2.5

2.4

Construction

6.9

6

5.9

7.9

Wholesale trade

5.4

5.6

5.2

4.9

Retail trade

6.6

6.9

6.5

5.8

Accommodation, cafes and restaurants

1.9

2.2

2.4

2.1

Transport and storage

5.6

5.5

4.8

5.1

Communication services

2.8

3.3

3.0

2.3

Finance and insurance

5.1

6.1

7.5

7.8

10.6

11.1

12.6

13.0

Government administration and defence

4.2

4.3

4.2

4.1

Education

4.5

4.7

4.7

4.4

Health and community services

5.5

6.1

6.2

6.3

Cultural and recreational services

1.2

1.4

1.5

1.6

Personal and other services

1.8

2

2.1

2

Ownership of dwellings

8.7

8.7

9.0

9.0

Gross value added at basic prices

100

100

100

100

Manufacturing

Property and business services

ABS (2008) 5204.0 Australian System of National Accounts 2007–08

source

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figure 4.6

Commodity exports contribution to total Australian exports (five-year averages) 80 70 60 50 40 30 20 10 0 1970-74

1975-79

1980-84 Agriculture

1985-89

1990-94

Mining & Energy

1995-99

2000-04

2005-07

Commodities

Averages collated by author based on ABARE (2007) Australian Commodity Statistics, Canberra, Commonwealth of Australia

source

Base metal prices increased enormously between 2002 and 2008, especially in US dollar terms, which is the currency used for most metals transactions (see Figure 4.7). They are now in decline, and early-2009 indications are that commodity prices will plummet over the year. Many forecasters predicted that prices would decline as supply increased to meet demand, but price rises continued unabated until late 2008 due to demand from China and India. Iron ore and coal prices provide an especially graphic indication of the extent of the boom.88 China’s imports of iron ore increased eight-fold between 1999 and 2007, and its total imports of minerals increased from $2.03 billion in 2000 to $13.2 billion in 2007. Between 1998 and 2008, Australia’s exports to China increased six fold and between 2005 and 2008 exports

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figure 4.7

Base metal prices index (2001–02=100) 400 350 300 250 200 150 100 50 0 1992/1993

1995/1996

1998/1999 $A

2001/2002 SDR

2004/2005

2007/2008

$US

RBA Index of Commodity Prices

source

doubled.89 Exports to India, particularly of gold, coal and copper, also expanded enormously, growing by 37 per cent in the year to 2006–07. Japan, however, remains the most important export market. Revenue from the mining sector increased from an average of 7 per cent of GDP for most of the 1980s and 1990s to 11 per cent in 2007– 08. The bulk of the increase in revenue was because of the massive spike in commodity prices. Compared to 2003–04, contract prices for coal in 2007–08 were 110 per cent higher and for iron ore 165 per cent higher. But in the following year, coal prices increased by 180 per cent and iron ore prices by 85 per cent.90 The mining boom funded a large increase in industry employment and investment but because most of the sector is foreign owned ‘most dividends and retained earnings accrue to foreigners and therefore do not add to national income’.91 Royalties and taxes, however,

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have played a significant role in the boom. Together they contributed more than one per cent of GDP in 2005–06 and probably more in following years. The significant slowdown in Asia is likely to put all the improvements in exports and revenue in reverse over the next few years, making Australia’s fiscal situation even worse. The best that Australia can hope for is that the recession is short rather than protracted, and that demand for commodities once again picks up. At the time of writing, contract prices for 2009–10 had not been set, but some analysts argued that the fall in prices could be as much as 60 per cent.92

The terms of trade Up until mid-2008, resource abundance led to significant improvements in Australia’s terms of trade. Indeed, Australia’s increase from 2002–07 was the third highest in the world; and in 2008 up until its peak in the September quarter, the terms of trade improved by a further 20 per cent.93 According to Eslake, from 1997 to 2007 improvements in the terms of trade increased ‘Australian real per capita gross disposable income by more than $3600 a year’, which shifted Australia’s per capita income ranking to eighth in the world, back to ‘where it was in the late 1950s and early 1960s’.94 Changes in the terms of trade are a key indicator of boom and gloom as variations can have important consequences for ‘consumption, savings and investment’.95 The improvement was mostly the result of increasing commodity prices, resulting from China’s growing demand and sustained demand from Japan, South Korea and elsewhere in Asia. Declining or stable import prices were also a factor. The decline in the terms of trade is likely to be severe over the coming year or so, although there is some hope that it will not return to its longerterm trend of decline. Figure 4.8 shows the terms of trade since Federation and the steep and sustained rise until recently. It also shows the previous peaks of 1950–51 and 1974, both of which were followed by substantial declines. Increasing prices for agricultural goods underpinned the mid-1970s

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table 4.2

Terms of trade – selected countries percentage change, 2002–07 Chile

78

Indonesia

1

Russia

64

United Kingdom

0

Australia

42

France

–2

Norway

38

Germany

–2

Argentina

21

Italy

–2

Canada

19

United States

–6

South Africa

13

Korea

–13

Mexico

4

Japan

–22

Turkey

4

source

RBA

figure 4.8

Terms of trade, 1901–2009 (2006–07=100) 140 1950-51

130

Sep 2008

1924-25

120 110 100

Mar 1974 90 80 70 60 50 40 1901 1907 1913 1919 1925 1931 1937 1943 1949 1955 1961 1967 1973 1979 1985 1991 1997 2003 2009

source

Treasury Data from September 2008 are Treasury Forecasts

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terms of trade boom, but the aftermath of this boom was devastating – an economic downturn, increasing inflation and higher unemployment. The shift to a floating exchange rate helped to manage the boom, but the consequence was a rising currency, which caused significant problems for ‘export and import-competing industries’, especially in the manufacturing and services sectors.96 The recent rise, which began in the mid-1990s, surpassed that of 1924–25 and even approached the heights of 1950–51. However, one of the major differences was that it was sustained for longer than previous booms because of Chinese demand. This contributed to a view that China’s continuing expansion would allow the boom to continue for even longer. Nevertheless, from late 2008 the terms of trade went into reverse, despite most policy-makers believing right up until this time that it would continue to rise into 2009 and beyond.97 Treasury Secretary, Ken Henry, argued that resource demand would protect Australia from a US recession: ‘It certainly used to be the case that the Australian economy used to go into recession if the US economy did. I don’t think that’s any longer the case’.98 Labor’s pre-election foreign affairs spokesperson Robert McClelland concurred, contending that, ‘The recent dramatic increases in Australian mineral and coal exports represent just the beginnings of this “resource boom”.’99 The chief executive of BHP argued that, ‘the industrialisation and urbanisation that has driven China’s growth will continue for several decades as billions of people strive for a better quality of life’.100 Treasurer Peter Costello argued in 2007 that, ‘our terms of trade will moderate, but will not be in long-term decline, which was the story of the twentieth century’.101 While many of the assertions of China’s continuing growth are probably correct for the medium term, many business people and policy-makers assumed that its growth path would be uninterrupted. In a speech given in September 2007, Henry argued that a strategic focus for policy advice should be centred on ‘medium-term (“over the horizon”) opportunities and vulnerabilities’. While there was a focus on ‘the implications of the Australian economy operating at close to full employment and experiencing its highest terms of trade in more than

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half a century’, there was no mention of the possibilities of Australia’s vulnerabilities to a global downturn or a substantial decline in the price of commodities.102 Economic policy-makers were too focused on dealing with the ‘problems’ of the boom and just did not appear to countenance the possibilities of gloom. Looking over the Treasury and Reserve Bank websites before the crisis, it was difficult to even find mention of Australia’s vulnerability to a severe economic downturn. The boom caused even the most cautious of analysts to gush, but a flick through any economics textbook or a cursory glance at the long-term terms of trade graph should have given reason to temper the hyperbole. One hopeful ‘benefit’ of its decline will be a reminder that Australia cannot rely on resource exports to sustain its prosperity into the future. While some business people and commentators waxed lyrical about a resources ‘super-cycle’, built around Chinese industrialisation, the long-term trend of industrial commodity prices has been downwards over the past 150 years, despite some significant spikes.103 According to John O’Connor, David Orsmond and Max Layton, ‘commodity prices have fallen by roughly one-half relative to consumer or GDP prices over the past century, compared with a decline of about one-quarter relative to manufactured goods prices’ and, despite recent rises, the real commodity price index ‘level is still far below that of a century ago’.104 The global financial crisis has obviously exacerbated the end of the boom, but this fact simply reinforces the notion that Australia always remains vulnerable to changes in international demand and global financial sentiment. The response should not be an embrace of closure or restriction but a recognition that a diversified economy should continue to be the aim of policy.

The coming transformation? One of the major issues for coming years will be the need to take action on climate change. The global financial and economic crises have altered the parameters of this task. Over the next few years, recovery and

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re-regulation of financial systems will take priority, but governments can and should multitask. Effective action to reduce carbon emissions will eventually have a substantial impact on Australia’s export structure as Australia and other countries attempt to reduce the amount of carbon released into the atmosphere. Coal is Australia’s most important export and major fuel for electricity generation. Given the importance of coal as a fuel source throughout the world, it is likely that demand for coal will continue and will grow when global growth returns. But over the longer term, if the world is serious about reducing emissions then restricting the burning of coal will be a major factor. This will be a big task. Coal accounts for around 50 per cent of electricity output in the United States and Germany, 70 per cent in India and 80 per cent in China and Australia. The possible rewards for developing new energy sources, improving the efficiency of renewable sources, especially solar, or clean-burning coal could be huge. Major states, including those from the developing world, will also need to take scientific claims about climate change seriously in order to develop a global strategy to cut emissions. But there can be no guarantees that other countries will take effective action or even whether calamitous climate changes can be averted if they do. While it will be beneficial if countries such as China and India, and of course the United States, make substantive progress on reducing the pressures on climate change, it seems obvious that the major focus should be on adjustment. Ross Garnaut argued in the light of the Victorian bushfire tragedy of February 2009 that Australia was the most vulnerable country in the developed world when it came to climate change. It seems evident that southern Australia is getting hotter and governments and populations will have to adjust. Dealing with climate change will require a judicious balance between intervention and market forces. A fundamental shift to a lowcarbon economy will require a dramatic regulatory transformation that attempts to reshape the Australian economy’s carbon polluting fundamentals. There are many political impediments to this restructuring process. Australia is still reliant on resource exports to earn foreign

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exchange and any changes will come up against powerful business and labour interests. It will also come up against popular concerns that Australia is sacrificing its living standards. Many of Australia’s manufacturing processes are dependent on coal-fired power stations and many Australians would not be prepared to pay higher prices for petrol. The Rudd Government has stated that it is serious about lowering carbon pollution and plans to introduce an Emissions Trading Scheme (ETS) in 2010 to reduce emissions. The ETS, however, seems so weakened by compensation that it is unlikely to provide much of an incentive to lower emissions. Now with the global recession clearly affecting Australia, business and unions are pressuring the government to delay its implementation. But even with a higher target, it is unclear whether the scheme would not be subject to fraud, corruption and trading manipulations, particularly when Australian firms are allowed to substitute higher Australian emissions for lower overseas ones, especially in developing countries. There is also the vexed issue of measurement of emissions. The scheme has also been rightly criticised for being too complex, difficult to police and providing a significant role for financial markets in pollution reduction. A tax and outright regulation would be a much more effective and adaptable strategy for the government to follow. Alas, this seems very unlikely. One of the most persuasive arguments of the regulatory transformation of the 1980s and 1990s was that Australia would benefit from liberalisation regardless of what other countries did. For an advanced economy like Australia, it was clear that market signals would lead to a more efficient allocation of resources away from protected industries. While a similar argument can be put that Australia will reap benefits by finding alternatives to high polluting industries regardless of what other countries do, economic liberals do not support this argument. Instead, the argument is that if the Australian government imposes costs on polluting industries while other countries impose no extra costs on theirs, then they will undermine growth in Australia. It is possible that events could overtake caution. If even some of the calamitous predictions about the impact of climate change come to frui-

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tion, there will be no choice but to adapt. A farsighted climate change strategy would involve supporting those industries in the emerging renewable energy sector, supporting both research and commercialisation. It would also focus on supporting industries associated with adaptation, such as dry-land agriculture and coastline defence. Whatever happens, a diversified economy and egalitarian society will be better able to adjust and to cope with climate change.

The lucky country revisited Underlying and driving the information revolution are two powerful tides that are rocking the power structures of the world: The first is the vast increase and swift and widespread dissemination of knowledge and information of all sorts. The second is the increasing importance of knowledge in the production of wealth and the relative decline in the value of material resources.105

Things change. And then they change again. In the late 1980s when Walter Wriston was eulogising about the end of the industrial revolution and touting the beginning of the information age, Australia appeared to be doomed unless it weaned itself off a reliance on resources. But Wriston was simply pointing out a long-term trend in the world economy – the relative decline in the price of mineral and agricultural products and the relative increase in the price of manufactured goods and services. In fact, the rise of Japan, followed by South Korea and Taiwan, Singapore, Malaysia, Thailand and other non-communist countries of Southeast Asia had provided significant export markets for Australian commodities, though not a sustained structural increase in the value of commodities. Then along came China, seemingly changing everything by reversing the long-term structural decline in Australia’s terms of trade. Not only did Chinese demand increase the price of Australian exports, but it also decreased the price of Australian imports. Manufactured imports became cheaper − just think about the prices of electrical goods over the past few years. Remember that the terms of trade is a

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ratio (or fraction) and so can be affected by both the numerator and the denominator. The longer-term verdict on the terms of trade will have to wait until the world and Asian economies recover from the global recession. But there can be no denying that Australia has been lucky to be in a position to take advantage of China’s industrialisation and to be located near the Asian region. Similarly, the severe downturn in Asia will now negatively affect Australia. The world economy provides both opportunities and risks. It makes us vulnerable but it also brings rewards to those who can adapt. Former RBA Governor Ian Macfarlane has argued that ‘if you only had one economic variable to predict the future direction of the Australian economy, the one you would choose would be the path of the world economy’.106 This is not a recent insight. Writing at the time of the last recession in 1991 and about a less globalised Australian economy, Bob Gregory argued that ‘world economic events are the predominant influence on Australia [and] the economic policy performance of Australian governments cannot be assessed without reference to the world environment’.107 Australia benefited enormously from the so-called ‘great moderation’ – the long period of stable growth and low inflation that underpinned prosperity throughout the world during the 1990s and most of the 2000s.108 But once again things have changed and this period is now over. Australian policy-makers must now manage this new adversity with an eye on Australia’s vulnerabilities. The risks of increased global engagement are worth it, but all Australians need to share the benefits of these risks, as well as the costs. Despite shortcomings in managing periods of boom throughout Australian history, policy-makers did manage to redistribute the wealth generated by resource abundance. In the beginning this redistribution through the protectionist-policy structure might not have been efficient, but it did generate political stability, enabled us to see ourselves as an egalitarian society and ensured that Australia’s resource abundance was a blessing rather than a curse. Australia has benefited from its luck because of political interventions, not despite them. But failure to recognise Australia’s long-term vulnerabilities has been a major

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shortcoming of Australian politics in recent years, and it is pertinent to end this chapter with the words of Donald Horne: ‘It’s quite appalling to discover people saying today that Australia is still the lucky country because we have all these minerals … There’s still a lucky country mentality’.109

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5

Asia, Anxiety and Opportunity

Today we live at the dawn of the Asia-Pacific century. With it comes the potential for fundamental change in the global order, resulting in both economic opportunities and potential security concerns for Australia. Kevin Rudd1

Australia’s relationship with Asia began the twentieth century marked by anxiety about the region’s teeming millions of people and ended the century with optimism about Asia’s boundless billions of business opportunities. At the very start of the twenty-first century, Australians fixed their gaze on China and its seemingly endless demand for Australian resources. But by late 2008 it became more and more obvious that Chinese demand had peaked and that the boom was well and truly over. As crisis took hold in 2009, the China boom, and Australian reliance on it, looked shaky, at least in the short-term. Some commentators foolishly argued that China had decoupled itself from Western growth and that it wasn’t an export dependent economy anyway. Too many policy-makers and commentators believed that China was re-writing the rules of capitalism, that it was immune from cycles of boom and gloom. They ignored the vulnerability of Asia to a global downturn and the resulting effects on Australia. The change in Asian fortunes will hit Australia particularly hard. A number of scenarios could adversely affect Asian growth: politics and

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the environment could intervene to stop China in its tracks, conflict or social unrest could undermine economic integration and development, or growth could simply slow down. There is a danger, however, that after a period of excessive optimism we might err in the opposite direction. In all likelihood China and the rest of Asia will continue on their growth path when the world economy eventually recovers. When they do, Australia will once again be a major beneficiary. What matters is working out the balance between opportunities and vulnerabilities. Opportunities for Australia in Asia extend well beyond just China. During the boom Japan remained our most important export market. India before the downturn was becoming vastly more important, and the ASEAN countries combined were just slightly less significant than China in terms of exports in 2008 (12.5 per cent vs 13.5 per cent). Nevertheless, it is the growth of China that has captured the public’s attention and China is now our single largest overall trading partner, accounting for 13.2 per cent of total trade (ASEAN accounts for 16.7 per cent of total trade).2 The principal absence in Australia’s economic relationship with Asia is investment. Most Australian investment still goes to and comes from the United States and the United Kingdom. If we combine trade and investment together, the United States is Australia’s most important economic relationship. Increasing investment in Asia will enhance the integration of the Australian economy with the growth economies of the region. Governments need to do more to encourage investment in Asia. More investment will encourage further service exports to Asia, thereby helping to diversify Australian exports. Governments will also need to manage negative reactions to rising Chinese investment in Australia over coming years. To reduce Australia’s vulnerabilities in Asia, Australia must become more than just a supplier of natural resources for Asian industrialisation. When it does supply those resources, policy-makers need to be aware of the strategic economic approaches of Asian countries in their attempt to control prices and supply.3 Asian policy-makers and business have less faith in the market, and often join together to seek advantage in negotiations with individual

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Western companies, particularly with those that supply resources. Phenomenal Asian development has benefited Australia perhaps more than any other developed country, but Australian governments will need to ensure that this benefits all Australians so as to avoid a return to Australia’s anxiety about Asia. Policy-makers will need to utilise any future largesse from Chinese and wider Asian growth more wisely than they did during the 2000s. The pitiful surplus built up during the boom means that Australia will need to go into significant deficit to counteract the effects of recession in Asia.

Anxiety about Asia Trade with Asia was an important source of goods and foreign exchange for the first 30 years of Australia’s white settlement. Blainey recounts that at this time, ‘Australia seemed to be a satellite of India as well as a colony of England’, with ships from Bengal providing food and that essential staple of early Australian life – rum. ‘Bengal rum, said to be stronger than Jamaica rum and not so sweet, was Australia’s first national drink and at times a form of national currency’.4 While authorities attempted to limit the amount of rum coming onshore, an early judge advocate of the colony reported, ‘such was the avidity with which it was sought after, that, if not permitted, it was generally got on shore clandestinely; and very few ships carried back any of what they had brought’.5 The East India Company’s trade monopoly, which lasted until 1834, restricted Australia’s direct trade with Asia, but did not stop it. Large profits encouraged clandestine truck and barter, often through American intermediaries. In the search for foreign exchange to pay for imports, settlers shipped whatever they could, including timber, coal, ‘curios’, ‘natural history items’, kangaroo and other skins, seal oil, pearlshell, trepang and sandalwood.6 According to Butlin during the 1810s, there were ‘very large volumes of Asian goods at auction, wholesale and retail, in Sydney and specialised Asian “bazaars”’. After 1820, however, British goods increasingly replaced Asian ones.7 The rapid expansion of

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the wool industry from the 1830s led to a significant increase in exports to Britain, but until the take-off of Japanese industrialisation in the late nineteenth century, Australian exports to Asia were restricted to coal, flour and sandalwood. In the first half of the nineteenth century, some Australians believed that the importation of large numbers of Chinese ‘coolies’ could solve the colonies’ endemic labour shortages. Early plans for Australia’s settlement had canvassed the idea and Edward Gibbon Wakefield, important in the establishment of the colony of South Australia, believed that coolie labour could turn ‘wilderness into gardens’.8 Pastoralists, finding it difficult to get workers to oversee their growing properties, also lobbied hard for cheap labour. In the late 1870s, the South Australian Government proposed to open up the Northern Territory to comprehensive Japanese immigration after the failure of small-scale efforts to attract Chinese and Afghani settlers. SH Roberts outlines how Premier Blyth planned to transport ‘all classes of Japanese’ – labourers, farmers and aristocrats – ‘and it was declared again and again that their position was not to be that of the Chinese coolies … they were to have their own lands … and were to enjoy all the rights they had in their native land’.9 Despite considerable planning and negotiation, nothing ever came of the scheme, and given the level of popular hostility to Asians, it is not surprising that the scheme failed to attract the support of the public. The arrival of significant numbers of Chinese, as indentured labourers after 1848 and as prospectors on the goldfields after 1851, caused increasing friction with Anglo-Celtic miners. By the late 1850s, there were 42,000 Chinese in Victoria alone.10 Their success in ‘tailing’ – the practice of sifting discarded and neglected diggings – led to riots and persecution. Despite all this, a small but growing trade with China served Chinese immigrants, and European settlers became keen buyers of Chinese goods. Melbourne became an important centre in the tea trade, and tea and sugar accounted for a growing trade deficit with Asia. Anti-Chinese sentiment flared again in the 1870s with new gold discoveries in Queensland. At this time, one in seven settlers in

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Queensland was Chinese.11 Determined to put a halt to the influx of Chinese immigrants, all Australian colonies had banned Chinese immigration by the late 1880s. There was to be no Chinese influx into the Western Australian gold boom at the turn of the century. Concerns about Japanese immigration also rose as Japan opened up to the world in the late nineteenth century.12 There was also significant opposition to the use of South Pacific labour in Queensland’s cane fields. That colony’s eventual decision to join the Federation was predicated on the acceptance of tariffs to protect the sugar industry in the absence of cheap Pacific and Asian labour. White Australia’s increasingly hostile attitude to Asia and Asian immigration in the latter part of the nineteenth century restricted the growth of trade, as did the preference for British goods, such as British grown tea from India and Ceylon. By 1890, despite a period of considerable boom in the colonial economies, Asia’s share of exports was only 1.6 per cent of the total.13 Some argued that buying from Asia was unpatriotic. Newspapers criticised housewives for buying cheap Chinese goods. As one mocked at the time, ‘the teapot will substitute the decanter … it will be green tea and there will be neither milk nor sugar but we shall drink it with a smile on our faces’.14 The Immigration Restriction Act 1901 – the White Australia Policy’s (WAP) official title – was the first major piece of legislation passed by the newly federated Australian Parliament.15 Hostility to Asia pervaded all levels of Australian society. Australia’s first Prime Minister, Edmund Barton proclaimed in Parliament: I do not think that the doctrine of the equality of man was really ever intended to include racial equality. There is no racial equality. There is that basic inequality. These races are, in comparison with white races … unequal and inferior.16

British concern about the WAP’s direct banning of non-white immigration and Japanese sensitivities to such overtly racist exclusion led the Australian government to introduce a dictation test, which could be conducted in any European language: failure to pass the test led to

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exclusion.17 Alongside official instructions was a secret provision on how officials should conduct the test: All aboriginal inhabitants of Africa, Asia and Polynesia should be subjected to the test … In the case of White Races, the test will be applied only under special circumstances … If in your opinion the immigrant would, for reasons which you would be prepared to state, be an undesirable immigrant, it may be better to substitute for the English test a passage from some other language.18

The WAP had widespread support and it was enshrined in the Federal Labor Party program of 1905. Workers saw cheap non-white labour as a threat to their level of wages, so unions acted to restrict the supply of labour in particular trades and to use labour shortages to maintain wages and conditions.19 Workers had established the principle of labour restriction in the interests of higher wages early on in Australia’s development. Blainey argues that nineteenth century colonial parliaments, influenced by newly enfranchised men, stopped the subsidisation of assisted immigration passages to Australia through colonial land sales to keep wages high.20 Even earlier, free settlers and ex-convicts had complained about the impact of convict labour on wages and conditions. The WAP, however, went beyond a concern for wages into a belief system encompassing both fear and racism. Asia-anxiety produced a contradiction in Australian society between workers’ aims to restrict the supply of labour and the perception that Australia needed a larger population to reduce its vulnerability. World War One enhanced the appeal of the WAP. In 1919, the Prime Minister, William Morris Hughes, hailed it as ‘the greatest thing we have achieved’. Hancock’s Australia, published in 1930, argued: The policy of White Australia is the indispensable condition of every other Australian policy. Embodied in the Immigration Restriction Act, 1901-1925, its intention and significance are exceedingly easy to understand once they have been freed

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from the rhetoric and special pleading in which they have been enveloped. During the debates of 1901, the rhetoricians declared that it would be unfair for a ‘nation of yesterday’ (China) to interfere with the ‘noblest race upon this sphere’ (the Australians). They even doubted whether some European nations, such as the Italians, were ‘civilised in the ordinary Australian sense’. However, their immediate concern was with black men and yellow men.21

The rise of Japan and World War Two Geographically with her wheat lands near the coast, Australia is better situated to supply an industrialised Asia with foodstuffs than are the mainland prairies of America or the steppes of Russia.22

During the early years of the twentieth century, Japan replaced China as Australia’s greatest Asian fear. Japan’s military defeat of China in 1895 and Russia in 1905 showed that Japan was a rising power. Despite Britain and Australia being more concerned about Russian expansionism, Japan’s naval defeat of Russia was no comfort to Australia, on the contrary, it made many Australians more wary about their isolation. From 1902 until 1921, Japan was a British ally. Britain saw a formal alliance as one way to solve its strategic problems in the Pacific as its global reach declined. It provided a temporary solution to Britain’s anxiety about Russian expansionism and allowed them ‘to do without a fleet in the Pacific’.23 Australia, however, did not share Britain’s faith. As one commentator remarked at the time, ‘Japan has ulterior motives. Her policy can be summed up in one word – expansion … Japan has no love [for] the white man, not even of her British ally’.24 Australia’s increasing insecurity and Britain’s declining power led Australia to seek closer ties with the new rising power of the Pacific, the United States. In 1908, against Britain’s wishes, Australians celebrated the visit of the ‘Great White’ US fleet to Sydney. The US Navy

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had painted the fleet white as a symbol of peace, rather than racial affiliation, although the symbolism was probably appropriate for white Australia. The universally positive reception to the US fleet provided a contrast to the mixed reception to the visits of Japan’s fleet in 1903 and 1906.25 Prime Minister Alfred Deakin argued that, ‘[t]he visit of the United States fleet is universally popular here, not so much because of our blood affection for the Americans … but because of our distrust of the yellow race in the North Pacific’.26 Deakin proclaimed whiteness as our link to the Americans and proposed ‘an extension of the Monroe Doctrine to all the countries of the Pacific’.27 Events at the 1919 Paris Peace Conference at the end of World War One further tested Australia’s relations with Japan. Japan wanted a racial equality clause inserted into the new League of Nations Covenant but Hughes saw the clause as a threat to White Australia and fought to have it rejected. Hughes won the day, despite the fact that the British made considerable effort to placate the Japanese. On return to Australia, Hughes pronounced to the Australian population: The White Australia is yours. You may do with it what you please, but at any rate, the soldiers have achieved the victory and my colleagues and I have brought that great principle back to you from the conference, as safe as it was on the day when it was first adopted.28

Hughes also resisted US President Wilson’s plans to allow the League of Nations to be responsible for German New Guinea because he did not want Japanese immigration to an island just off the coast of Australia. Despite these rebukes to its sensibilities, Japan was shaping as Australia’s most important Asian export market. Exports of wool grew as Japan industrialised and militarised. Japanese imports increased nine-fold between 1913 and 1919, and exports to Asia increased from 5.6 per cent in 1913 to 9.2 per cent in 1919 (imports from Asia increased from 3.7 per cent to 12.9 per cent with Japan as the major Asian trading partner).29 Trade with Japan and the rest of Asia continued to expand in the 1920s.

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With the world economy in depression, Britain abandoned free trade and developed a system of Imperial Preference with the aim of increasing inter-Empire trade. The Ottawa Agreement of 1932 created a British trading bloc, providing markets for Australia’s rural producers. Many in Australia thought the deal too heavily biased towards Britain, but the Minister for Trade and Customs HS Gullet countered: ‘our industrial position and wage standards are wholly due to our White Australia policy and … this policy could not have been maintained for any time had it not been for the might of Great Britain’.30 Others in Australia, especially wool and wheat growers, worried about the impact of Imperial Preference system on growing Asian trade. Japanese trade – mostly wool and wheat – had increased significantly between 1928 and 1933, and a Bank of New South Wales report from 1934 stated that: Australia needs markets for her primary products. The great potential markets for these products are the Far Eastern countries … China is at present the largest buyer of our wheat and Japan the largest buyer of our wool.31

Alongside increasing anxiety about Japanese militarism, the major impediments to increasing trade were Australia’s servile attitude to Britain and the concerns of Australian manufacturers and protectionist policy-makers about low-cost Japanese competition. Australia sent a trade delegation to Japan in 1934 and in early 1935 established a trade post in Japan, but it refused Japan’s request for a trade treaty. In 1927, Australia had informed Japan that it would not sign the Anglo-Japanese Commercial Treaty of 1911 or its supplement of 1925. Japan, however, continued to push Australia to sign a commercial treaty. The Ottawa agreements, which created an Empire trading bloc and gave Australian exporters privileged access to British markets, had made a treaty more important for Japan because the agreements had raised tariffs against Japanese imports.32 While it may seem understandable with hindsight that Australia would not agree to a treaty in the light of Japan’s enemy status from 1941, Japan already had commercial treaties with Britain, Canada, New Zealand and Ireland.33 Even in 1935, with Japanese mili-

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tarist expansionism evident, a major study of Australian-Asian relations reported: On the whole, then, the present position of Austral-Japanese relations is distinctly healthy. At the moment, all emphasis is on trade relationships, and this is preferable to the stage of a decade ago, when national feelings were being openly paraded. Trade disputes can be kept within bounds, but nothing can restrain emotional patriotism, especially when brought into play between peoples of different colour and traditions.34

Australia’s subsequent policy of ‘trade diversion’ in favour of Britain – the Lyons Government’s attempt to strengthen the Ottawa bloc – further damaged Australia’s trade with Japan and another increasingly important trading partner, the United States. Prime Minister Joseph Lyons was so concerned about Japanese textile imports into Australia that he made great effort to inform British producers of the fact. In 1936, the Trade Minister, Gullet, informed parliament that Australia was embarking on a new trade policy, whose object was ‘increasing our exports of primary produce, expanding secondary industry and bringing about a considerable increase of rural and industrial employment’.35 The practical outcome of the policy was to raise tariffs on Japanese and US imports. The minister argued that the policy diverted trade from ‘bad’ to ‘good’ customers, but this was ridiculous given that Australia ran a substantial trade surplus with Japan.36 The policy only lasted until late 1937, but the damage to Australia’s Asia-Pacific trade was severe. Hitherto, Japan had relied on Australia for 95 per cent of its wool imports and 75 per cent of its wheat imports.37 The Japanese responded by restricting the import of Australian wool in favour of more expensive and lower quality South African wool. They also restricted all other Australian imports. Australia then retaliated by increasing tariffs on Japanese imports. In 1938, Australia banned exports of iron ore – a policy aimed primarily at Japan. Although the dispute was soon settled, Australian exports did not recover in the years before the outbreak of war. Between 1936 and 1939, Australian exports

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to Japan declined from ₤17.7 million to ₤4.9 million and Australia’s surplus with Japan switched to a deficit. Trade with the United States also suffered.38 The overall result was a deepening of Australia’s trade dependence on Britain and a boost to Australian manufacturers. Australian output of steel, for example, increased three times over the 1930s.39 Trade with Japan continued even after the outbreak of war in Europe, despite the fact that Japan and Germany were allies. Eventually Australia agreed to sanctions against Japan, freezing Japanese assets in July 1941. From 9 December 1941, the Trading with the Enemy Act forbade further trade with Japan. World War Two was very significant because it made it clear that Australia could no longer rely on the British for protection. Realising the full extent of British impotence in the region, Curtin argued that: I make it quite clear that Australia looks to America free of any pangs as to our traditional links or kinship with the United Kingdom …we shall exert all our energies towards the shaping of a plan, with the United States as its keystone which will give to our country some confidence to be able to hold out.40

During World War Two, Australia swapped one ‘great and powerful friend’ for another. General MacArthur took control of Australian forces and set about defeating Japan in the Pacific. The Japanese bombing of Darwin, Broome and other targets across northern Australia between 1942 and 1943 brought war to Australian shores and resulted in the loss of 900 lives. The most important battles ever fought by Australian troops took place in New Guinea; the defeat of Japan there was essential to protect Australia from further Japanese aggression and possible invasion. The fall of Singapore, the Burma railway and the images and stories of Australian prisoners of war made Australians particularly hostile to Japan in the aftermath of war.

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The post-war world The defeat of Japan provided an end to Japan’s hegemonic ambitions and an end to one source of Australian anxiety, although many Australians saw Japan’s rise to power as a warning for the future. The victory of the communists in China in 1949 combined an old fear with a new one. The most populous country in the world had joined forces with the Soviet Union and Eastern Europe in a burgeoning communist sphere of influence vehemently opposed to the capitalist West. Labor Immigration Minister Arthur Calwell utilised an earlier slogan, ‘populate or perish’ and proclaimed that Australia had ‘twenty-five years at most to populate this country before the yellow races are down on us’.41 This tied in with arguments about post-war economic development and, once again, policy-makers made connections between industry protection and population growth. Yet despite the perceived desperate need for a larger population, Australia’s Anglo-Celtic policy-makers continued to discriminate against non-white immigrants. Post-war immigration continued to take place under the rubric of White Australia, officially defined by the phrase: ‘In pursuance of the established policy, the general practice is not to permit Asiatics or other coloured persons to enter Australia for the purpose of settling permanently’.42 Nevertheless, Anglo preferences were relaxed and large numbers of southern and eastern Europeans were amongst the million-plus migrants who came to Australia between 1945 and 1959. The most intense period of migration was between 1947 and 1951 when Australia received a net inflow of just fewer than half a million people.43 There were some positives in the relationship with Asia. After the war, Australia supported Indonesia independence from the Dutch, and in 1950, Australia allowed Asian students to enter the country under the Colombo Plan. But Australia’s primary focus soon centred on securing a US security commitment. The government and most Australians, however, disagreed with the United States’ easy peace treaty with Japan signed in 1951. In 1950, Australia rushed to join the United States in

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fighting alongside the South Koreans against the communist North Korean forces. Roger Bell argues that the United States agreed to the ANZUS alliance ‘because it paved the way for a “soft” peace settlement with Japan, and provided another link within a broad anti-communist network in Asia’.44 The External Affairs Minister Percy Spender argued on the other hand that the United States had agreed to the alliance because of Australia’s commitment of troops to Korea. Despite most Australians’ negative sentiments about Japan, exporters were keen to reinvigorate the trading relationship. The United States occupation of Japan meant that it was firmly in control of Japanese commercial dealings and Australia continued to damage its prospects for increased Asian trade by maintaining preferences for British trade. The Australian government signed a 15-year trade agreement with the United Kingdom allowing Australian meat exporters to export only three per cent of the exportable meat surplus to other countries.45 Percy Spender, remarked in Parliament, ‘Australia has a population of approximately 7,000,000 and to the North are the coloured peoples of Asia numbering 1,000,000,000 … our primary task is to re-establish the British people throughout the world’.46 Developing new trade ties should not come, he said, at the expense of the British. Empire loyalty overrode the obvious fact that Australia’s trade with Britain was in decline and that opportunities in Asia were on the rise. By the mid-1950s, it was clear to many policy-makers, even if not to Prime Minister Robert Menzies, that Australia needed to move on from its subservient economic relationship with Britain. The policy-maker who was most important for this reorientation was the Trade Minister, John ‘Black Jack’ McEwen. McEwen overrode hostility to Japan in the Australian community by signing the Australia-Japan Commerce Treaty in 1957. The treaty tied Australia economically to what was at the time the fastest growing economy in the world. McEwen argued that Australia could no longer rely on its ‘great and powerful friends’ for economic favours. Australia’s economic relationship with Japan grew considerably over the following decades with Australia supplying many of the raw materi-

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als for Japan’s rapid growth as a manufacturing power. Japan grew at an annual rate of 10 per cent in the 1960s. The increased receptivity to Japan signalled that there were often crosscurrents in Australia’s relationship with the region – lingering hostilities from the war and anxieties about the rise of Asian communism, but a growing realisation that Australia was a major beneficiary of Japanese industrialisation. In 1964, the Minister for External Affairs announced, ‘Friendship with Asia, reciprocal trade, closer cultural relations and a clearer understanding of Asia and its people are at the forefront of Australian policy’.47 Friendship, however, didn’t extend to all in Asia. Fierce anti-communism had a profound impact on Australian domestic politics and also shaped foreign policy in Asia. In 1954, Australia, France, Great Britain, New Zealand, Pakistan, the Philippines, Thailand and the United States created an anti-communist coalition in the region called the South East Asian Treaty Organisation (SEATO), but it was never very effective because of significant differences of opinion between members over the Vietnam War. SEATO was finally disbanded in 1977 after Pakistan left in 1973 and France in 1974. In 1965, Menzies committed Australian troops to Vietnam to fight alongside the United States against the communist forces of North Vietnam. Prior to Vietnam, Australia had been extremely worried about developments in Indonesia where President Sukarno was increasingly allied with the Indonesian Communist Party. There were also concerns about the communist insurgency in Malaya. Anxieties about Asia had become inextricably intertwined with ideological concerns about the possible domino effect of Asian communism. Menzies argued that: The takeover of South Vietnam would be a direct military threat to Australia and all the countries of South and South-East Asia … It must be seen as part of a thrust by Communist China between the Indian and Pacific Oceans.48

Vietnam was the first war Australia had fought without Britain and signalled the unequivocal replacement of Britain by the United States as Australia’s most important ally.

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The decline of British Australia The WAP was a major impediment to Australian-Asian relations. There had been some minor concessions to Asian immigration in 1949 when Australia allowed the entry of non-European refugees and Japanese war brides but the first major breakdown of the WAP occurred in 1957 when Australia allowed non-Europeans who had been living in Australia for 15 years to stay in Australia. The following year the government abolished the dictation test. In 1961, the new editor of the Bulletin – Donald Horne – removed the slogan ‘Australia for the White Man’ from its masthead: the slogan had graced the front cover since 1905. After replacing Menzies, Harold Holt removed discriminatory elements of Australian immigration law and between 1966 and 1971 non-European migration increased from 746 a year to 2696. Although the Whitlam Government reduced overall immigration as a response to the economic downturn, it legislated to enable all migrants to become citizens after three years and instructed all overseas immigration posts to disregard race as a criterion for settlement. The Fraser Government removed all vestiges of the policy from the statute books and allowed the entry of a large number of Vietnamese refugees.49 This influx of Vietnamese was the first significant migration of Asians to Australia since the nineteenth century. Although New Zealand and British migrants remain the two largest groups from any one country, since the mid-1980s Asia has usurped Europe as the largest regional source of migrants. Asian immigration went from 3 per cent of the total in the early 1960s to 7 per cent in the late 1960s to an average of 33 per cent from 1975 to 1985. By 1997–98, migration from Asia was slightly over 40 per cent and, for 2007–08, it was 42.2 per cent of the total intake. South Asian migration, particularly from India, has also become increasingly important in recent years.50 In 1973, Britain joined the European Economic Community (now the European Union) meaning that British-centric Australians could no longer pretend that Australia and Britain had a special relationship.

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In June 1971, while still in opposition, Gough Whitlam visited China, pre-empting by eight months US President Richard Nixon’s visit. At the time Whitlam was called the ‘Manchurian Candidate’ of Australian politics, until the announcement that Nixon was going to China blunted the government’s jibes. As Prime Minister, Whitlam quickly recognised the People’s Republic of China and withdrew Australian troops from Vietnam. The Labor Party while in opposition had been highly critical of the US role in Vietnam, so not surprisingly Australia’s relationship with the United States suffered under Whitlam, but the relationship was soon reinvigorated under his replacement, the Coalition Prime Minister Malcolm Fraser, and Australian concerns about communism in Asia, revitalised. The Fraser Government bolstered efforts to increase Australia’s trade with Southeast Asia and to strengthen Australia’s position as a supplier of resources to the region. Foreign Minister Andrew Peacock argued that economic development in the region required a reorientation of Australia’s economic policies: ‘if we want close political relations with our neighbours, we must appreciate that we cannot do so while remaining economically inward-looking and protectionist – economic and political relations are different sides of the same coin’.51 The Fraser Government supported the efforts of Asian countries to improve their access to world markets and made some concessions to allow developing countries to gain access to Australian markets. Australia developed an economic dialogue with ASEAN to improve trade in the late 1970s, but the most important relationships were in North Asia.52 By the late 1970s, China, Hong Kong and South Korea had followed Japan as major destinations for Australian exports, and by the late 1980s Taiwan and Southeast Asia had become major markets. Imports from Asia increased as well, although at a less dramatic rate. Australia’s trade balance with Asia remained in the black from 1955, but investment remained low. A series of disputes between Australian investors and Asian joint venture partners in the early 1980s led to negative perceptions about doing business in Asia.53 Asia also created problems for the Australian manufacturing sector. Even with high

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tariffs it was still cheaper to buy some goods in Asia. Increasing the costs of these goods through tariffs was an extremely ineffective and regressive strategy to protect Australian jobs. The long-term strategy of dealing with economic vulnerability had passed its use-by date and was instead increasing vulnerability by limiting adaptability.

‘Enmeshment’ and ‘engagement’ The Hawke and Keating Labor Governments increasingly framed Australia’s relationship with Asia as a choice between history and geography. Bob Hawke argued that he wanted ‘enmeshment with Asia’, and later in the 1980s as Australia recovered from recession and the terms of trade crisis of 1985–86, his government set about increasing Australia’s Asia focus. The mid-1980s was also the only time Japanese investment flows have been more important than British or US flows. The high value of the yen saw the Japanese export capital to the rest of the world. Japanese investment attracted considerable controversy, particularly in Queensland, but as the Japanese economy stagnated in the 1990s, Japanese investment stocks faded to a distant third behind Australia’s traditional investors. In 1989, the government released a report, Australia and the Northeast Asian Ascendancy, written by Ross Garnaut – the Rudd Government’s climate change guru. Garnaut had been an economic adviser to Bob Hawke from 1983−85 and Ambassador to China from 1985−1988. His 1989 report provided an intellectual justification for the government’s arguments about the importance of East Asia for Australia.54 It argued that Japan, South Korea and Taiwan had succeeded economically because of their international orientation. But the view that Australia should see Northeast Asia as a policy role model and a reason for embracing economic liberalism was incongruous, as many commentators at the time pointed out.55 Japan was a mercantilist export-oriented economy with an outward focus, but its policy-makers had little time for the shibboleths of economic liberalism. Despite his purist view of East Asian success, Garnaut presciently predicted that China would become

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a major market for Australian exports. Not everyone at the time agreed with his assessment. Another former Ambassador to China, Stephen FitzGerald, argued in the late 1980s that, ‘Australia’s China is possibly built on a large measure of illusion’.56 Sandra Tweedie, writing a few years later, argued that the idea of China as salvation was a myth. China had continually disappointed. Until the late 1990s, the most successful year had been 1932–33 when China accounted for 6.4 per cent of merchandise exports.57 In 1944, Australia’s first minister to visit China, Sir Frederic Eggleston, upon hearing a rumour that the Nationalist government in China planned to fit out postmen in woollen uniforms, remarked, ‘if every Chinese person was able to buy one pound of wool a year, enough to make a pair of warm socks, half the Australian wool clip would be marketed’.58 That didn’t quite work out! While some may have been sceptical about a major future role for China, there could be no doubt about Asia’s growing importance to the Australian economy. Government and business could see the benefits of the shift, but needed to convince some in the wider Australian population. The most important regional initiative for Australia during the Labor years was the development of the Asia Pacific Economic Co-operation (APEC) forum. The strengthening of the European Union and the development of the North America Free Trade Agreement made the Labor Government worried that a world of trade blocs could diminish trade opportunities for Australia. A trade forum that involved Asia and the Americas would likely restrict the development of an exclusive Asian bloc and keep the United States involved in Asia. Australian commentators generally credit Hawke with the idea for APEC in a speech in Seoul Korea in early 1989, although there is dispute over its origins. Some Japanese commentators argue that Japan gave the idea to Australia because Japan couldn’t directly propose such a body given regional sensitivities to a major Japanese role in the region.59 According to journalist Greg Sheridan, ‘one senior Australian figure’ described this claim as ‘self-serving Japanese horse-shit’.60 APEC was important as a signal to the Australian population of Asia’s increasing importance and the need for policy changes. At the

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first APEC meeting, Hawke highlighted a message that he had long been selling: With our historical roots in Europe, and our reputation – let me concede it was sometimes a well-earned reputation – for economic and cultural insularity, Australia has not been seen by some in the region as an integral part of the region. Indeed sometimes Australians haven’t seen themselves in that light either. But those days are gone – gone forever. Increasingly our domestic attitudes – and certainly at the level of my Government, our domestic and foreign policy-making – recognise the truth that our future is thoroughly interwoven with that of the Asia Pacific region.61

After becoming Prime Minister, Keating continued to push Hawke’s Asian agenda, substituting ‘engagement’ for ‘enmeshment’ with Asia.62 On a trip to Asia in September 1992, Keating unequivocally confirmed Australia’s commitment to the region and offered support for Japan in its ongoing trade disputes with the United States. In reviewing his trip, Keating argued that he wanted Australians to know ‘how much our future depends on successfully carrying forward this engagement’.63 For one commentator at the time, Keating’s speeches in Asia signalled a shift comparable to Curtin’s 1942 speech acknowledging Australia’s turn to the United States.64 Keating insisted APEC was pivotal to Australia’s future prosperity and he pushed hard to get the leaders of APEC countries to meet in Seattle in November 1993 – a meeting that signalled APEC’s arrival as an important international forum.65 The Seattle meeting was also significant for sparking a rift between Australia and Malaysia when Keating called the Malaysian Prime Minister, Mahathir Mohammed, ‘recalcitrant’ for not attending. This incident showed how easily good relations could be derailed. Nevertheless, in 1994, APEC countries agreed to the Bogor Declaration, which committed developed members to free trade by 2010 and developing members by 2020. Keating argued that the agreement was:

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an absolute triumph for the Asia-Pacific. It is a triumph for the world trading system and it is a triumph for Australia because we will be a very clear beneficiary. [It is] the beginning of the Pacific century, and Australia is set up for it.66

Keating also aimed to change the way Australians viewed their security in the region. Australia, he argued, had ‘to find its security in Asia not from Asia’. Australians needed to accept their place in the region and stop looking at Asia with suspicion and fear. The only way to deal with Asia was through engagement.67 One of Keating’s major security projects was the construction of an Australian-Indonesian security agreement. Many Australians were sceptical about Keating’s enthusiasm for both the treaty and authoritarian President Suharto, pointing to human rights abuses and the annexation of East Timor as moral impediments to fostering a closer relationship. The treaty was eventually revoked by Indonesia over Australian support for East Timorese independence in 1999. In an obituary for Suharto in 2008, Keating contended that Australians should be grateful to Suharto for keeping Indonesia relatively prosperous and stable.68

Australia is not an Asian country We believe that the industrialisation and urbanisation that has driven China’s growth will continue for several decades as billions of people strive for a better quality of life.69

In the lead up to the 1996 election, the Howard-led Opposition heavily criticised Labor’s ‘excessive’ focus on Asia. Through a series of speeches, Howard signalled to the region and the Australian people that the election of his government would mean a shift in Australia’s focus. Howard defended British Australians and offered solace to those who did not concur with Keating’s Asian vision. We Australians, Howard stressed, did not need to choose ‘between our past and our future, our history and our geography’: instead, we needed ‘a renewal

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and renovation in the symbols and structures of our national institutions’.70 Howard included Asian integration as part of Labor’s ‘politically correct’, ‘big picture’ agenda, which also included the Republic issue, multiculturalism, Mabo and support for special interest groups. Howard’s message was ‘Asia first but not Asia only’, which really meant not Asia first. Labor attacked the Opposition as backward looking, but Howard knew that there was considerable support for these views. Upon taking government, Howard declared that while Asia would be his first port of call, he would not deal with Asia at the expense of Australia’s ‘great liberal democratic traditions’.71 During his visit to Asia, Howard declared unequivocally (and repeatedly) that Australia was not an Asian country.72 Over the following years, the Howard Government retreated – at least in rhetoric – from engagement with the region and shifted its focus to bilateral relationships and to a reinvigoration of Australia’s ‘special relationship’ with the United States. It is important, however, to place the shift in emphasis in perspective. The government changed its rhetoric for different audiences. Alexander Downer declared soon after the election that Asia was Australia’s ‘highest foreign-policy priority’ and that it presented Australia with opportunities ‘few countries can enjoy’.73 In its 1997 foreign policy White Paper, In the National Interest, the government argued that the continuing rise of East Asia, along with globalisation, would be the ‘two most profound influences on Australian foreign and trade policy’.74 While the government argued that it was not downgrading relations with East Asia, it repeatedly stressed that the United States was Australia’s most important partner. It also argued that ‘closer engagement with Asia [did not] require reinventing Australia’s identity or abandoning the values and traditions which define Australian society’.75 The question is not whether this is true, because it undoubtedly is, but whether the government really needed to reinforce the message, especially in the context of the Hanson phenomenon. In the lead up to the 1996 election, the Liberals disendorsed Pauline Hanson, but she won the inner regional seat of Oxley – centred on

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Ipswich just outside Brisbane – anyway. Hanson argued in her maiden speech that ‘Australia was in danger of being swamped by Asians’. The failure of Howard to criticise these anti-Asian views attracted widespread condemnation in the region and reinforced the perception of a downgrading of Asian engagement.76 In a polity marked by bipartisanship on many of the major issues, Pauline Hanson was a media treat. Her naiveté only added to her attraction for many, as did her support for what was mainstream policy in the 1950s and early 1960s. She garnered support among some disillusioned white Australians, especially those in regional areas, because she offered a return to the past on Asian immigration, attitudes to Aborigines, industry protection and welfare policy. The East Asian Crisis of 1997–98 led some commentators to argue that Labor had oversold Asia, that the East Asian growth miracle was at an end, and that state-led capitalism was unable to cope with globalisation.77 By January 1998 – the lowest point in the crisis – the Indonesian rupiah had fallen by 81 per cent from its July 1997 level; the Malaysian ringgit by 46 per cent; and the Thai baht by 55 per cent. Between October and December 1997, the Korean won depreciated by 55 per cent. The IMF reported that ‘private capital flows to the four Asian emerging markets in crisis declined by almost $US100 billion in 1997, with the bulk of the reduction taking place during the last quarter’.78 The Howard Government made a virtue out of Australia’s relatively excellent economic performance during the crisis and exhibited a degree of schadenfreude over Asia’s fall from grace. Howard called Australia ‘the economic strongman of Asia’ during the 1998 election campaign.79 Despite the severe effect on Indonesia, Thailand, Malaysia and South Korea, for Asia as a whole, the crisis was a blip on the development path. Most importantly, out of the crisis, China was to emerge triumphant and ready to become the economic story of the 2000s. Before China’s rise became the dominant focus of Australian-Asian relations, two major events severely challenged Australian foreign policy: the government’s eventual support for East Timorese independence from Indonesia and its deployment of peacekeeping troops. Both

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these events created significant tensions with Indonesia and bad press all over Asia. Some Asian policy-makers and commentators likened Australian policy to neo-colonialism.80 The deployment of troops to East Timor was a significant change in the attitude of previous Australian governments to East Timor. Labor’s Foreign Minister, Gareth Evans, had argued that East Timor was an integral part of Indonesia and that Australians had to accept this fact. The Howard Government’s formal support for East Timorese independence was popular in Australia, but much less so in Indonesia and the rest of Asia. Another negative in Asia was Howard’s agreement in an interview with a description of Australia’s regional role as akin to that of a ‘Deputy’ to the United States. Howard soon disowned the label, but the damage had been done. Australia’s unwavering support for US military action in Afghanistan and Iraq created more friction in Asia, particularly amongst the majority Muslim countries of Malaysia and Indonesia. In 2002, the Bali bombings helped to reinvigorate some Australian anxieties about Asia as a hostile region, but really highlighted why good relations – especially with our closest neighbour – are so essential. Howard’s response to a hypothetical question about pre-emptive Australian military action against terrorists in Asia reignited views of Australia as a colonial power hell-bent on subduing the natives. Howard then repeated the comments in the 2004 election campaign. Howard’s response was not wrong – most governments would do whatever they could to protect their citizens – but answering the question was unnecessary and damaging to Australian-Asian relations. Howard had previously made a virtue of telling journalists that ‘he did not deal in hypotheticals’. Similar to the controversy surrounding Pauline Hanson, it appeared that Howard was willing to sacrifice Asian sensibilities for political advantage at home. In response to his many critics, Howard argues that he had a very ‘deliberate strategy’ in Asia, ‘the building block approach as opposed to the grand sweep approach’. Implicitly acknowledging his unease with Asia at the beginning of his prime ministership in 2004, Howard argued he was ‘a lot more familiar with the region and a lot more at ease with it and I enjoy it more’.81

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Agreement between Howard and US President George W Bush on most issues did not initially extend to the role of APEC. In Santiago in 2004, while Bush emphasised security issues,82 Howard argued for retaining APEC’s trade focus: I think it is important that we don’t allow APEC to drift into being a forum for detailed discussion for environmental issues; a forum for detailed discussion of labour relations issues; a forum for discussion of all manner of other issues – not that those issues are unimportant – but the central role of APEC was trade and economic facilitation.83

It is not surprising, however, that the Leader’s meeting agenda moved on from trade because very little was happening on that front. Security issues had already become more important after the events of 11 September 2001. After APEC, Howard went to Vientiane Laos for the 2004 ASEAN Summit. At the end of June, an Indonesian foreign policy spokesperson had announced that Australia’s invitation to the ASEAN summit was to be a ‘commemorative … one-off ’ event.84 The Summit was to mark the 30th anniversary year of the dialogue partnership between ASEAN and Australia. This guarded Indonesian assessment appeared to be contradicted by Malaysian Prime Minister Abdullah Badawi, who declared that while Howard’s talk of pre-emptive strikes had not been popular in the region, ‘Australia is our friend, of course’.85 Progress was also made on an Australia-China Trade Agreement and trade negotiations with ASEAN and New Zealand also went ahead (with the parties signing off on an agreement in early 2009).86 This was only the second time Australia and New Zealand had been invited to attend an ASEAN Summit and was an important event in backing up Howard’s claim that Australia was well received in Asia. In the lead-up to the Summit, ASEAN officials placed pressure on Australia to sign the Treaty of Amity and Co-operation (TAC). Such pressure intensified during the Summit, with many commentators suggesting that Howard should simply acknowledge that Australia

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would consider it.87 Howard and Downer, however, maintained their refusal, arguing that an Australian signature was incompatible with ANZUS, and that the provisions of non-interference would stop Australia from criticising countries like Burma on their human rights record.88 Sheridan suggested that Howard’s refusal to sign was because he did ‘not want to get back into the business of having to satisfy any pre-conditions for an invitation to join the region’.89 The issue continued to attract considerable attention, but in 2005 the government got an invitation to the East Asian Summit and quietly agreed to sign.90 Despite the shenanigans over the TAC, this period was a high point in Howard’s Asian engagement. In 2005, the Malaysian and Indonesian leaders visited Australia and Howard went to China and Japan. Howard also changed his mind on APEC’s purpose when he decided that the leader’s meeting in Sydney in 2007 could be an electoral asset for his government. Howard saw the meeting as a chance to play the role of statesman, but he was gazumped by then opposition leader, Kevin Rudd, who addressed the Chinese leader in fluent Mandarin. Little was achieved on trade, but some soundings were made on developing an Asia-Pacific Partnership on Climate Change, which Howard and Bush saw as a mechanism to bypass the Kyoto Agreement. Though Howard and foreign minister Alexander Downer made many diplomatic stumbles, these were never to have a lasting effect on Australian-Asian relations. despite many dire assessments that Howard had irrevocably damaged Australia’s position in Asia. Undoubtedly, booming economic times helped to smooth some of the problems. China’s expansion went from strength to strength in the 2000s and although China attracted most of the headlines, the growth story extended across the region. The rate of growth in the value of exports to Asia was remarkable. From 1999 to 2007, exports to China and India grew by nearly 25 per cent per annum. Exports to Japan grew at 7.1 per cent and South Korea at 10.5 per cent a year. China went from the seventh largest destination in 1999 to second by 2007 and India went from 13th to seventh.91 Most of the improvement in Australia’s

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export performance came as a result of rising prices rather than rising volumes. Seven of Australia’s top ten export destinations are in Asia and large surpluses on trade with Japan and South Korea more than offset deficits with Singapore, Thailand, Malaysia, Vietnam and China, so that Australia runs overall a trade surplus with Asia of $13.1 billion.92 Many Australians would probably be surprised that we run a deficit with China despite its huge purchases of Australian resources, but China exports a wide array of manufactured goods. The growth of Chinese manufacturing exports (outlined in Chapter 3) has been truly astonishing, but Shaun Breslin argues that many of China’s exports start their production process elsewhere in Asia: ‘the majority of exports to China from other East Asian states are actually disguised exports to Japan, Europe and the US’. China is a ‘manufacturing conduit’ for the region.93 Chinese growth in recent years has provided a considerable stimulus to growth in other countries, and conversely a Chinese downturn will exacerbate the downturn in other Asian countries. There are increasing links between the countries of Asia and the Chinese economy, and hence increasing trade links between Australia and Asia. The major negative story on trade has been with countries with which Australia has trade agreements. A trade agreement with Singapore started in 2003 and since this time Australia’s trade deficit has more than doubled. Another with Thailand came into effect in 2005 and since then Australia’s deficit has more than tripled.94 Given that ASEAN countries are major trade partners, Australians should be worried about the outcomes of the Australia, New Zealand and ASEAN trade deal concluded in 2008. Detailed study of the poor outcomes will be vital in negotiating trade deals with China, Japan and Malaysia. Engineering a bigger trade deficit with China or a reduction of the huge surplus with Japan would be a disaster for the Australian economy. During the 1996 election campaign, Paul Keating argued that Asian leaders wouldn’t ‘deal’ or ‘seriously negotiate’ with Howard.95 Eleven years later, he was still pressing his claim, despite considerable evidence to the contrary:

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Australia’s vital interests are in East Asia … They are here, here where we live, in the fastest growing part of the world. It is in this region that Australia’s destiny lies; it is only in this region that our security can be found and that will only happen when our foreign policies and our economic and trade policies are in appropriate and sensible alignment. The Howard Government’s ambivalence towards Asia and its willingness to throw our strategic eggs solely in the North American basket, will cost us dearly down the years. We must go to Asia as Australians and not as some derivative outfit pretending to be someone else’s deputy.96

Despite Keating’s claims, important progress in Australia’s position in the region was made during the Howard and Downer years.97 Howard visited Asia more than any other prime minister before him and the unprecedented billion-dollar donation to Indonesia after the Boxing Day tsunami of 2004 underpinned an improving relationship. Successes at getting Australia a seat at the East Asian Summit table (even if it turns out to be the wrong table), trade deals with Singapore and Thailand and improved relations with Malaysia and Indonesia (essential for dealing with terrorism in the region) all belie Keating’s ungenerous assessment. Howard chose a different approach to Asia from his Labor predecessors and although he was heavily criticised by the Left and many in the foreign policy establishment, the result has been further engagement.

Chairman Rudd and ‘comprehensive engagement’ Upon his election, most commentators expected Australian-Asian relations to improve under a Rudd Government. Years as a foreign policy professional and opposition spokesperson on foreign affairs meant that Rudd had a better foreign policy background than any previous prime minister. His first year or so of office appeared to bear this out. At times, it appeared that Rudd was foreign minister as well as prime minister,

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and the tag ‘Kevin747’ soon accompanied his numerous trips overseas. Rudd’s close affinity with China caused some concern in Japan and Indonesia, especially when Rudd did not include either on an extensive world tour.98 Others saw Rudd’s visit to China as a triumph, signalling a new level of engagement with the nation.99 Distinct from China, Australian policy-makers often take Japan for granted because they can: apart from the issue of whaling, there is very little that excites tensions. The next few years could be a difficult time for Australian exporters as the global recession is likely to be self-reinforcing across the region. Japan and China are each other’s most important trading partners and both are heavily dependent on Western markets. As the Treasurer Wayne Swan repeated ad nauseum over the latter months of 2008, ‘Australia is not immune from the global crisis’. In early 2009, a flurry of bad news for Australia emerged from Asia: slowing of growth and imports from China, and a fall in the Japanese GDP by 3.3 per cent (12.7 per cent on an annualised basis) in the December quarter of 2008, the largest for 30 years.100 Between January 2008 and January 2009 Chinese imports had fallen by 43 per cent; and in Japan 32 per cent. These are ominous figures for Australia. Australian prosperity is more dependent on continuing growth in Asia than ever before, and a prolonged downturn in Asia will be particularly bad news for Australia’s resource industries. The longer-term prognosis is, however, much brighter. Growth will eventually return to China and the rest of the region, so Australia should prepare now for the upturn. With further work on Australia’s trade infrastructure – ports and transportation systems – Australia will increase volumes even if prices stay subdued. Australian companies and investors need to be encouraged to invest in Asia. Government can do this by organising stable investment frameworks to accompany trade treaties. Figures 5.1 and 5.2 shows that at present Australian inward and outward investment remains focused on the Anglosphere. Investment in ASEAN countries comprised only 2.6 per cent of the stock of outward investment at the end of 2006. Japan was the largest destination with 4.8 per cent. The United States accounted for 38.4 per

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figure 5.1

Australian foreign investment abroad, stocks at end of 2006 (percentage of total) 45 40 35 30 25 20 15 10 5

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da na

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0

ABS (2007) 5352.0

cent and the United Kingdom 16 per cent. Australia invested slightly more in Papua New Guinea than China with both at 0.4 per cent. Combined investment in Hong Kong and China constituted only 2.3 per cent. However, Chinese investment in Australia is on the rise. Given commitments of about $40 billion over 2008 and early 2009, China should move up the ranks to match the level of Japanese investment in Australia. Asian countries have been slightly less reluctant to invest in Australia than Australians have been to invest in Asia, but the United States and the United Kingdom still dominate inward investment. Chinese investment in Australia will be a controversial issue over the next decade or so. China has built up huge amounts of capital reserves, which means that it has the capital to pick up assets while world commodity markets are low. The Chinese will attach the same

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figure 5.2

Foreign investment in Australia, stocks at end of 2007 (percentage of total) 30

25

20

15

10

5

source

ur g bo

m xe Lu

ain

a

ina Ch

Sp

re Ko

sia lay

um

Ma

da na

lgi Be

d

ce

Ca

an Fr

y

lan

an

er

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itz

re

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ABS (2008) 5352.0

importance to the supply of resources to fuel industrialisation as the Japanese have done since the 1960s. And the danger of Chinese investment in the resource sector for Australia is the same as it was for Japanese investment: that a major buyer of resources will control supply and prices, leading to lower revenue for Australians. So Australian policy-makers need to do whatever they can to maximise prices. Over the medium-term, policy-makers need to think strategically about the ownership and control of Australian resource assets. A major challenge for the Rudd Government will be balancing the need for investment in resource extraction and limiting the ability of a major buyer of Australian resources from becoming a supplier. The government should also exact concessions from the Chinese to open up opportunities for Australian investment in China.

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Leaving foreign investment decisions entirely to the short-term focus of the ‘market’ will not necessarily produce sound longer-term outcomes that reduce Australian vulnerabilities. There is a role for government through the Foreign Investment Review Board to consider the national interest when making decisions on foreign ownership of economically important national assets. Equally, however, policymakers need to avoid making Asian investment an issue that excites xenophobic sentiments in the Australian population. Ownership, as long as it is widely spread, may matter less than the ability of government to extract benefits from Australian resource exports through taxation and royalties. Any debate about foreign investment needs to involve a base-line understanding that Australia has always been reliant on foreign investment, and that increasingly, as countries in the region become more important to the global economy, much of this investment will come form Asia. A long-term decline in commodity prices will mean less investment and greater incentive to consider all foreign investment. This includes investment from Chinese sources keen to ensure longterm resource supply. But the problem is the extent of Chinese state control of investments in the resources sector. Some difficult decisions lie ahead. It is unlikely that the Coalition will support increased restrictions, but some sections of the Labor Party and the unions might come out against Chinese investment if it increases dramatically. While there has been an increase in Chinese investment in recent years, stocks are small compared to those of the United States and United Kingdom. Nevertheless, some Chinese investment comes into Australia through Hong Kong and through ‘tax havens such as the Cayman Islands and the British Virgin Islands’.101 For most of the last 50 years or so, Australia has been a price-taker on international markets and has been thoroughly out manoeuvred by Asian, particularly Japanese, negotiators in contract deals for iron ore and coal. The massive spike in commodity prices between 2003 and 2008, especially for coal and iron ore, created a seller’s market. But this is likely to be an exception to the long-term rule: lower growth and

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falling commodity prices will shift the balance back to buyers. Australia could do more at the negotiation table, even in a buyers market of low prices, by thinking and acting strategically about its resource assets. Over supply of Australian resources onto world markets may not lead to the best medium- to long-term returns for the Australian owners of these assets. Of course countenancing such strategic thinking remains blasphemous in Australian economic debate. A return to growth will help to support stability in the region. This is particularly the case for those countries that rejected insularity during the 1990s – China, Vietnam and India. But a period of economic stagnation could undermine the attraction of openness, and even greater growth will bring challenges. Some analysts, including Prime Minister Rudd, worry that a wealthier China will be a more politically and militarily assertive China.102 Asia’s rise will create increased demand for Australia’s resources but this will lead to increased military spending and perhaps an increase in regional tensions. Both China and India are increasing the size and scope of their navies, which may necessitate the US Seventh fleet staying engaged in the region. Japan also will not want to see a widening gap between Japanese and Chinese capabilities and will be forced to commit to greater military spending. The Rudd Government’s response has been to flag increases in the size of the Australian military, especially the navy. A bigger navy is problematic for Australia given the inability of the Australian Defence Force (ADF) to find enough sub-mariners for its existing submarines. Any substantial increase in the size of the military will require considerably greater expenditure on salaries to attract recruits. Advanced military hardware doesn’t come cheaply either and the global recession will put further pressure on spending. These concerns do not mean that the Rudd government will hope for a slowdown of China’s rise to power, rather China’s rise will be balanced by diplomatic missions, increased military spending, and efforts to keep the United States actively and positively involved in the region. A re-embrace of multilateralism by the United States under the Obama administration would help to smooth relations in East Asia.

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Another factor that could help to underpin prosperity and security in Asia is the further development of regional institutions. An abundance of acronyms represent various regional agendas and issues. The most wide-ranging regional body is APEC, but this is also its major problem. Many East Asian issues do not concern the countries of South America and vice versa. ASEAN Plus Three (the ASEAN countries plus China, Japan and South Korea) is Asia wide but does not include Australia, New Zealand or India. The East Asian Summit (or ASEAN Plus Six) includes them but doesn’t include the United States. Asian leaders see ASEAN plus three as the most important regional forum. ASEAN itself is the most cohesive regional body, but it is only representative of Southeast Asia. The major players in the region will need to make strategic choices over the next few years about what regional institutions will cover security problems and what institutions will support economic integration and handle inevitable disputes. In June 2008, Rudd suggested that none of the existing regional institutions were adequate for the task ahead.103 Rudd’s proposal for an Asia-Pacific Community was high on ambition but low on details. Initially, Rudd implied that it would be a ‘regional institution which spans the entire Asia-Pacific region – including the United States, Japan, China, India, Indonesia and the other states of the region’. Acknowledging the abundance of existing institutions, Rudd suggested, ‘APEC, the ASEAN Regional Forum, the East Asia Summit (EAS), ASEAN Plus Three and ASEAN itself will continue to play important roles, and longer-term may continue in their own right or embody the building blocks of an Asia Pacific Community.’ He was careful to distance his proposal from comparisons with the European Union, although he argued that the creation of the EU showed that it was ‘necessary to take the first step’. The architects of Australia’s enhanced Asian engagement – Bob Hawke and Paul Keating – criticised the proposal. Keating said it is ‘a very difficult task and not necessarily an appropriate one to seek to superimpose some sort of union across the disparate societies that make up the Asia Pacific’.104 Many others said it smacked of hubris.

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‘Half-baked’, ‘policy on the run’ were some of the nicer things the Opposition said.105 The proposal had some academic supporters, who pointed out that regional institutions will have to develop further over the coming years and that Rudd’s proposal is a part of a necessary debate.106 Rudd sent a roving ambassador – foreign policy establishment figure Richard Woolcott – to canvass regional opinion on the issue, but regional reaction was lukewarm at best. At the end of 2008, Woolcott noted that there was ‘no appetite’ for a new regional body but presented the government with some options for getting the proposal moving anyway. The best options, he suggested, would be either to have a core group of members to guide the proposal or simply to add the United States to the EAS.107 For Rudd’s proposal to get anywhere, he needs substantive support from either China or the United States. This currently seems unlikely, but Rudd is certainly correct in arguing for advances in Asian regionalism. Improvements to regional institutions will also help to deal with climate change. Much of the stimulus for Australia’s Asian engagement has come from trading coal, iron ore and other minerals. As policymakers throughout the world accept the idea that climate change is real, trade in coal is likely to become increasingly controversial. Coal and iron are Australia’s two biggest exports and provide the basis for both Asian growth and global environmental degradation. No effective international action on climate change can exclude China or India. There could be no more important role for the Rudd Government than to encourage China to participate in global negotiations on climate change.

Continuing the Asian journey A core challenge for Australia is – how do we best prepare ourselves for the Asia Pacific century – to maximise the opportunities, to minimise the threats and to make our own active contribution to making this Asia-Pacific Century peaceful, prosperous and sustainable for us all.108

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Australia has come a long way from its early apprehensions about Asia. While critics of the Howard Government argued that Asian engagement took a backward step during its 11 years of office, the Rudd Government took office in 2007 with Australia’s Asian relationships in good order. But despite Australia’s progress, the Asian journey could still be derailed. To help avert this disaster, policy-makers must do what they can to ensure wide Australian support for Asian engagement. The shift to Asia was an essential accompaniment to the transformation of the Australian economy since the 1980s. Shared prosperity and, in tough times, shared costs, will provide support for continuing adaptation and engagement. Deft management of the domestic politics of engagement requires government to look both outwards and inwards. A hard-headed assessment of Australia’s economic relationships and interests in the region is vital for future prosperity. Australia must continue good relations with Asian countries, participate in the development of regional institutions, encourage the United States to engage more productively and provide support for continuing and widespread Asian prosperity. Australia continues to see the importance of its ‘great and powerful friend’, the United States, but increasingly it sees good relations with Asia as fundamental to Australia’s security and prosperity. Australia needs to place its importance in the region in perspective. Rudd’s Asia-Pacific proposal appears grandiose and presumptuous. Nevertheless, Australia has played a pivotal role in Asian industrialisation, and the likelihood that this role will continue gives Australia some status in the region and bargaining power at least on the economic front. Australian policy-makers and businesses also need to recognise that doing business in Asia often requires a strategic approach. Asian countries have embraced freer markets, but they are not afraid to downgrade their importance for economically strategic reasons. Policy-makers need, in turn, to consider the longer-term implications of Asian ways of doing business, and the frequently close links between the private sector and the state.

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6

Finance, Investment and Debt

The unsustainable cannot be sustained attributed to John Maynard Keynes

It would be hard to blame working- and middle-class Australians for being a little cynical about global finance. Financiers lectured governments and citizens for years that they needed to get used to a world where financial markets would discipline the excesses of profligate governments; a world where currency and bond markets would sell out if governments spent too much helping the poor or raising taxes to fund infrastructure. However, when financiers took too many risks, leaving the banks and finance companies dangerously exposed after the market turned, they expected not to be disciplined by the very market they espoused. Instead, they demanded public funds to bail them out. Worse, bankers and policy-makers argued that if public funds were not made available then the system would collapse making us all worse off. Even worse still, this is probably true. As the world has discovered, once again, the global economy cannot function with a paralysed financial system. Increasing debt was the governing principle in the financial realm until recently – from the working-class battler borrowing to buy an over-priced first or a bigger house, to hedge funds leveraging huge sums of money into enormous funds to gamble on global financial markets. The difference is that debt troubles for battlers are their problem, while

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debt problems for the banks are everyone’s problem. Ordinary borrowers must take some responsibility for borrowing too much, but it is the financial system and the regulatory authorities that allowed this state of affairs to go unchecked. The financial system suffered from the same boom mentality that afflicted the Australian economy and much of the developed world; the belief that good times would continue indefinitely and that house and other asset prices would continue to rise and finance more borrowing and spending. The financial system was the conduit through which the boom spread throughout the Australian suburbs and which has left Australia vulnerable in the face of global recession. Australian governments have set up a more effective financial-system regulatory structure than many other countries, but Australian households and the economy generally still built up a debt burden that is unprecedented in Australian history. The repayment and unwinding of private debt will severely hinder Australia’s recovery from recession. It will, of course, be partly compensated for by the increase in public debt as governments attempt to use fiscal policy – increased government spending – to ameliorate the effects of the recession. The explosive growth of the Australian financial system drove the globalisation of the Australian economy. Finance, however, can also be a source of instability that damages the rest of the economy. This chapter outlines the impacts of finance, investment and debt on Australia. It analyses how debt and the financial crises have increased Australia’s economic vulnerability. While finance can help with the production of wealth, too many people believed that it could be a major form of wealth production in itself, divorced from the real economy of goods and services. Many analysts and policy-makers have now had an epiphany about the dangers of financial speculation. After the damning reality of the financial crises had revealed itself, Australia’s Reserve Bank Governor Glenn Stevens mused that: Perhaps the finance sector globally will return to fulfilling something more like its historical role of being ‘the handmaiden of industry’, with a bit less in the way of exotic innovation of its

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own. In such a world, a renewed focus on the processes in the real economy which generate growth in productivity could also be apt.1

It is a pity that financial authorities around the world, especially in the United States, did not counsel caution before finance brought the world economy to its knees.

The impacts of global finance The financial crisis has shown just how important finance is for the Australian economy. The Australian financial sector channels funds to companies and households, and with mandated superannuation it also determines the future of most Australians. Many Australians buoyed by the rapid rise of the share market and house prices failed to consider the vulnerabilities that lie at the heart of a globalised financial system. In this complacency, they were not alone. Policy-makers acted as though the good times would last forever. Until the bad assets of the developed world’s banks and major financial players are completely revealed and isolated, it is likely that foreign lending to Australia will be impaired. This is a problem because of Australia’s huge foreign debt. As foreign lending declines and as the need to pay back loans increases, companies will cut back on investment and Australians will cut back on spending. Advocates of financial liberalisation in the 1970s and 1980s argued that liberated financial markets would effectively discipline governments because investors would be able to move their capital more freely around the world. Capital would go where it was treated best, and capital unbound would spur the long-term expansion of wealth. The assumption was that what was good for the wealthy and well financed was good for growth, which, in turn, was good for the poor, at least eventually! Many scholars also argued that liberalised financial markets disciplined governments of the Left more than those of the Right.2 Certainly social democratic governments were keen to court and give advantage to the financial sector to avoid negative financial market reactions.

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Kelly’s description of the Hawke Labor Government’s reaction to the 1986 currency crisis illustrates how persuasive financial markets are: The currency crisis hit Australia on Monday 28 July when the ERC [Expenditure Review Committee] ministers were finalising the budget. Keating had his little Reuters screen on the cabinet table and kept pointing to the falling $A rate … The cabinet was infiltrated by a distinct mood of panic. Keating’s banana republic warning had never seemed so real … The response took two forms – immediate and budgetary … [I]t was decided that Keating would announce his more liberal foreign investment policy, ease the withholding tax provision, and that the Reserve would throw a lot of money to hold the dollar rate. It was Keating who synthesised these responses. The upshot was a stabilisation of the currency and a gradual rise … At the same time the crisis led Hawke and Keating to reopen the budget deliberations to tighten fiscal policy even further.3

The vision of finance as disciplinarian was a vital rhetorical tool to push the case for the liberalisation and globalisation of the Australian economy.4 But assertions in the 1980s and 1990s that the globalisation of finance would profoundly weaken the role of the state and make domestic political choices redundant were just wrong. The fact that governments around the world are now taking responsibility for banking systems shows clearly what has always been implicit: ultimately the globalised economy is dependent on politics and the state. We shouldn’t take this argument too far. Even properly regulated financial markets can create enormous problems for governments, as we are now all too aware. Panicky negative reactions in financial markets can cause immense damage to the wider economy, forcing governments to quickly manage financial market reactions to avoid unnecessary instability. Over the ensuing 20 years or so after the ‘banana republic crisis’, policy-makers gradually adapted, perhaps globalised, their perceptions of what was ‘normal’ behaviour in financial markets. Each episode of a

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sudden collapse or rapid rise in the Australian dollar attracted declining concern. The fall of the dollar in the late 1990s after the Asian financial crisis attracted much media commentary, but the government and the Reserve Bank of Australia (RBA) did not panic. And when the currency fell to an intra-day low of 47.75 US cents in April 2001, there was concern but also a grudging acceptance of the ‘normal’ momentum of currency trading. The RBA allowed the currency to fall and Australia reaped a reward in increased exports. The rapid fall in the Australian dollar in late 2008 made the ‘crisis’ of 1986 appear minor in comparison, but no policy-maker today believes that falls in the currency are necessarily related to poor policy. The best way to keep financial markets happy is to keep inflation subdued. Investors do not like inflation because it erodes the value of their investments. High inflation in the 1970s and 1980s was so disastrous for the global economy it drove central banks to raise interest rates as high as was necessary to crush inflation. Unfortunately they also crushed economic growth at the same time. One of the great mysteries of the global economic upswing after the short recession of the early 2000s was the quiescence of inflation. Some argued that the abandonment of insularity by China, India, Eastern Europe and the former Soviet Union led to a so-called ‘positive supply-side shock’ to the world economy, which means that they increased the global supply of labour, productive capacity and surplus capital. In 2007, the IMF argued that there had been a fourfold increase in the global labour supply since the early 1990s, which meant that wage pressures were kept subdued.5 Unlike the 1970s, rising oil (and other resource) prices did not lead immediately to increased inflation or lower growth. One of the theories was that although Chinese demand for resources pushed up prices, the Chinese supply of low priced manufactured goods put downward pressure on prices. By 2007, however, it seemed clear that this period of low inflationary growth was coming to an end. Inflationary pressures were increasing within China itself; and accelerating Chinese demand for resources was pushing up the price of nearly all mineral commodities. Food prices were also rising rapidly because of increased consumption

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in the developing world and the increased use of foodstuffs like corn for biofuel. Finally, oil began a meteoric rise to $US150 a barrel, with some analysts predicting it would go to $US200 a barrel.6 Generally in times of growth, it is reasonable to assume that if inflation increases, central banks will lift interest rates. But by late 2007, it was clear that these were not normal times. Nevertheless, while some central banks were cutting rates, the RBA was so concerned about inflation that it raised rates during the 2007 election campaign, severely damaging the Coalition’s claim to being the party of low interest rates. Despite the increasing signs that the global financial system was in trouble and the US economy was heading for recession, throughout early 2008, the RBA’s major concern was still with future inflation rather than future growth. In June Governor Glenn Stevens remarked: In fact, around much of the emerging world at the moment, the bigger problem seems to be neither the near or actual recession of the United States, nor the credit crunch about which we hear so much in the discussion of the major countries, but inflation. From Asia to Latin America to Africa, as well as in many of the industrial countries, we are hearing a lot more about inflation now.7

According to Stevens, what was true for the emerging economies was also true for Australia. Even as late as July, the RBA’s focus was on inflationary pressures.8 But the RBA was not alone in its prognosis: Treasury and the government also believed that Australia would continue to grow. It appears that the economic bureaucracy swallowed the hype of China’s supposed ‘decoupling’ from the US economy. Some commentators even argued that the RBA should have increased interest rates even higher and that the government should have cut spending further.9 These arguments now appear ridiculous given the perilous state of the global financial system and the world economy. The new Rudd Government also quickly made inflation its major focus and did what all new governments try to do – show voters that tough decisions were necessary because of the profligacy of the

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previous government. The Prime Minister declared a ‘war on inflation’ and argued that it was ‘public enemy number one’.10 The Treasurer Wayne Swan argued that there was ‘no doubt that the former government let the inflation genie out of the bottle’.11 The government framed the May 2008 Budget as though inflation was Australia’s major problem, making considerable effort to find savings and deliver a bigger surplus. Some commentators argued that the government should have deferred the tax cuts or put them into superannuation.12 Given how much most Australians have lost on their super during late 2008, this really would have been a bad decision. A few months later, it became clear that inflation was irrelevant to the problems facing Australia in 2009. To be fair to policy-makers and commentators, it did appear in early 2008 that the economy was overheating. Australia was experiencing a once-in-a-generation lift in its terms of trade, with most analysts predicting that it was going to rise even further. As Chapter 4 pointed out, a rise in the terms of trade increases national income and spurs spending. Nevertheless, the US Federal Reserve had started cutting rates in late 2007 and the RBA was taking a risk by going in the opposite direction. The RBA raised rates 12 times from 2002 to 2008 before realising that they had erred on the side of discipline and needed to begin a rapid and extensive rate-cutting exercise. Policy-makers must adapt to global financial developments that they cannot control and make judgements about events they often cannot fully understand. The government, through the RBA, gave up trying to control the level of the Australian dollar when it floated the currency in December 1983, instead it opted to use interest rates to restrict inflationary pressures from building up. In the 1960s, two economists Robert Mundell and J Marcus Fleming asserted that with capital mobility governments could either pursue exchange-rate stability or control interest rates but they could not do both. With the breakdown of the Bretton Woods regulated exchange-rate system, economists argued that floating exchange rates would lead to more stable foreign exchange markets, reduce the imbalances between countries discussed in Chapter 3, and allow a greater level of monetary policy autonomy.

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table 6.1

Monetary policy, 2001–09 Change in Cash Rate

New Cash Rate Target

8 April 2009

-0.25

3.00

4 February 2009

–1.00

3.25

3 December 2008

–1.00

4.25

5 November 2008

–0.75

5.25

8 October 2008

–1.00

6.00

3 September 2008

–0.25

7.00

5 March 2008

0.25

7.25

6 February 2008

0.25

7.00

7 November 2007

0.25

6.75

8 August 2007

0.25

6.50

8 November 2006

0.25

6.25

2 August 2006

0.25

6.00

3 May 2006

0.25

5.75

2 March 2005

0.25

5.50

3 December 2003

0.25

5.25

5 November 2003

0.25

5.00

5 June 2002

0.25

4.75

8 May 2002

0.25

4.50

–0.25

4.25

5 December 2001 source

RBA

The first two assertions turned out to be false hopes, but the latter eventuated as long as central banks were prepared to accept exchangerate volatility and variability. The float of the dollar in 1983, and the continued willingness to let the exchange rate vary, has meant that the RBA can make monetary policy decisions with Australian domestic economic conditions in mind rather than the exchange rate. This has been hugely beneficial for the Australian economy, although it does make managing exchange-rate risk more difficult for businesses. It is

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worth it, however, and better for business over the longer-term than the alternative of adjusting interest rates to keep the currency at a particular level and forcing the economy to slow down through tight monetary policy. Global foreign exchange markets have grown almost exponentially in recent years and swings in currency values can discourage exporters, especially smaller companies without financial expertise. The value of the Australian dollar can move by several cents over a few days and even more over a period of weeks. Hedging strategies have become an essential tool for businesses in their attempts to offset the potentially damaging impact of exchange-rate volatility. A simple example will illustrate this: an Australian company forecasting that the Australian dollar will fall against the US dollar over the coming months might want to lock in the exchange rate at its current level to make a big purchase in the United States in six months’ time. The company may use a sixmonth forward contract, which locks in the rate; or they may take out a currency option, which gives them the right but not the obligation to take the rate specified. These hedges are the most simple, but there are many other more complicated hedges that firms can make, especially ones that involve interest rates as well. More complex derivative products can be extremely dangerous for companies without sufficient expertise. Indeed, companies may get themselves into trouble even with advice from the experts! Up until recently, there has been significant temptation for businesses not in the financial sector to play with derivatives and to take greater risks to make large profits. Although there were other bad decisions involved, the collapse of Australian zinc miner Pasminco was assured when it lost $850 million after betting that the Australian dollar would not fall in the early 2000s. The subsequent collapse of the dollar was a disaster for the company.

The increased importance of finance in Australia Until the 1980s, Australia had a very restrictive financial system. These restrictions in the financial sector were an integral part of the overall

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protectionist policy structure. By the 1970s, the financial sector increasingly faced pressures for change. The market share of banks in Australia had declined significantly, with building societies, finance companies and merchant banks emerging to meet the demand for finance created by regulatory restrictions. The declining market share of the banks caused concern at the RBA because of their essential role in managing monetary policy. In the late 1960s the RBA began to look for ‘a more market-oriented method of implementing monetary policy’.13 Some regulatory changes were made in the early 1970s, but in the latter part of the decade, the movement towards liberalisation was cut short through the reimposition of credit ceilings and direct controls on bank balance sheets.14 Under the Whitlam Government, capital inflow regulations were tightened and then subsequently relaxed as the need for capital to fund the current account became necessary. A similar tightening and subsequent loosening occurred again during the years of the Fraser Coalition Government.15 In January 1979, with Australia’s tightly regulated financial system increasingly under attack from major financial interests and pressured by global developments, the Fraser Government established the Committee of Inquiry into the Australian Financial System (Campbell Committee). In its report released in November 1981, the Committee recommended wide-ranging liberalisation of the financial sector, based on a view that ‘the most efficient way to organise economic activity is through a competitive market system which is subject to a minimum of regulation and government intervention’.16 During its final years, the Fraser Government made some moves towards liberalising the financial sector, but it was replaced by the Hawke Labor Government before many changes could be implemented. The Hawke Government, in its first year of office, opted to float the Australian dollar and abandon exchange controls. A few years later, after bitter debate within the party, Labor allowed the entry of foreign banks. Financial liberalisation broke down the regulatory boundaries separating the Australian financial system from the outside world, and so began the enormous expansion of finance in Australia. In 1987,

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Keating argued that floating the dollar was ‘the Hawke Government’s greatest single reform, [which] pushed Australia into the world and made it face its problems’.17 Since the 1980s, Australia has become an increasingly important player in global finance, which means that it is also now more exposed to the impacts of financial contagion. As a result of Australian companies accessing international debt markets and foreign banks entering Australia, the financial sector has grown massively in size and importance. Debt, rather than investment, now dominates foreign liabilities. Holdings of financial assets were around 100 per cent of GDP from 1960 to 1980, but by 2005 they had jumped to around 325 per cent of GDP.18 Today more Australians own shares than ever before, although numbers have declined from the peak in 2004. In 2006, 38 per cent of adult Australians owned shares directly (down from 44 per cent in 2004), and the number of investors who had foreign exposure increased from 7 per cent in 2002 to 19 per cent in 2006.19 Much of the increase in share ownership in the 1990s and early 2000s was due to publically owned companies like the Commonwealth Bank and Telstra being listed on the share market, and the demutualisations of AMP, NRMA and many building societies and credit unions. Many more Australians own shares indirectly through superannuation funds. In superannuation there has been a move away from defined benefit – where you end up with a pre-determined payment (based on the scheme’s rules) at the end of your working life – to defined contribution – where you receive only what your employer’s (and your) contributions have returned on their investment. This has made retirement incomes increasingly dependent on the success of the financial sector. Risk has been transferred from the operators of funds to the recipients of super. Share market turmoil and decline in Australia in 2008 and early 2009 has made many investors extremely anxious and less proud of John Howard’s claim that Australia was a great shareholder’s democracy. The All Ordinaries lost 43 per cent or $718 billion in 2008 and the S&P/ASX 200 fell by 41.3 – for losses of about $680 billion.20 Those about to retire will be wishing for a rebound in the share market over

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2009–10, but it is possible that Australia will experience a prolonged bear market. The Australian share market was one of the worst performing share markets in the developed world after the 1987 crash, taking until the mid-1990s to recover its high point before the crash. In the lead up to the ’87 crash, shares had risen by 56 per cent in the preceding 12 months (and almost 100 per cent in the previous two years), whereas in 2007 the share market rose a more modest 12 per cent (14 per cent for the All Ords).21 In 1973–74 the share market fell by just under 60 per cent and in 1987 it fell by almost 50 per cent.22 Australia ranks as the 15th largest country in terms of GDP, but has the seventh most active foreign exchange market, the fourth most traded currency pair on global markets (Australian dollar/US dollar) and the sixth most traded currency. In April 2007, foreign exchange turnover averaged $US170 billion per day, an increase of 66 per cent on 2004.23 Currency trade in 2001 was about $US50 billion a day. Australia now accounts for 4.3 per cent of global forex turnover, up from 3.4 per cent in 2004. This is a significant role in the financial world for Australia, given that Australia accounts for about 1.7 per cent of global GDP (1.2 per cent on a PPP basis).24 Within the Australian market the Australian dollar/US dollar pairing accounts for 45 per cent of trades and the Euro/US dollar is next with 14 per cent. These are followed by US dollar/New Zealand dollar trades with 9 per cent and US dollar/Japanese yen trades with 8 per cent. International institutional investors have played a significant role in the expansion of the Australian foreign exchange market and their search for the higher yields available from foreign exchange trading. Foreign exchange has become an important type of investment in its own right, with most buying and selling unconnected to trade in goods and services or foreign investment. Also important in encouraging growth in foreign exchange has been the so-called ‘carry trade’. This is where investors borrow in one currency where interest rates are low to invest in another currency where interest rates are high. Substantially higher interest rates in Australia than Japan drove this trade, and for a long period of time investors made large sums of money.25 The credit crunch led to an

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unwinding of the carry trade in late 2008. Overseas banks are now playing a much greater role in Australia’s foreign exchange markets. Reflecting its increased global role, most of the trade in the Australian dollar takes place outside of Australia. In April 2007, global trade in the dollar averaged US$215 billion per day, which was double that measured in the 2004 BIS survey. The Australian dollar was on one side of 6.7 per cent of all global currency transactions. The level of offshore trade in the dollar, and the fact that it is often used as a tool of speculation, means that its value and degree of volatility is often heavily influenced by events and actions that are unrelated to Australia. The level of the dollar over the short- to medium-term is often determined by momentum in the market. Explanations for the fall of the Australian dollar in the early 2000s were many, including the elaborate one that because Australia was an ‘old’ economy its dollar would continue to fall, reflecting Australia’s backwardness in relation to the United States.26 But as one trader remarked at the time: ‘Who cares if the economy is sound? The trend is down so traders short the currency. It’s that simple’.27 While the fall in the dollar made it difficult for importers and those with debt denominated in US dollars, the fall was a boon for exporters. American travellers to Australia liked it too: as one said to me at the time, ‘I love Australia, everything’s half price’. As Figures 6.1 to 6.4 show, the Australian dollar has predominantly been in decline against all the major currencies since the mid-1970s. This supports the contention that the dollar was held at artificially high levels by governments before the 1983 float. The precipitous fall in late 2008 provides an indicator of Australia’s continuing role as a commodity currency. As the prices of commodities rises so does the dollar and vice versa. The dollar fell from almost $US1.50 in 1973–74 to a low below 50 US cents in 2001. It then haphazardly recovered to as high as 98 US cents in mid-2008. Its fall in late 2008 was, ironically, due to a ‘flight to quality’ by international investors to US dollar securities. Other reasons for its fall were the end of the carry trade and weakening commodity prices. The fall of the Australian dollar against the yen over the past

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30 years has been even more marked. The fall has been a result of a general decline in the value of the Australian dollar and a strengthening of the yen against all currencies. The Australian dollar strengthened against the renminbi from 1984 before falling from the late 1990s, then rising with other currencies from 2002 until falling again along with most other currencies in 2008. The exchange rate is affected by the Chinese central bank’s fixing of the renminbi to a basket of currencies. Finally, Figure 6.4 shows the so-called trade weighted index (TWI), which charts the value of the Australian dollar in relation to currencies weighted according to the amount of trade conducted with Australia. This is a valuable indicator of Australia’s trading relationships and international competitiveness. The TWI was used from 1974 as an indicator to set the value of the Australian dollar up until the float of 1983.28 The renminbi’s position in the TWI has become increasingly important in recent years. figure 6.1

Australian dollar-US dollar exchange rate, 1972–2008 1.60 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 1972

source

1976

1980

1984

1988

1992

1996

2000

2004

2008

RBA

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figure 6.2

Australian dollar-Japanese yen exchange rate, 1972–2008 500 450 400 350 300 250 200 150 100 50 0 1972

source

1976

1980

1984

1988

1992

1996

2000

2004

2008

RBA

figure 6.3

Australian dollar-renminbi exchange rate, 1984–2008 8 7 6 5 4 3 2 1 0 1984

source

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

RBA

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figure 6.4

Australian dollar-trade weighted index exchange rate, 1972–2008 (May 1970 = 100) 140

120

100

80

60

40

20

0 1972

source

1976

1980

1984

1988

1992

1996

2000

2004

2008

RBA

During 2001–04, the Australian derivative market expanded by 47 per cent compared to 74 per cent globally. However, between 2004 and 2007, it expanded significantly, growing by 68 per cent compared to a global growth of 66 per cent. Interest-rate derivatives are most important, averaging $US23 billion per day in April 2007 (77 per cent of the total Australian derivative market). This is made up of forward rate agreements ($US3.6 billion), swaps ($US17.8 billion) and options ($US1.3 billion). Foreign exchange derivatives account for $US6.8 billion (23 per cent of the total), that is $US2.1 billion of currency swaps and $US4.7 billion of options. The US dollar is the major currency in the Australian foreign exchange derivatives market, and is on one side of more than 80 per cent of all transactions. And half of all these transactions involved the Australian dollar/US dollar pairing.

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The Australian foreign exchange derivative market has become more globally integrated in recent years, with offshore counterparties becoming more important. The relationship between Australian dealers and foreign financial institutions became even more dominant between 2004 and 2007, increasing from 63 per cent of the total to 69 per cent, and turnover increased by 86 per cent, showing just how rapid the growth of exotic financial instruments was up until the crisis.29 As Chapter 3 pointed out, part of the problem for assessing the extent of the financial fallout from the crisis is knowing (or not knowing, as the case may be) how exposed some of the major financial institutions are to toxic derivatives. In 2008 the Australian banks supposedly had more than $13 trillion in off-balance-sheet derivatives, but as of early 2009, it is hard to tell just how exposed they are. Their total assets are a modest $2.1 billion, and though the big four banks in Australia have made some provision for losses, no one really knows whether these are adequate or grossly inadequate.30 In February 2009, brokers were still worried that the ANZ Bank and the National Australia Bank might have skeletons in their closets.31

Foreign investment in Australia Alongside the growth of short-term financial movements there has been an amazing expansion of foreign investment since the 1980s. Foreign investment is mostly made up of portfolio and direct investment and reserve assets.32 Foreign investment, particularly foreign direct investment, is a more productive form of financial transfer, with investors generally committed to a longer time frame.33 As Figures 5.1 and 5.2 show in the previous chapter, foreign investment – both inward and outward – has been dominated by the United Kingdom and the United States. Nevertheless, it is likely that Asia will finally become more important over the next quarter century. While the United Kingdom dominated investment flows up until World War Two, after the war US investment became more important. The major component was foreign direct investment, with most

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of it, until the 1960s, going into manufacturing.34 Although the Chifley Labor Government had reservations about foreign control, it was adamant that foreign investment was necessary for the development of a strong manufacturing base.35 Australia turned to the United States as the major source of capital and technology for the manufacturing sector.36 This was especially the case in the nascent Australian car industry with the first fully manufactured Australian car, a product of General Motors-Holden, rolling off the assembly line in 1948.37 Investors were protected by extensive tariff walls and import quotas, so that their investments were made with the assurance that the market was fixed and competitive pressures minimised.38 The Menzies Government also encouraged foreign investment. HW Arndt describes the policy towards foreign investment during the 1950s and 1960s as ‘a policy of the “open door”’.39 The door, however, was not open to all areas of the economy; restrictions remained in banking, the media and civil aviation. In the 1960s, the focus of foreign investors switched from manufacturing to mining and from direct to portfolio investment.40 In the late 1960s investment more than doubled, and in 1972 the inflow of private capital accounted for 5 per cent of GDP, which was the ‘highest percentage inflow since 1949–50’.41 The increase in portfolio investment continued through the 1970s. Growing economic nationalist feeling accompanied this change and some on the Left argued that Australia was becoming a ‘client state’.42 Concerns about foreign investment weren’t just tied to the Left but also had some wider historical pedigree. Country Party Minister for Trade, John McEwen, argued in 1960 that ‘we want US business here with all its magnificent skills of management at all levels. But we don’t want to be taken over. We will not be taken over’.43 Under the leadership of John Gorton between 1968 and 1971, the Coalition moved towards a more restrictive investment regime. Restriction was increased further by the McMahon Government, which introduced the Foreign Companies (Takeovers) Act in late 1972. This act increased the ability of the state to block foreign investment and introduced a ‘not contrary to the national interest test’.

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In the early Whitlam years, hostility towards foreign investment grew markedly, especially foreign investment in the mining industry.44 The cause of economic nationalism was championed by the Minister for Minerals and Energy, Rex Connor, who attempted to develop natural resource projects dominated by the state, rather than by foreign investors. The enthusiasm of the government and, especially, Connor to ‘buy back the farm’ (which was originally a Country Party slogan) led to the ‘Loans Affair’. The government sought to borrow US$4 billion from Arab sources without Cabinet or Loan Council approval. In addition to strong opposition to the scheme from the Coalition, ‘voracious opposition to the proposed loan came from the financial interests in London and New York, from the foreign companies whose assets in Australia were likely to be subject to the buy-back policy and from the Commonwealth Treasury, which regarded the source of funds as highly dubious’.45 Middle East ‘petro-dollars’ were to become an important source of capital on international financial markets in the later 1970s and 1980s, but in 1974 they were warily regarded. The Loans Affair badly damaged the government’s reputation and economic credibility, and was used by Malcolm Fraser as a justification for the Senate’s refusal to pass Supply – an event that led to the dismissal of the government. Towards the end of its period of office, the Whitlam Government moved towards a less nationalistic stance and reconfirmed Australia’s need for foreign capital. This more moderate position was confirmed by the Fraser Government which relaxed some of the provisions set up by Labor. After the low levels of foreign investment during the early 1970s, due partly to the effects of the recession and partly to Labor’s negative attitudes, the Fraser Government wanted to see increased foreign investment. Nevertheless, significant areas of restriction remained and the Foreign Investment Review Board (FIRB) was established in April 1976 to advise the government on foreign investment policy and to administer the Foreign Acquisitions and Takeovers Act 1975, which had been pushed through previously by the Whitlam Government.46 The Hawke and Keating Governments further liberalised Australia’s foreign investment regulations. Facing vocal opposition from the

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Left in the party, Keating hectored the delegates of the 1984 ALP National Conference stressing that the abandonment of foreign investment restrictions in the banking sector was a strike against the existing banking oligopoly in Australia: It really surprises me that some people in this Party think that we owe Westpac something, or the ANZ Bank, or the National. That really surprises me … So if you want to start talking about equity and fairness you better start with unemployment. But you can’t do it with a sick economy. Banking is the artery of the economy and we’ve had hardening of the arteries for too long in this country.47

In February 1985, the government announced that there were to be 16 new banking licenses issued to foreign banks, overturning a policy of foreign restriction that had been in existence since 1945.48 Labor further liberalised foreign investment in Australia to encourage capital inflows to deal with the burgeoning current account deficit, but it resisted US pressure to abandon the foreign investment screening process through the FIRB and was generally equivocal about the moves that the World Trade Organization (WTO), the Organization for Economic Co-operation and Development (OECD) and the Asia Pacific Economic Co-operation (APEC) were making to extend liberalisation to investment issues. After making much of the level of foreign debt in Australia during the 1996 election campaign, once in office the Howard Government aimed to keep a lid on popular concerns about increasing foreign investment and foreign debt. Howard mused in 1997, however, that there was merit in the idea of protecting ‘national champions’ from foreign takeovers. In relation to the restrictions on foreign media ownership, Howard argued that ‘there is some national benefit in having a powerful, fully Australian-based media company … If you are to have a presence in the region and a presence around the world then you need a very, very strong domestic base’. At the same time, the government emphatically rejected Pauline Hanson’s criticism of foreign investment.

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Costello argued ‘we are not going to walk down the isolationist path which tries to throw out foreign investment and job creation in this country’. Howard also backed foreign investment arguing that ‘[t]hose who deride and criticise foreign investment are doing Australia in the eye’. The Howard Government then resisted calls from the United States that it disband the FIRB. Policy-makers do not want to lose their discretionary powers over controversial foreign investment, such as the bid by Shell to take over Woodside Petroleum, which Costello rejected in 2001. The Australia-United States Free Trade Agreement, which began in 2005, further liberalised restrictions on investment for US investors, but retained a role for the FIRB. As pointed out in Chapter 5, the next major test for foreign investment in Australia will be Chinese state investment in the Australian mining industry. A major aim of China in negotiations for a free trade agreement is to get the same deal the United States got in its trade deal. The Australia United States Free Trade Agreement (AUSFTA) increases the limits on proposals that require scrutiny by the FIRB from $50 million to $800 million. Recent reviews of Chinese investment in the mining industry show the continuing importance of the FIRB and the decisions made by the Treasurer (who has responsibility for interpreting Australia’s national interest test for large scale foreign investment). Substantial restrictions still remain in airlines, telecommunications and the media. In 2008, with Chinese state investment as the focus, Treasurer Swan outlined several criteria for assessing foreign investment by foreign governments: 1 Whether an investor’s operations are independent from the relevant foreign government. 2 Whether an investor is subject to and adheres to the law and observes common standards of business behaviour. 3 Whether an investment may hinder competition or lead to undue concentration or control in the industry or sectors concerned. 4 Whether an investment may impact on Australian Government revenue or other policies.

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5 Whether an investment may impact on Australia’s national security. 6 Whether an investment may impact on the operations and directions of an Australian business, as well as its contribution to the Australian economy and broader community.49 In particular the Treasurer expressed some concern about the extent to which ‘participation by a consumer of the resource increases to the point of control over pricing and production’. What this means is that the government does not think it is in Australia’s national interest to have a major buyer of Australia’s resources controlling the sale of those exact same resources. The national interest provisions of Australia’s foreign investment regulations – criticised by economic liberals as being too vague – rightly provide the potential for Australian governments to make decisions on foreign investment that provide wider benefits for Australians. The national interest test also provides flexibility for the government so it can think more strategically about major foreign investments, and therefore should be maintained. In 2007, levels (stocks) of total foreign investment in Australia increased by a little over $200 billion to reach $1,660 billion at the end of the year. Portfolio investment accounted for $1007 billion (61 per cent), direct investment for $377 billion (23 per cent), other investment liabilities totalled $206.8 billion (12 per cent) and financial derivatives $69.4 billion (4 per cent). Portfolio investment liabilities were made up mainly of debt securities, which accounted for $628.7 billion (62 per cent), with equity securities accounting for $377.8 billion (38 per cent). The major investor countries at the end of 2007 were the United States ($445.9 billion or 27 per cent), the United Kingdom ($410.4 billion or 25 per cent) and Japan ($57.5 billion or 3 per cent). Foreign ownership of equity issued by Australian corporations (the amount of the share market owned by foreigners) has been remarkably stable in recent years. In 2007, foreigners owned 28.8 per cent of total equity in Australian companies, down from 30.2 per cent in 2003.50 Australia’s foreign liabilities are made up of foreign equity and

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foreign debt. As Figure 6.5 shows, most of Australia’s foreign liabilities are debt liabilities, which we will discuss in the next section. Net equity – the difference between equity investment in Australia and Australian equity investment overseas – has declined as Australian investors and companies have substantially increased their outward focus. The increase in Australian investment abroad has a corollary, however, in an increased level of foreign debt, because some Australian companies have borrowed overseas to fund their foreign investments. Institutional investors, including super funds, have also increased their level of overseas investment, although recent events are likely to see a reversal of this trend in the coming year or so, as the financial crisis causes an increased home bias for investment. figure 6.5

Net foreign liabilities, 1988–2008 (percentage of GDP) 70 60 50 40 30 20 10

08

07

20

06

20

05

20

04

20

03

20

02

20

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00

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99

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98

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19

97

19

96

19

95

19

94

19

93

19

92

19

91

19

90

19

89

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19

88

0

Net Debt

ABS (2008)

source

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At the end of 2007, the level of Australian investment abroad reached $987 billion, which was an increase of $126 billion on 2006. Similar to foreign investment in Australia, portfolio investment accounted for nearly half of this figure at $442 billion (45 per cent), this was followed by direct investment abroad at $324 billion (33 per cent), then other investments at $119 billion (12 per cent), financial derivatives at $72 billion (7 per cent) and reserve assets at $31 billion (3 per cent). In contrast to inward investment, equity is the most important form of Australian investment abroad and has been for the past decade. This accounts for the decline in net equity discussed above. Equity accounted for $608 billion or 62 per cent of the total level of investment abroad at the end of 2007. The major recipients of Australian investment at the end of 2007 were the United States ($403.4 billion or 41 per cent), followed by the United Kingdom ($127.8 billion or 13 per cent), and then New Zealand ($70.8 billion or 7 per cent).51 Australia has rapidly increased its stocks of both inward and outward foreign direct investment (FDI). As Chapter 3 noted, FDI involves a substantial investment in a company of greater than 10 per cent. Inward FDI stock is higher as a percentage of GDP for Australia than for the global or developed country average, as Figure 6.6 shows. In 1980, inward Australian FDI stock was 15 per cent of GDP (5 per cent for the developed economies) and by 2007 it was 34 per cent of GDP. The year 2004 was a high point, as inward FDI reached 41 per cent of GDP in Australia (compared to 22 per cent for the developed economies as a whole). Flows – the amount of investment coming and going out of an economy measured on a yearly basis – can vary significantly. In 2005, Australia experienced a marked decline in inflows and a similarly large decline in outflows because of the shift of News Corporation to the New York Stock Exchange.52 The financial crisis will probably lead to a significant decline in flows over the next few years and the lack of investment from elsewhere will make it difficult for the Australian government to restrict Chinese state investment. When weighing up the significance of Chinese investment, Australians should be aware that its expansion comes from a very low base and that foreign owner-

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figure 6.6

Inward FDI stock 1980–2007, Australia and developed economies average (percentage of GDP) 45 40 35 30 25 20 15 10 5 0 1980

1983

1986

1989

1992 Australia

source:

1995

1998

2001

2004

2007

Developed Economies

UNCTAD, World Investment Report Tables

ship in the Australian mining sector is not a new development: there is already majority-foreign ownership in the sector as a whole. On the other side of the ledger, Australian FDI abroad lagged the developed world until the late 1980s. As Figure 6.7 reveals, outward FDI from Australia increased from 3 per cent of GDP in 1980 (compared to 6 per cent for the developed economies as a whole) to a bit over 30 per cent of GDP in 2007 (compared to 34 per cent) . The ratio of outward to inward FDI in Australia increased from one-fifth in 1980 to being almost on equal terms in 2001 and back to 89 per cent in 2007 (see Figure 6.8). This has been a major change in the Australian economy: it represents an increase in the outward focus of Australian companies and has been, therefore, a major component of the globalisation of the economy.

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figure 6.7

Outward FDI stock 1980–2007, Australia and developed economies average (percentage of GDP) 40 35 30 25 20 15 10 5 0 1980

1983

1986

1989

1992 Australia

source:

1995

1998

2001

2004

2007

Developed Economies

UNCTAD, World Investment Report Tables

figure 6.8

Outward FDI stocks as a percentage of inward FDI stocks, 1980–2007 100 90 80 70 60 50 40 30 20 10 0 1980

source

1983

1986

1989

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1995

1998

2001

2004

2007

Author’s calculations based on UNCTAD Data

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Foreign debt and the current account deficit While the levels of Australian investment abroad has been a positive development, as Figure 6.5 showed most of Australia’s net foreign liabilities are debt liabilities. Australia’s foreign debt is at historically unprecedented levels. Historical comparisons associate high debt with particularly bleak periods of Australian economic history. Before the 1980s, the highest debt levels were recorded during the depressions of the 1890s (34.1 per cent of GDP) and 1930s (38.8 per cent of GDP).53 Foreign liabilities built up in more prosperous times have often exacerbated the severity of subsequent downturns. In the June quarter of 2008, foreign debt reached $600 billion ($658 billion in the September quarter with most of the increase associated with the fall of the dollar) or 54.3 per cent of GDP.54 Figure 6.9 shows the massive rise in debt since the mid-1970s.55 figure 6.9

Foreign debt, 1976–2008 (percentage of GDP) 60

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0 1976

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sourceABS

(2008) ; Reserve Bank of Australia

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Reserve Bank research in 2005 argued that foreign debt was less of a problem than in earlier periods because most of the debt was denominated in Australian dollars or hedged through forward foreign exchange contracts, cross-currency interest rate swaps, futures and currency options.56 However, such research assumed relatively normal conditions in financial markets and did not canvass the possibilities of a severe financial disruption. One of the major factors in the sustainability of foreign debt is how much of Australia’s export income is required to service the debt and the amount of income that must be paid overseas (see Figure 6.10). The economic crises of the 1890s and 1930s were both associated with a large increase in the costs to service and rollover debt. The two measures of interest are the ratio of foreign debt to export credits (the amount of money earned through exports) and the ratio of net investment income (the difference between income earned by Australians and that paid to foreigners to service debt and pay dividends) to exports credits. The dip in relative servicing costs after the build up in the late 1980s perhaps explains why policy-makers became more complacent about rising debt. The large increase occurred during the early 1990s recession. The persistent caveat of analysts was that a high foreign debt left Australia ‘vulnerable to a change in global financial market sentiment’. There certainly has been a change in global market conditions, and the next few years will see whether sentiment about Australia changes too. The main variable here is uncertainty and the dangers of self-reinforcing movements of sentiment. If Australia’s foreign debt is seen as a problem by those who matter (that is those foreigners who play a role in funding the debt), then it will be a problem. The Rudd Government has been extremely worried about the rolling over of debt and in 2008 guaranteed the banks’ foreign borrowings. This will assist medium-term capital needs but the problem is that the financial sector is becoming increasingly dependent on short-term funding. The IMF argues there is an increasing risk of a ‘pernicious circle’ developing:

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figure 6.10

Servicing foreign debt and income payable overseas (percentage of export credits) 30

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10

5

0 1960

1964

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1980

Net investment income to Export Credits

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2008

Net Foreign Debt to Export Credits

ABS (2008)

source

As corporates tap banks for short-term loans, the maturity structure for corporate debt also shortens, further raising rollover risks. Capital markets remain reluctant to lend, pending large external rollover needs and corporates face the additional challenge of falling revenues as the global economy slows, raising the risk of corporate defaults.57

As governments around the world attempt to clean up the bad debts and partially nationalise their own banking systems, it is likely that capital flows will slow considerably. When in government, both political parties have effectively accepted the ‘consenting adults’ view of foreign debt – the idea that as long as

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debt is between private businesses with the aim of creating productive economic activity, it should not be the focus of deliberate government policy.58 Prime Minister Keating argued this view when he said that foreign debt was a matter of private concern and that Australians did not need to worry if companies like BHP borrowed overseas to fund expansion.59 Foreign debt was an indicator of Australia’s attractiveness as a location for investment and in his 1996 campaign speech he reiterated the point that only 5 per cent of foreign debt was Commonwealth government debt.60 ‘The vast majority’, he stressed, was ‘private debt, and much of that is invested in major national projects which will be of considerable long-term value to Australia’.61 As one Labor source stated, ‘Keating made foreign debt sound positively good for you’.62 Although he drove a debt truck in the 1996 election campaign, as Treasurer, Costello agreed with Keating’s post-1991 recession view that foreign (private) debt was not a problem because Australia had low net public debt. Keating has since changed his mind, arguing that Labor in opposition should have attacked the Howard Government over debt: Now the national debt – remember the debt truck they had running around in my time. It had $199 billion written on the side of it. It’s now $473 billion. It’s now 51 per cent of GDP. Between 1999 and 2004 there was no investment in Australia, it all went into housing and consumption all borrowed on the current account. When Peter Costello runs around saying, ‘Oh we’ve paid off the debt’, it’s like the pea and thimble trick.63

Those who are worried about the debt worry that increased (foreign funded) investment in Australia has not gone into creating the productive capacity that could earn the foreign exchange that would eventually lower the level of debt. Much of the increase in debt has gone into housing loans in Australia. John Edwards argues that ‘about half the increased investment in the last decade has been in the construction of houses’.64 Increasing levels of foreign debt mean that the income deficit component of the current account deficit (CAD) will keep increasing

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figure 6.11

Current account, trade balance and net income, 1960–2008 (percentage of GDP) 4

2

0

-2

-4

-6

-8 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 Current Account

Trade Balance

Net Income

ABS (2007) 5302.0 Table 85

source

(see Figure 6.11). The current account is a component of the balance of payments (BoP), which is a statistical measure of Australia’s transactions with the rest of the world. The Australian Bureau of Statistics explains the BoP as ‘a system of consolidated accounts in which the accounting entity is the Australian economy and the entries refer to economic transactions between residents of Australia and residents of the rest of the world (non-residents)’. These transactions include both trade and financial flows. The BoP is made up of a set of double entry accounts – on one side a current account and on the other a capital and financial account, which statistically must be in balance. The financial and capital account is made up of ‘capital transactions, such as capital transfers, and financial transactions involving Australian claims on,

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and liabilities to, non-residents’.65 The current account is made up of exports and imports of goods and services, income earned and paid overseas, and transfers such as international aid, family payments from overseas and gifts (both incoming and outgoing). A CAD occurs when there is a trade deficit or a net income deficit (or both). Put another way, a CAD ‘measures the extent to which Australia draws on foreign savings to fund that portion of national investment that is not funded by domestic national savings’.66 By far the largest component of the CAD in Australia is the net income deficit, which includes interest paid to foreign lenders and dividends paid to foreign shareholders minus money earned by the RBA on its reserve assets invested overseas minus money earned by Australians from interest and dividends. By way of comparison, the huge US CAD is accounted for by a trade (in goods) deficit because the United States runs a surplus on services and in its income account.67 Like foreign debt, Australian policy-makers seem to have reconciled themselves to a higher CAD. The question remains: what level of CAD would be a problem? After improving in the early years of this decade, the CAD blew out to over six per cent of GDP in 2005 and to 6.5 per cent in December 2007.68 Since that time, with the resources boom finally producing a trade surplus (just as the boom ended!) the CAD fell to 5.3 per cent in the September quarter of 2008. Some analysts have predicted the CAD could rise to over $100 billion or 9 per cent of GDP with even a shallow recession.69 Such a high CAD would make international investors extremely concerned about Australia’s financial position and could lead to the fundamental reassessment that commentators have long warned about.

Household debt Much of the increased foreign debt outlined above was lent by banks to households. Like so many good things in life, increased access to credit is a double-edged sword. Credit and debt are, of course, two sides of the same coin, but credit sounds much more benign than debt! Now

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Fi n a n c e , I n v e s t ment and Debt

figure 6.12

Household debt as a percentage of disposable income, 1978–2008 180 160 140 120 100 80 60 40 20 0 1978

1980

1982

1984

1986

1988

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1992 Total

source

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RBA . 103 Kevin Rudd (2008) ‘It’s Time to Build an Asia Pacific Community’, Address to the Asia Society AustralAsia Centre, Sydney, 4 June . 104 Paul Keating (2008) ‘I Got it Right the First Time’, The Australian, 6 June . 105 Tim Colebatch, Mark Forbes & Mary-Anne Toy (2008) ‘Keating Blast for Rudd’s Asia Union’, The Age, 6 June . 106 See Andrew MacIntyre (2008) ‘Rudd’s Pacific Plan: Dead or Alive?’, East Asian Forum, 3 October and Andrew Elek (2008) ‘Kevin Rudd’s Vision for Asia Pacific Institution-Building’, East Asian Forum, 12 June . 107 Paul Kelly (2008) ‘The Shape of the Future’, The Australian, 20 December . 108 Rudd, ‘It’s Time to Build an Asia Pacific Community’.

Chapter 6 1

2

Glenn Stevens (2008) ‘Australia, New Zealand and the International Economy’, Address to the Trans-Tasman Business Circle Business Luncheon, Sydney, 21 October 2008 . Helen V Milner & Robert O Keohane (1996) ‘Internationalization and Domestic Politics: An Introduction’, in Robert O Keohane & Helen V Milner (eds) Internationalization and Domestic Politics, New York, Cambridge University Press, p. 18.

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N o t e s t o p a g es 166–72

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Paul Kelly (1994) The End of Certainty, 2nd edn, Sydney, Allen & Unwin, p. 220. The ERC was the Expenditure Review Committee of Cabinet. See for example Paul J Keating (1986) ‘Speech to Banking Summer School’, Commonwealth Record, 10–16 February, p. 173; (1986) ‘Speech to Australian Bankers’ Association’, Commonwealth Record, 16–22 June; Bob Hawke (1994) The Hawke Memoirs, Melbourne, William Heinemann, p. 236; Paul Kelly (1994) The End of Certainty: Power, Politics and Business in Australia, 2nd Edition, Sydney, Allen & Unwin, ch. 4; Michelle Grattan (1994) ‘The Float: An Economic and Political Discipline’, Economic Papers, 13(1), March, pp. 42–43; The Economist (1994) ‘Leaders Should be Used to Economic Understeer’, The Australian, 22 June, p. 11; Roger Hogan (1995) ‘RBA: Deregulation the Answer to Lobby Bias’, Australian Financial Review, 28 April, p. 12. IMF (2007) World Economic Outlook, April, Washington, ch. 5. Neil King (2008) ‘Oil Tipped to Hit $US200 by End of Year’, The Australian, 8 July . Glen Stevens (2008) ‘Economic Conditions’, Address to the American Chamber of Commerce in Australia Business Luncheon, Melbourne, 13 June . Glen Stevens (2008) ‘Challenges for Economic Policy’, Address to the Anika Foundation Luncheon Supported by Australian Business Economists and Macquarie Bank, Sydney, 16 July . Shane Wright (2008) ‘Interest Rates May Need to Rise: RBA’, The West Australian, 10 May . Michelle Grattan & Tim Colebatch (2008) ‘Rudd Government Vows to Cut Fat’, The Age, 16 January ; Alan Wood (2008) ‘Pressure Will Remain on Monetary Policy’, The Australian, 14 May ; ABC News (2008) ‘Inflation Public Enemy Number 1: Rudd’, ABC Online, 1 February . Carrie LaFrenz (2008) ‘Economy facing Inflation Problem: Swan’, The Age, 3 February . See for example Ross Gittins (2008) ‘Cut Taxes, then … Cut Spending or Increase Super’, The Sydney Morning Herald, 11 February . Stephen Grenville (1991) ‘The Evolution of Financial Deregulation’, in Ian McFarlane (ed.) The Deregulation of Financial Intermediaries, Sydney, Reserve Bank of Australia, p. 15. Ibid., pp. 23–24. Edna Carew (1991) Fast Money 3, Sydney, Allen & Unwin, pp. 7–10.

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N o t e s t o p a g es 172–79

16 Cited in Tom Valentine (1993) ‘An Appraisal of Financial Deregulation’, in Chris James, Chris Jones & Andrew Norton (eds) A Defence of Economic Rationalism, Sydney, Allen & Unwin, p. 29. 17 Paul J Keating (1987) ‘Speech to Life Insurance Federation’ (28 May 1987) Commonwealth Record, 25–31 May, p. 830. 18 Ric Battellino (2006) ‘Developments in Australian Retail Finance’, Address to Retail Financial Services Forum, Sydney, 22 August . 19 Scott Murdoch (2007) ‘Share Ownership Dips, But More Buy Offshore’, The Australian, 18 May. 20 Allison Jackson (2008) ‘Hope for 2009 After Sharemarket Loses $680bn in 2008’, The Australian, 31 December . 21 For historical data see Yahoo 7 Finance . For a historical graph see ASX . 22 Nick Gardner (2008) ‘Share Market Falls Worse than 1987 Crash’, Perth Now, 21 November . 23 Reserve Bank of Australia (2008) ‘The Australian Foreign Exchange and Derivatives Markets’, Reserve Bank Bulletin, January . See also Bank for International Settlements (2007) Triennial Central Bank Survey December 2007: Foreign Exchange and Derivatives Market Activity in 2007, Basel . 24 Reserve Bank of Australia, ‘The Australian Foreign Exchange and Derivatives Markets’. 25 Reserve Bank of Australia (2005) ‘The Australian Foreign Exchange and Derivatives Market’, Reserve Bank Bulletin, June, p. 1 . 26 See for an example of this explanation Robert Gottliebsen (2000) ‘Macfarlane in Dark but PM, Costello see the Light’, The Australian, 13 September. For a typically excellent analysis of the currency situation see Barry Hughes (2000) ‘Currency Bound to Rise Again, but Slump Will Have its Price’, The Weekend Australian, 28–29 October. 27 Cited in Stephen Romei (2000) ‘Traders Not Buying Costello’s Dollar Defence’, The Australian, 25 October. 28 Chris Becker & Michael Davies (2002) ‘Developments in the TradeWeighted Index’, Reserve Bank Bulletin, October . 29 Reserve Bank of Australia, ‘The Australian Foreign Exchange and Derivatives Market’. 30 See Adele Ferguson (2008) ‘Economies Count the Cost of Derivatives’, The Australian, 18 October. 31 Ben Potter (2009) ‘IG Markets Australian Market Wrap’, International Business Times, 11 February .

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N o t e s t o p a g es 179–84

32 For Australian investment abroad there is a residual category – other investment. For an explanation see ABS . 33 FDI involves an investment level of greater than 10 per cent in a company. See chapter three. 34 HW Arndt (1963) ‘Overseas Borrowing – The New Model’, in HW Arndt & WM Corden (eds) The Australian Economy, Melbourne, Cheshire, p. 436. Arndt notes that the composition of direct investment also changed in this period from mining and agriculture to manufacturing. 35 Carol Johnson (1989) The Labor Legacy, Sydney, Allen & Unwin, pp. 14–27; HW Arndt (1977) ‘Foreign Investment’, in John P Nieuwenhuysen & Peter J Drake (eds) Australian Economic Policy, Melbourne, Melbourne University Press, p. 133. 36 Brian Pinkstone, Global Connections: A History of the Exports and the Australian Economy, Canberra, AGPS, p. 146. 37 Barrie Dyster & David Meredith (1994) Australia in the International Economy, Melbourne, Cambridge University Press, pp. 188–89. 38 NG Butlin, A Barnard & JJ Pincus (1982) Government and Capitalism: Public and Private Choice in Twentieth Century Australia, Sydney, Allen & Unwin, p. 142. 39 Arndt, ‘Foreign Investment’, pp. 132–33. 40 JON Perkins (1970) Australia in the World Economy, Second Edition, Melbourne, Sun Books, ch. 5. 41 Dyster & Meredith, Australia in the International Economy, pp. 260–261. 42 Greg Crough & EL Wheelwright (1982) Australia: A Client State, Melbourne, Penguin. 43 HW Arndt, ‘Foreign Investment’, p. 135. 44 Ibid., pp. 138–39; Peter Loveday, Promoting Industry: Recent Australian Political Experience, Brisbane, University of Queensland Press, 1982, p. 100. 45 Dyster & Meredith, Australia in the International Economy, pp. 271–72. 46 HW Arndt, ‘Foreign Investment’, p. 140; Boehm, Twentieth Century Economic Development in Australia, pp. 161–62 & 169; Crough & Wheelwright, Australia: A Client State, p. 8. Crough & Wheelwright argued that the Foreign Investment Review Board should have been called Foreign Investment Attraction Board. 47 ABC Television, Labor in Power, 1993. See also Ian Reinecke, ‘Bankers’, Australian Society, September, 1988, p. 24. 48 Alan Gunther (1995) ‘An Outline of Australian Government Policy Towards Foreign Investment from 1976 to the Present’, Research Paper, 493, The University of Melbourne Department of Economics, November, p. 16. 49 Wayne Swan (2008) ‘Australia, China and this Asian Century’, Speech to the Australia-China Business Council, Melbourne, 4 July . For detail see Wayne Swan (2008) ‘Government Improves Transparency of Foreign Investment Screening Process’, Media Release, 17 February . ABS (2008) ‘International Accounts – Statistical Overview’, Yearbook 2008 . ABS (2008) 5352.0 International Investment Position, Australia: Supplementary Statistics, 2007 . UNCTAD, World Investment Report 2006, p. 85. According to the Report: ‘The reincorporation resulted in a debt entry in FDI outflows and caused both debit and credit entries in FDI inflows. Conceptually, there is no overall impact on the balance of FDI flow account. The FDI position (stock) was also treated in a similar manner.’ See p. 99. Boehm, Twentieth Century Economic Development in Australia, p. 172. ABS (2008) ‘Table 85. Selected International Accounts Ratios – Financial Year’, 5302.0 – Balance of Payments and International Investment Position, Australia, September 2008 . Given the different methodologies and the breaks in the series, the data before and after 1988 comparisons are indicative rather than strictly comparable. Reserve Bank of Australia (2005) ‘Australia’s Foreign Currency Exposure and Hedging Practices’, Reserve Bank Bulletin, December, p. 2 . Cited in David Uren (2009) ‘Foreign Bank Withdrawal is the Big Danger’, The Australian, 2 February . John Pitchford (1990) Australia’s Foreign Debt: Myths and Realities, Sydney, Allen & Unwin. For a more up-to-date appraisal of the CAD, see Rochelle Belkar, Lynne Cockerell & Christopher Kent (2007) Current Account Deficits: The Australian Debate, Reserve Bank of Australia, Research Discussion Paper, RDP2007-02 . Glen Milne (1995) ‘Labor Urges Keating to Account for Deficit’, The Australian, 14 August, p. 11. See for example Ian Henderson (1996) ‘Leaders Seek Political Capital in Foreign Debt Issue’, The Australian, 7 February, p. 5 and (1996) ‘Keating Loses Credibility on Banana Road’, The Australian, 8 February, p. 29. Paul J Keating (1996) ‘ALP Campaign Launch’, Melbourne, 14 February, p. 3. Cited in Ian Henderson (1995) ‘Keating’s Conundrum on Foreign Investment’, The Australian, 14 September, p. 11. Paul Keating interview with Kerry O’Brien from ABC Television (2006) The 7.30 Report, 8 May . Cited in Kenneth Davidson (2007) ‘Foreign Debt a Cause for Concern’, The Age, 21 May . ABS (1998) 5331.0 - Balance of Payments and International Investment Position,

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N o t e s t o p a g es 194–200

66

67

68

69

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Australia, Concepts, Sources and Methods, 1998 . David Gruen (2005) ‘Perspectives on Australia’s Current Account Deficit’, Keynote Address to the Australian Business Economists Forecasting Conference, 13 December See Bureau of Economic Analysis (2009) U.S. International Transactions: Fourth Quarter 2008 and Year 2008 . Sid Marris (2008) ‘Current Account Balloons to Record’, The Australian, 5 March . Peter Martin (2009) ‘Is This the Recession We Had to Have?’, The Age, 31 January . There remains one major exception to the general trend towards debt reduction and that is the mini boom in first homeownership spurred by Rudd Government grants of up to $21,000 for new dwellings. Unless wealthy parents are backing their children and will help them with loan repayments if unemployment rises, the grants are likely to see rising defaults in coming years. The grants succeed mainly in raising the price of houses and should be scrapped. Guy Debelle (2004) The Macroeconomic Implications of Rising Household Debt, BIS Working Papers, No 153 . Ric Battellino (2007) ‘Some Observations on Financial Trends’, Address to Finsia-Melbourne Centre for Financial Studies, 12th Banking and Finance Conference, Melbourne, 25 September . See RBA Bulletin Statistical Tables Table B21 Household Finances – Selected Ratios . RBA (2008) Financial Stability Review, March, p. 47 . Ibid. Ric Battellino (2008) ‘Background Notes for Opening Remarks to Senate Select Committee on Housing Affordability in Australia’, Melbourne, 24 April . The arrears rate for loans on banks’ balance sheets is about 0.3 per cent, while that for securitised loans is about 0.6 per cent in total, or 0.4 per cent for prime mortgages. We estimate that there are around 15,000 households in Australia which are 90 days or more in arrears on their housing loan repayments. An additional 30,000 or so are between 30 days and 90 days in arrears. These are quite low numbers for a country the size of Australia.

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N o t e s t o p a g es 200–06

77 RBA (2008) Financial Stability Review, p. 49. 78 Ibid., p. 26. 79 See Mark Jones & Alison Bell (2008) ‘Big Four Dominate Mortgage Market’, The Australian, 8 October . The report put household stress at 35 per cent of income taken up by loan repayments.

Chapter 7 1 2

3 4

5 6 7 8

9

10

11 12 13

14

15 16

Paul Keating (2000) Engagement: Australia Faces the Asia-Pacific, Sydney, Macmillan, p. 280. Peter Groenewegen (1983) ‘The Political Economy of Federalism’, in Brian Head (ed.) State and Economy in Australia, Melbourne, Oxford University Press; Francis Castles (1988) Australian Public Policy and Economic Vulnerability, Sydney, Allen & Unwin. NJ Butlin, A Barnard & JJ Pincus (1982) Government and Capitalism: Public and Private Choice in 20th Century Australia, Sydney, Allen & Unwin, p. 76. JM Greene cited in David Pope (1987) ‘Population and Australian Economic Development 1900–1930’, in Rodney Maddock & Ian W McLean (eds) The Australian Economy in the Long Run, Melbourne, Cambridge University Press, pp. 53–54. Alf Rattigan (1986) Industry Assistance: The Inside Story, Melbourne, Melbourne University Press, p. 3. EW Hancock (1930) Australia, London, Ernst Benn, p. 89. Ibid., p. 90. W Max Corden (1997) The Road to Reform: Essays on Australian Economic Policy, Melbourne, Addison-Wesley Longman, p. 115. See also Richard Snape (1984) ‘Australia’s Relations with GATT’, Economic Record, 60(168). Ann Capling & Brian Galligan (1992) Beyond the Protective State: The Political Economy of Australia’s Manufacturing Industry Policy, Melbourne, Cambridge University Press, p. 110. Cited in Barrie Dyster & David Meredith (1994) Australia in the International Economy in the Twentieth Century, Melbourne, Cambridge University Press, p. 253. Brian Pinkstone (1992) Global Connections: A History of Exports and the Australian Economy, Canberra, AGPS, p. 159. Cited in Castles, Australian Public Policy and Economic Vulnerability, p. 139. John Warhurst & Jenny Stewart, ‘Manufacturing Industry Policies’, in Brian Head & Alan Patience (eds) From Fraser to Hawke, Melbourne, Longman Cheshire, 1989, p. 162, Leon Glezer (1982) Tariff Politics, Melbourne, Melbourne University Press, p. 132. Gough Whitlam, cited in Stephen Bell (1993) ‘Weak on the State: Economic Rationalism in Canberra’, Australia and New Zealand Journal of Sociology, 29(3), December, p. 397. Warhurst & Stewart, ‘Manufacturing Industry Policies’, p. 162. Corden, The Road to Reform, p. 68.

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N o t e s t o p a g es 206–11

17 Bob Hawke (1985) ‘Stan Kelly Memorial Lecture’, Commonwealth Record, 2–8 September, p. 1518. See also Andrew Leigh (2002) ‘Trade Liberalisation and the Australian Labor Party’, Australian Journal of Politics and History, 48(4). 18 Trevor Matthews & John Ravenhill (1992) ‘Strategic Trade Policy and its Implications’, in Stephen Bell & John Wanna (eds) Business-Government Relations in Australia, Sydney, Harcourt Brace Jovanovich. 19 Bob Hawke, Paul Keating & John Button (1991) Building a Competitive Australia, Canberra, AGPS. 20 Bob Hawke (1985) ‘Speech to Centre for European Policy Studies’, Commonwealth Record, 4–10 February, p. 97. 21 The group includes 15 members: Australia, Argentina, Brazil, Canada, Chile, Colombia, Fiji, Indonesia, Malaysia, New Zealand, Paraguay, the Philippines, South Africa, Thailand, and Uruguay; Paraguay and South Africa joined later. 22 Brendan Pearson (1999) ‘Trade Barriers Worse Than Before: ABARE’, Australian Financial Review, 26 February, p. 12. 23 Lenore Taylor (2001) ‘Farm Trade Barriers Remain’, Australian Financial Review, 12–16 April, p. 8. 24 See Tom Conley (2001) ‘The Domestic Politics of Globalisation’, Australian Journal of Political Science, 36(2). 25 Nina Field (1996) ‘Moore Signals Tougher Line on Tariff Cuts’, Australian Financial Review, 8 November. 26 Cited in Michael Stutchbury (1996) ‘Mutuality the Key to Import Tariff Cuts’, Australian Financial Review, 2 October. 27 Department of Foreign Affairs and Trade (1997) In the National Interest: Australia’s Foreign and Trade Policy, Canberra, Commonwealth of Australia; (1997) Trade Liberalisation: Opportunities for Australia, Canberra, Commonwealth of Australia. 28 The new Coalition government changed the name of the Industry Commission (formerly the Tariff Board then the Industries Assistance Commission) to the Productivity Commission. 29 John Howard (1997) ‘Transcript’, Address at the Queensland Chamber of Commerce and Industry Dinner, Brisbane, 15 August. For criticism see Richard Gluyas (1997) ‘Flotsam of Policy Leaves Captains of Industry all at Sea’, The Australian, 1 March. 30 Michelle Grattan (1997) ‘Business of Industry Policy’, Australian Financial Review, 9 December. 31 Cited in Alan Wood (1997) ‘Growth Target a Thin Stake for Leadership’, The Australian, 9 December. 32 Michael Dwyer, ‘PM Rules Out Aid for Industry’, Australian Financial Review, 20 January 1998. 33 See for example Michelle Grattan (1997) ‘PM Draws a Fundamentalist Lesson’, Australian Financial Review, 24 October; John Howard (1998) ‘For Sake of Nation and the Citizen: Let’s Get Real’, The Australian, 29 January. 34 Cited in Peter Roberts (1998) ‘Fundamental Weakness in Canberra’s values’, Australian Financial Review, 13 February. 35 Ian Henderson & Stephen Brook (2001) ‘$2.9 Bn Knowledge Offensive’, The

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N o t e s t o p a g es 211–17

Australian, 30 January. 36 George Megalogenis (2005) ‘Farmers Well Irrigated with Cash’, The Weekend Australian, 28–29 May. 37 Stephanie Peatling (2006) ‘I’ll Never Shut Failing Farms, Howard’, The Age, 17 October. 38 Siobhain Ryan (2008) ‘Drought Aid Drains Treasury’, The Australian, 4 April. 39 See Sid Marris (2002) ‘We Pay $14 billion for Export Drive’, The Weekend Australian, 14–15 December. The extra 10 billion mentioned in the title refers to the cost of tariffs for consumers. 40 Philip King (2008) ‘Cars at a Fork in the Road’, The Weekend Australian, 16–17 August. 41 Figures based on Adrian Rollins & Mark Skulley (2006) ‘Carrots and Sticks Drive the Car Industry’, Australian Financial Review, 4 August. 42 Steve Lewis & Patrick Walters (2006) ‘Car Firms Plead for Bailout’, The Australian, 20 December. 43 Tim Colebatch (2006) ‘40,000 Factory Workers to Lose Jobs to Imports’, The Age, 20 April. 44 Cited in Angus Grigg (2006) ‘Electrolux Moves Out of SA’, Australian Financial Review, 15 September. 45 Ian MacFarlane (2007) ‘$254.1 Million to Help Australian Exporters’, Media Release, Department of Industry, Tourism and Resources, Canberra, 1 May. 46 Chris Milne (2006) ‘SA Economy Moving Away From Manufacturing’, Australian Financial Review, 10 November. 47 John Howard (2000) ‘Transcript’, Address at World Economic Forum, Melbourne, 11 September http://pandora.nla.gov.au/pan/10052/20030821-0000/www. pm.gov.au/news/speeches/2000/speech440.htm. 48 John Howard (2005) ‘Address to the APEC CEO Summit’, Busan, Korea. 18 November 49 Ann Capling (2001) Australia and the Global Trade System, Melbourne, Cambridge University Press. 50 APEC (2005) ‘A Mid-Term Stocktake of Progress Towards the Bogor Goals’, Busan, Korea, 15–16 November. 51 Greg Earl (2006) ‘APEC Spurns US Trade Push’, Australian Financial Review, 17 November. 52 Cited in Morgan Mellish (2007) ‘Prime Minister Pushes China Over Trade Deal’, Australian Financial Review, 15 January. 53 Cited in Symons & Kerr (2007) ‘Prime Minister Eyes Regional Pact on Trade’, The Australian, 16 January. 54 Cited in Joseph Kerr (2007) ‘Call to Push for US in Asian Trade Bloc’, The Australian, 17 January. 55 APEC (2007) ‘Strengthening Our Community, Building a Sustainable Future’, 2007 Leaders’ Declaration, Sydney, 9 September . 56 APEC (2007) Sydney APEC Leaders’ Declaration on Climate Change, Energy Security and Clean Development, Sydney, 9 September . APEC (2008) ‘A New Commitment to Asia-Pacific Development’, 2008 Leaders’ Declaration, Lima, 22–23 September . Ross Garnaut (2002) ‘An Australia-United States Free Trade Agreement’, Australian Journal of Political Science, 56(1), p. 123. Colleen Ryan (1997) ‘Howard Jumps China’s Trade Wall’, Australian Financial Review, 22–25 April. Greg Sheridan (2000) ‘Trade Winds of Change’, The Australian, 7 June. Steve Lewis (2002) ‘Howard Pushes Bush on Trade Deal’, The Australian, 14 June. For the legislation see US Free Trade Agreement Implementation Act 2004 No. 120, 2004 and US Free Trade Agreement Implementation (Customs Tariff ) Act 2004 No. 121, 2004 . For a list of participants in the debate, see the Senate (2004) The Senate, Final Report of the Select Committee on the Free Trade Agreement between Australia and the United States of America, Canberra, Parliament of Australia, August . In the print media, The Australian provided a generally positive view of the agreement and The Age a more critical view. Global Trade Watch provides a comprehensive (critical) archive of stories on the agreement . Ross Garnaut (2005) ‘Australia, US and China: Open Regionalism in an Era of Bilateral Trade Deals’, Paper presented at a Public Lecture, Asialink, Melbourne, 22 March; Alan Oxley (2003) ‘Free Trade Agreements in the Era of Globalisation: New Instruments to Advance New Interests – The Case of Australia’, Australian Journal of International Affairs, 57(1). Paul Kelly (2004) ‘Trade Deal: The New Cash Flow’, The Weekend Australian, 14–15 February. Ross Garnaut (2005) ‘Australia, US and China: Open Regionalism in an Era of Bilateral Trade Deals’, Paper presented at a Public Lecture, Asialink, Melbourne, 22 March.; Peter Lloyd & Donald MacLaren (2004) ‘Gains and Losses from Regional Trading Agreements: A Survey’, The Economic Record 80(251); Ann Capling (2004) All the Way with the USA: Australia, the US and Free Trade, Sydney, University of New South Wales Press; Linda Weiss, Elizabeth Thurbon & John Matthews (2004) How to Kill a Country: Australia’s Devastating Trade Deal with the United States, Sydney, Allen & Unwin. Michael Priestly (2007) ‘Australia’s Free Trade Agreements’, Background Note, Parliamentary Library, Parliament of Australia, 2 December . Cited in Christine Wallace (2003) ‘Mandarins Segregated over Bi Versus Multilateral Deals’, The Australian, 6 November. Simon Crean (2008) ‘Australia and the Multilateral Trade System – Seizing the Opportunities’, Address to the Lowy Institute, 28 February . 70 Simon Crean (2008) ‘Building Prosperity through Trade: Helping Developing Countries Reap the Benefits’, The Biennial Sir Alan Westerman Lecture in Australian Trade Policy, 15 October . 71 Cath Hart & Steve Lewis (2006) ‘New Team Pledges a Future for Industry’, The Australian, 5 December . 72 AAP (2006) ‘Gillard Promotes Labor’s Industry Policy’, The Age, 16 December . 73 AAP (2007) ‘Invention Will Make Us Prosperous: Rudd’, The Age, 24 April. 74 AAP (2007) ‘Guess What? Time’s Up’, The Age, 27 April . 75 Ben Potter (2008) ‘PC Questions $6.5bn Budget package’, Australian Financial Review, 28 March. 76 Both cited in Lenore Taylor (2008) ‘Nation-Building Back in Vogue for Kevin Rudd’s Labor’, The Australian, 16 May . 77 Sinclair Davidson (2008) ‘Industry Policy Madness’, The Age, 12 June . 78 Australian Chamber of Commerce and Industry (2007) ‘Media Release: ACCI Releases Manufacturing Sector Position Paper’ . 79 Louise Dodson (2008) ‘Industry Innovation the Key’, Australian Financial Review, 29 August. 80 Kevin Rudd (2008) Questions and Answers National Press Club, Canberra, 27 August . 81 Tim Colebatch (2009) ‘Exporters to Lose Out After Refusal to Make Up Shortfall’, The Age, 26 February . 82 Steve Bracks (2008) Review of Australia’s Automotive Industry, Canberra, 22 July ; Roy Green (2008) Building Innovative Capacity: Review of the Australian Textiles, Clothing and Footwear Industries, Canberra ; Terry Cutler (2008) Venturous Australia: Building Strength in Innovation, Melbourne, 29 August . 83 David Mortimer (2008) Winning in World Market: Review of Export Policies and Programs, Canberra. 84 Most of the statistics are based on Department of Innovation, Industry, Science and Research (2008) Key Automotive Statistics, Canberra, July . 85 Department of Innovation, Industry, Science and Research (2009) Automotive Industry Fact Sheet, Canberra, February . 86 Bracks, Review of Australia’s Automotive Industry, p. 16. 87 Philip King (2008) ‘Holden Loses $6m but Happy at Turnaround’, The Australian, 30 July. 88 Andrew Trounson (2007) ‘Ford Puts Focus on Domestic Sales’, The Australian, 26 July. 89 Katharine Murphy (2007) ‘Labor Offers Green Relief to Car Industry’, The Age, 16 March . 90 Bracks, Review of Australia’s Automotive Industry, ch. 11. 91 Ibid., ch. 9. 92 Andrew Trounson (2008) ‘Auto Sector Reels as Ford Cuts 450 jobs on Top of Holden Job Losses’, The Australian, 17 October . 93 Kevin Rudd (2008) Remarks at the launch of the New Car Plan for a Greener Future, Melbourne, 10 November . 94 Department of Innovation, Industry, Science and Research (2008) A New Car Plan for a Greener Future, Canberra . 95 Lenore Taylor (2008) ‘PM Kevin Rudd Backs Green Machine’, The Australian, 23 December . 96 See Nicholas Gruen (2006) ‘The Trouble with our Car Industry’, The Age, 4 August; Ian Porter (2007) ‘Car makers Need to Specialise to Survive’, The Age, 9 March. 97 Author’s calculations based on ABS (2008) 5302.0 Table 85. 98 Kevin Hamlin (2009) ‘China’s Imports, Exports Plunge on Global Recession’, Bloomberg.com, 11 February . 99 DFAT (2008) Trade Topics September Quarter, Canberra, p. 21 . 100 Tracy Sutherland (2008) ‘Indonesia, Malaysia Refuse Car Tariff Cuts’, Australian Financial Review, 12 December.

Chapter 8 1 2 3

John Howard (1998) Election Victory Speech, Sydney, 3 October. Tony Abbott, cited in Mike Steketee (2003) ‘Still Work in Progress’, The Weekend Australian, 7–8 June, p. 22. John Edwards (2000) Australia’s Economic Revolution, Sydney, University of New South Wales Press, p. 55.

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N o t e s t o p a g es 238–42

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13

14 15 16 17 18 19 20

Ken Henry (2002) ‘Globalisation, Poverty and Inequality: Friends, Foes or Strangers’, Towards Opportunity and Prosperity Conference, University of Melbourne, April, pp. 31–32. See Tom Conley (2004) ‘Globalisation and the Politics of Persuasion and Coercion’, Australian Journal of Social Issues, 39(2). Peter Saunders (2004) ‘Towards a Credible Poverty Framework: From Income Poverty to Deprivation’, SPRC Discussion Paper, No. 131, January, p. 2. There are two Peter Saunders writing on these issues in Australia with very different interpretations of the data. Bob Woodward (1994) The Agenda: Inside the Clinton Whitehouse, New York, Simon & Schuster, p. 84. See for example Thomas Friedman (2006) The World is Flat: A Brief History of the Twenty-First Century, New York, Farrar, Strauss, Giroux; Kenichi Ohmae (1995) The End of the Nation State: The Rise of Regional Economies, London, Harper Collins; Peter Drucker (1989) The New Realities, Oxford, Heinemann. See for example, Naomi Klein (2007) The Shock Doctrine: The Rise of Disaster Capitalism, New York, Metropolitan Books; Peadar Kirby Randal Germain (ed.) (2000) Globalization and Its Critics: Perspectives from Political Economy, London, Macmillan; John Gray (1998) False Dawn: The Delusions of Global Capitalism, London, Granta. See William Greider (1997) One World, Ready or Not: The Manic Logic of Global Capitalism, New York, Simon and Schuster; Philip G Cerny (1997) ‘Paradoxes of the Competition State: The Dynamics of Political Globalization’, Government and Opposition, 32(2); Susan Strange (1996) The Retreat of the State: The Diffusion of Power in the World Economy, Cambridge, Cambridge University Press. Christian E Weller & Adam Hersh (2002) ‘The Long and Short of It: Global Liberalization, Poverty and Inequality’, Economic Policy Institute Technical Papers, p. 6. OECD (2008) ‘Income Inequality and Poverty Rising in Most OECD Countries’, OECD, 21 October. See OECD (2008) Growing Unequal: Income Distribution and Poverty in OECD Countries, Paris, OECD . David Dollar & Aart Kraay (2002) ‘Spreading the Wealth’, Foreign Affairs, January/February. See also World Bank (2002) Globalization, Growth and Poverty: Building an Inclusive World Economy, World Bank and Oxford University Press. Weller & Hersh ‘The Long and Short of It’, pp. 1 & 16. Reported in Mattias Lundberg & Branko Milanovic (2000) ‘Globalization and Inequality: Are They Linked and How?’, PovertyNet Newsletter, World Bank. Rafael Reuveny & Quan Li (2003) ‘Economic Openness, Democracy and Income Inequality: An Empirical Analysis’, Comparative Political Studies, 36(5). Ibid., pp. 577–83. Ibid., pp. 593–94. Lundberg & Milanovic, ‘Globalization and Inequality’. Timothy M Smeeding (2002) ‘Globalisation, Inequality and the Rich Countries of the G-20: Evidence from the Luxembourg Income Study’, in David Gruen, Terry O’Brien & Jeremy Lawson (eds) Globalisation, Living Standards and

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N o t e s t o p a g es 242–53

21 22 23 24 25 26

27 28

29 30 31

32 33 34 35

36 37

38

Inequality: Recent Progress and Continuing Challenges, Proceedings of a Conference held in Sydney 27–28 May, Reserve Bank of Australia and Australian Treasury, p. 179. David Dollar & Aart Kraay (2004) ‘Trade, Growth and Poverty’, Economic Journal, 114, p. 27. Henry, ‘Globalisation, Poverty and Inequality’, p. 15. For a critique, see Branko Milanovic (2003) ‘The Two Faces of Globalization: Against Globalization as We Know It’, World Development, 31(4), p. 676. Stephanie Moller et al. (2003) ‘Determinants of Relative Poverty in Advanced Capitalist Democracies’, American Sociological Review, 68, p. 39. Ibid., p. 44. Tom Conley (1996) ‘The Politics of International Finance’, Flinders Journal of History and Politics, 18; Fred Argy (1995) Financial Deregulation: Past Promise – Future Realities, CEDA; (1998) Australia at the Crossroads: Radical Free Market or a Progressive Liberalism?, Sydney, Allen & Unwin. Anonymous (2004) ‘The Rising Tide of Red Ink’, The Economist, 23 August, p. 56. Wayne Swan & Lindsay Tanner (2009) Updated Economic and Fiscal Outlook, February, p.2 http://www.budget.gov.au/2008-09/content/uefo/download/ Combined_UEFO.pdf. Ibid., p. 45. Ann Harding (2002) ‘Research Highlights a Nation Growing Apart’, The Australian, 25 February, p. 8. Verona Burgess, Tracy Sutherland & Laura Tingle (2006) ‘PM’s Agenda Swells Public Service Ranks’, Australian Financial Review, 1 December. See also Australian Public Service Commission (2006) State of the Service Report: 2006–07, Canberra, Australian Government . Figures are for the number of staff covered by the Public Services Act. OECD, Growing Unequal, p. 16. Kevin Rudd (2009) ‘The Global Financial Crisis’, The Monthly, February, pp. 21–22. Ibid., p. 27. See David Card & Alan B Krueger (1997) Myth and Measurement: The New Economics of the Minimum Wage, Princeton, Princeton University Press. For an Australian discussion see PN Junankar (2000) ‘Are Wage Cuts the Answer? Theory and Evidence’, in Stephen Bell (ed.) The Unemployment Crisis in Australia: Which Way Out?, Cambridge, Cambridge University Press. Tom Conley (2002) ‘Globalisation as Constraint and Opportunity: The Restructuring of the Australian Political Economy’, Global Society, 16(4). John Howard (2004) ‘Address to the Committee for Economic Development of Australia’, Melbourne, 25 February . Lenore Taylor (1995) ‘PM Admits Gap between Rich and Poor has Widened’, The Australian, 6 October, p. 2. For a sympathetic view of Labor’s social policies,

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N o t e s t o p a g es 253–58

39 40

41 42

43

44

45

46

47

48

49

see Francis Castles (1996) ‘Australian Social Policy: Where are We Now?’, Just Policy, 6; for one less so, see Lois Bryson (1996) ‘Transforming Australia’s Welfare State’, Just Policy, 6. John Howard (2000) ‘Quest for a Decent Society’, The Australian, 12 January, p. 11. John Howard (2003) Address at the Launch of the Queensland Deaf Foundation, Brisbane, 7 April . Howard cited in Dennis Shanahan (1997) ‘Strength, Not Size, Howard’s Way’, Australian, 6 May, p. 7. For discussion see David Trigger (2003) ‘Does the Way We Measure Poverty Matter’, Discussion Paper No. 59, November, National Centre for Social and Economic Modelling. See Tim Callen (2008) ‘What is GDP?’, Finance & Development, December . For a more complex discussion on the accuracy of the various GDP measures (expenditure, income and production) see ABS (2008) ‘Accuracy’, 5216.0.55.002 - Information Paper: Quality Dimensions of the Australian National Accounts, 2007 . The missing percentage is accounted for by gross mixed income, which is the operating profits of the unincorporated (small business) sector. ABS (2008) Australian System of National Accounts 2007–07, (5204.0) . Braham Dabscheck (1995) The Struggle for Australian Industrial Relations, Melbourne, Oxford University Press, 1995. See also Paul J Keating (1985) ‘Speech to Institute of Directors’, Commonwealth Record, 2–8 September, p. 1533; and (1988) Address to the Asia Society and American/Australian Society, New York, 4 October, pp. 4–5. For an account of the various versions of the Accord see Tom Conley (1999) Economic Discipline and Global Punishment: Globalisation and Australian Economic Policy during the Hawke and Keating Years, unpublished PhD dissertation, Department of Politics, University of Adelaide, Adelaide, June, ch. 6. Ann Harding, Rachel Lloyd & Harry Greenwell (2001) Financial Disadvantage in Australia 1990–2000: The Persistence of Poverty in a Decade of Growth, Smith Family/NATSEM. The Smith Family is a social welfare organisation, NATSEM is the National Centre for Social and Economic Modelling and the CIS is a economic liberal think tank. Kayoko Tsumori, Peter Saunders & Helen Hughes (2002) ‘Poor Arguments: A Response to the Smith Family Report on Poverty in Australia’, Issue Analysis, No. 21, 16 January. Ann Harding (2002) ‘Research Highlights a Nation Growing Apart’, The Australian, 25 February, p. 8.

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N o t e s t o p a g es 258–66

50 Peter Saunders & Kayoko Tsumori (2002) ‘For Richer or Poorer, We’re Still a Lucky Country’, The Australian, 16 January, p. 11. 51 Harding, Lloyd & Greenwell, Financial Disadvantage in Australia 1990–2000, pp. 18–19. 52 Saunders, ‘Examining Recent Changes in Income Distribution in Australia’, p. 9. 53 Michael Pusey (2003) The Experience of Middle Australia: The Dark Side of Economic Reform, Melbourne, Cambridge University Press. See also RG Gregory (1993) ‘Aspects of Australian and US Living Standards: The Disappointing Decades 1970–1990’, Economic Record, 69(204). 54 John Howard (2004) Joint Press Conference with Brendan Nelson, Canberra, 11 March . Emphasis added. Howard was commenting on The Senate Community Affairs Reference Committee (2004) A Hand Up, Not a Handout: Renewing the Fight Against Poverty (Report on Poverty and Financial Hardship), Canberra, Commonwealth of Australia. 55 Yongping Li (2005) ‘Impact of Demographic and Economic Changes on Measured Income Inequality’, Research Paper, Canberra, Australian Bureau of Statistics. 56 Cited in Bill Emmott (2008) Rivals: How the Power Struggle Between China, India and Japan Will Shape Our Next Decade, London, Penguin, p. 131. 57 OECD (2008) Growing Unequal: Income Distribution and Poverty in OECD Countries, Paris, OECD. 58 John Howard (2005) ‘Real Wages’, Media Release, 29 August . 59 Australian Centre For Industrial Relations Research & Teaching (2005) ‘Real Earnings Trends by Income Distribution’, Research Commissioned by Unions NSW, August. See for a discussion ABC Radio (2005) ‘Research Casts Doubt on PM’s Wage Growth Boast’, AM, 29 August . 60 Ann Harding, Quoc Ngu Vu & Alicia Payne (2007) A Rising Tide? Income Inequality, the Social Safety Net and the Labour Market in Australia, NATSEM . 61 ABS (2007) 4102.0 – Australian Social Trends, 2007 Purchasing Power, 7 August . 62 Kevin Rudd (2006) ‘Howard’s Brutopia: What the Prime Minister Doesn’t Want to Talk About’, The Monthly, November. 63 Kevin Rudd (2001) ‘Social Democratic Responses to Globalisation’, Sydney Papers, 12(4), p. 27. 64 See for example ABC Radio (2006) ‘Rudd’s New Vision for the Nation’ AM, 5 December . 65 Rudd, ‘The Global Financial Crisis’, p. 21. 66 Paul Kelly (2008) ‘Two Cheers for Rudd’, The Australian, 27 September .

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N o t e s t o p a g es 267–68

67 Source unknown, but it seems pertinent for Australia’s future. 68 See for example Andrew Charlton (2007) Ozonomics: The Myth of Australia’s Economic Superheroes, Sydney, Random House; Tony Aspromorgous (2006) ‘The Uses of Fiscal Policy and the Role of Monetary Policy’, Australian Review of Public Affairs, 23 February . 69 Dennis Shanahan (2007) ‘Whom to Trust on China’, The Australian, 19 October. 70 ABC Television (2007) ‘Tony Jones Interview with Paul Keating’, Lateline, 7 June . 71 John Howard (2007) Address to Lyne Federal Electorate Council Luncheon, Port Macquarie, 9 February . The quote: ‘I’m a great believer in luck, and I find the harder I work, the more I have of it’ is generally attributed to Thomas Jefferson. 72 Kevin Rudd (2008) ‘Building Australia’s Economic Future’, Address to Lord Mayor’s Business Breakfast, Perth, 21 January . 73 Kevin Rudd cited in Frank Walker (2007) ‘Rudd’s Bold Challenge’, Sydney Morning Herald, 16 September . 74 See Henry, ‘Managing Prosperity’. 75 Cited in Don Stammer (2005) ‘Australia 2005: The Australian Economy: Success and Further Challenges’, Centre for Policy Development, 19 July . 76 Paul Kelly (2007) ‘Time for a Rethink’, The Australian Literary Review, October.

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Index

Australia invited to join 151–52 investment in 155 relations with 143 trade agreements with 219

4-wheel drive vehicles 213 A New Car Plan for a Greener Future 225 Abbott, Tony 237 Accord with trade union movement 258, 261 ACIS 212 ADF 159 adjustment strategies 28 Afghanistan war 150 Africa, regional trade in 77 ‘age of affluence’ 38 agricultural trade attempts to deregulate 76, 215 decreasing importance of 78–79, 114–15, 230 excluded from GATT 36 prices for 119–20 protection of 44, 204–5, 208 All Ordinaries index 173 ALP, see Australian Labor Party alternative engine technologies 227 American International Group 90–91 Angell, Norman 30 Anglo economies, globalisation of 55 Anglo-Japanese Commercial Treaty 136 ANZ Bank 179 ANZUS alliance 140 APEC, see Asia Pacific Economic Cooperation forum arbitrating mechanisms 49 Argentina 9–10 Arndt, HW 180 arrears rates 200 ASEAN nations 160 as trade partners 129, 153, 231–35

Asia economic growth of 39–40 economic influence of 57 financial crises in 18, 111, 149, 210–11 immigration from 142 imports from 143 relations with 22–23, 128–62 trade surplus with 153 Asia–Pacific Community proposed 160 Asia Pacific Economic Co-operation Forum 145–47 Australian attitudes to 182 problems with 160 under Hawke and Keating 208–9 under Howard 215–17 US attitudes to 151–52 Asia–Pacific Partnership on Climate Change 152 Asian tigers 39, 67, see also ASEAN nations ‘aspirational’ goals 216–17 asset prices, decline in 196–97 Association of Southeast Asian Nations, see ASEAN nations ASX 200 index 173 ATS 225 Australia, see also names of administrations attitudes to poverty 259 Australia–United States Free Trade Agreement 183, 217–19 contribution to global GDP 6–7

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currency falls in value 167 currency floated 106, 121, 169–70 current account deficits 24, 229– 30, 246 disposable income levels 119 economic history 94–127 economic vulnerability 8–14, 163–65 financial markets 171–79 foreign debt levels 97–98, 165 foreign investment by 85, 155–56, 173, 186 foreign investment in 85–87, 156–58 GDP growth 97 globalisation in 49–50, 252–55 government debt in 244–45 growth in 2–3, 113 Human Development Index 63 military readiness 159 monetary policy in 170–71 poverty in 39, 239–40 security agreement with Indonesia 147 social services spending 247–48 sovereign wealth funds in 84 superannuation funds 83 supports East Timorese independence 149–50 tax levels 246–47 telegraph link to 31–32 terms of trade 21 trade dependency of 79 trade outcomes 228–35 world economy and 18 Australia and the Northeast Asian Ascendancy 144–45 Australia (book) 133–34 Australia–China Trade Agreement 151 Australia–Japan Commerce Treaty 140 Australia–United States Free Trade Agreement 183, 217–19 Australian Bureau of Agricultural Economics 208 Australian Chamber of Commerce and Industry 221

Australian Council of Trade Unions 258 Australian Defence Force 159 Australian Labor Party relations with US 143 supports free trade 24–25 supports protectionism 203 supports White Australia policy 133 trade policy 218–19 ‘Australian Settlement’ 1–2, 99 Australian Stock Exchange 173, see also shareholders Automotive Competitiveness and Investment Scheme 212 automotive industry, see car industry Automotive Transformation Scheme 225 autonomy of the state 47–48 Backing Australia’s Ability 211 Badawi, Abdullah 151 balance of payments 193–94, see also current account balance; terms of trade Baldwin, Richard 76 Bali bombings 150 Bank of America 90 Banking Act 1945 (Cth) 102 Banks, Gary 221 banks in Australia 172 Barings Bank 98 Barton, Edmund 132 base metal prices 117 Battellino, Ric 195–97 bear markets 92, 174 Bell, Roger 140 Bengal rum 130 Big Mac Index 60 bilateral investment treaties 87 bipartisan support for liberalisation 50 Bisley, Nick 51 Blainey, Geoffrey 130, 133 Boehm, EA 100, 103 Bogor Declaration 146, 215–16 Bracks Review 222, 224–25 Brazil 39, 45 Breslin, Shaun 153

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Bretton Woods agreements 35–37, 40, 47–48 Britain abandons free trade 136 as trade partner 130–31, 140 Australian dependence on 1 Australian investment in 186 declining importance of 142–44 free trade in 29 immigrants to Australia from 100 interwar period 32 investment in Australia 179–80, 184 Japan as ally of 134 social services spending 247 Brittan, Samuel 41 broadband policy 227 Bruce, Stanley M 100 Brunt, Maureen 205–6 Building a Competitive Australia 207 Bulletin, The 142 Bush (GW) administration 44, 151–52, 254 ‘Buy American’ clause 75 Cairns Group 208 Calwell, Arthur 139 Cameron, David 51 Campbell Committee 172 Canada, Human Development Index 63 capacity of the state 47–49 capital control, see financial markets capital inflow regulations 172 capitalisation of financial sector 81 capitalism exploitative nature of 240 market control in 46–47 shift away from mooted 264 car industry foreign investment in 180 government support for 211–14 in China 66 tariff reform in 209–10 under Rudd 222–27 carbon emissions reduction 123, 224, 228

Carr, Kim 220 carry trade 174–75 Castles, Francis G 12, 52, 98 CDOs 72, 88 CDSs 90–91 central agencies 48, 168, see also Reserve Bank of Australia central planning economies 39–40 Centre for Independent Studies 258 CEOs, see executive bonuses Cerny, Philip 46 Chifley Labor government 180 children, access to education and health 26, 249 Chile, trade agreement with 219 China as trade partner 230–31 Australian exports to 117–18, 143–45 car industry in 226 central planning in 18, 39–40, 44 defeat by Japan 134 demand for resources 111, 128 economic growth of 3–4, 58–59, 125, 152–53 economy of revalued 60 effect of sub-prime crisis 155 fall in imports from 230 foreign investment by 72–73, 85, 156–57 foreign investment in 85 foreign reserve assets 83 GDP per capita 63 immigration from banned 132 indentured labourers from 131–32 iron ore imports 117 keeps global prices low 167 manufacturing sector 64–66 military threat from 159 official recognition of 143 proportion of global GDP 61–62 reasons for growth 67–68 relations with US 57 resources boom due to 21 state investment in Australia by 23–24, 183–84, 186–87

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trade blocs proposed by 215 trade dependency of 79 trade imbalance with 69–70, 153 trade policy 44, 80 CIS 258 Clark, Colin 53 clean technology 228 climate change 9, 21, 96, 122–24 Asia–Pacific Partnership on Climate Change 152 car industry response to 224 Clinton administration dependence on bond traders 240 increases housing loans to poor 89 supports globalisation 43–44 trade deals with 217 Clinton, Hillary 73 coal 117–18, 123 coercion to adopt liberal policies 49 collateralised debt obligations 72, 88 Colombo Plan 139 command economies 39–40 Committee of Inquiry into the Australian Financial System 172 commodity prices 117–18, see also resources currency value depends on 175 fluctuations in 9, 119 investment and 158–59 under Howard 111 Commonwealth Bank Act 1945 (Cth) 102 communism as alternative to capitalism 39–40 collapse of 44 in China 139 opposition to 141 Community Reinvestment Act (US) 89 compensatory spending 53 competitiveness 45 components for car industry 223 comprehensive engagement policy 154–61 compulsory pensions 82–83 Connor, Rex 181 ‘consenting adults’ view of foreign debt

191–92 construction sector 114 consumer spending 68–69, 262 convict labour 133 Coombs, HC ‘Nugget’ 102 Corden, W Max 87 corporate profits, from financial sector 81 corporate regulation 237 Costello, Peter on bilateral trade deals 210 on industry policy 211 on isolationism 183 on private debt 192 on terms of trade 121 Crean, Simon 216, 219–20, 222 credit ceilings 172 credit default swaps 90–91 credit markets, see financial markets Crosland, Anthony 38 cross-border capital flows 81 currency options 171 currency trading, see foreign exchange current account balance 9, see also terms of trade across OECD 246 countries in surplus 70, 93 deficits in 24, 189–94 during Great Depression 34 global imbalances 69–71 in 1970s and 1980s 107–8 in Australia 104 income deficit component 192–93 public sector and 52–53 Curtin, John 138 de-leveraging 93 Deakin, Alfred 135 debt securities in Australia 184 debt servicing costs 100, 163–201 deficit countries 70, 93 deficit spending, see current account balance democracies, see social democracy depressions and recessions, see also Great Depression

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1890s 29, 97–98 1952-53: 103 1988-89: 109–11 debt levels during 189 in Asia 111 deregulation of foreign investment 87, see also liberalism developed world 37–38, 68, 70–71 developing world 61, 70–71 ‘dictation test’ 132–33 direct government assistance 262 direct investment 31, 184, 186, see also foreign investment disposable income levels 119 dispute settlement in international trade 75 Doha Round of WTO 76, 215, 219 Dollar, David 241 domestic car sales decline 212–13 domestic defence policy 98–99 domestic products favouritism 75 double taxation treaties 87 Dow Jones Industrial Average 92 Downer, Alexander 148, 152, 217 Dreher, Axel 53 droughts 98, 211–12 Dunn, John 50 East Asian Summit 152, 154, 160, 215 East India Company 130 East Timorese independence 22, 149–50 economic cooperation agreements 87 economic crises, see financial crises; subprime crisis, effects of ‘economic’, defined 16 economic liberalism 43, 49, 265 economic reform 13, 106–8, 266 economic vulnerability 8–14, 23–24 Economist, The 60, 268 education sector 230 children’s access to 26, 249 rising costs in 262 Edwards, John 192, 237 egalitarianism 10–11, 239, see also inequality; redistribution of wealth Eggleston, Frederic 145

Eichengreen, Barry 31 elaborately transformed manufactures 115 electoral success, constraints from 48 Electrolux 214 embedded liberalism 35 Emissions Trading Scheme 124 employment levels, by industry sector 115, see also unemployment enfranchisement, economic effects of 30 environmental priorities 48, 203, 266 equity ownership 173, 184–86 ETMs 115 Euro, trading in 82 Europe 39, 81, 139, see also European Union European Union as example for regional blocs 160 automotive imports from 223 Britain joins 142 protectionism in 208, 215 trade policy in 57 Evans, Gareth 150 exchange rates, see foreign exchange executive bonuses 11, 236–38, 249–50 Export Market Development Grants 222 exports Asian dependence on 68–69 composition of 231 from car industry 212, 223 main destinations 234 required to finance debt 190–91 top commodities 232 trade balance and 229 family payments 262 Farm Management Deposit Schemes 212 Farrell, Diana 81 FDI, see foreign investment Federation, principles of 98 financial crises, see also sub-prime crisis, effects of as opportunity for reform 266 in Asia 18, 111, 128–62

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Rudd on 264–65 financial derivatives hedging strategies 171 in Australia 184, 186 innovations in 88 market for expands 178 trading in 82 financial markets, see also global finance boom mentality 164 capital flow into 70–71, 172 collapse of 89–90 crisis in 163–201 dominate economy 23–24 in Australia 112 increasing power of 46 liberalisation of 106 regulation of 36–37, 54, 264 under Menzies 103 US dominance in 68 financial sector, corporate profits from 81 financialisation 265 Finland 243 fiscal crisis of the state 41 fiscal policy 34, 249 FitzGerald, Stephen 145 fleet sales 223 Fleming, J Marcus 169 food prices, increases in 167–68 Ford 213, 222–26 Foreign Acquisitions and Takeovers Act 1975 (Cth) 181 foreign banks in Australia 172, 182 Foreign Companies (Takeovers) Act 1972 (Cth) 180 foreign debt 8–9 as proportion of GDP 243 contribution to growth 104 dominance of 173 during Great Depression 100 effects of 23–24 in Australia 97–98, 165, 189–94 foreign exchange $AU floated 106, 121, 169–70 $AU trading 174–75 $AU value in 167, 230

currency options 171 financial derivatives 178–79 global markets 171 international comparisons using 59 markets in 81–82 foreign investment 163–201 direct investment 84–87 in Asia 129 in services 79 Foreign Investment Review Board 158, 181, 183 foreign ownership 81, see also foreign debt; foreign investment foreign reserve assets 83 forward rate agreements 178 France, covert protectionism in 78 Fraser Coalition government abolishes White Australia Policy 142 devalues $AU 206 investment policy 181 minerals boom under 105 relations with US 143 tariff reform under 206 free trade, see also protectionism agreements for 87, 183 in Australian history 202 support for 24–25 Free Trade Area of the Asia–Pacific proposed 215–17 Frieden, Jeffrey 31 Friedman, Milton 40–41 fuel trade 79, 104, 230 full employment goals, see unemployment Future Fund 84 Garnaut, Ross 123, 144–45 Garrett, Geoffrey 52 GATT 36, 74, 205 GC 260–61 GDP in Australia 62, 64, 112–13, 222 General Agreement on Tariffs and Trade 36, 74, 205 General Motors 225–26 Germany 69, 79, 231

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Gillard, Julia 220 Gini Coefficient 260–61 global finance 56–93 government financial liabilities 243–44 imbalances in 57, 68–74 impacts of 165–71 losses spread by 91–92 productivity no longer linked with 18 global GDP 6–7, 61–63 Global Integration: Changing Markets, New Opportunities 214 global trade 74–81 global warming, see climate change globalisation, see also global finance defining 241 egalitarianism and 11–13 history of 18–20, 28–40 in late 20th century 43–44 limits to 54 of Australian industry 214 politics and 45–55 regional trade agreements and 76 sustainability of 27–55, 236–69 under Rudd 263–67 gold 97, 99, 131–32 Gold Standard 31, 34 ‘good politics’ 15 goods and services tax 255–56, 262 Gorton Coalition government 180 government bonds 73, 81 government financial liabilities 243–44 Great Britain, see Britain Great Depression effects of 18 in Australia 100 protectionism and 21 responses to 32–34 ‘great moderation’ 126 Green Car Fund 224–26 Green Review 222 Greene, JM 204 greenfield investment 84 Greenspan, Alan 6 Gregory, Bob 126

Gross Domestic Product, see GDP in Australia Growing Unequal 260 GST 255–56, 262 Gullet, HS 136–37 Hancock, EW 204–5 Hanson, Pauline 23, 148–49, 182–83 Harding, Ann 258 Hawke, Bob on competitiveness 110 on regional blocs 160 on trade policy 207–8 plans APEC forum 145 Hawke Labor government Accord with trade union movement 258, 261 Asian policy 144–47 currency crisis under 166 economic reform by 2, 7–8, 106 financial deregulation 172–73 investment policy 181–82 on rising inequality 252–53 promotes globalisation 49 relations with Asia 22 tariff reform under 25, 207 wage–profit ratios under 256–57 wages policy 261 health 26, 249, 262 hedge funds 83 hedging strategies 171 Henderson Report 39 Henry, Ken 114, 121–22, 237–38 Hersh, Adam 241 Hewson, John 209 Holden 213, 222–26 Holt Coalition government 142 home consumption pricing 99 Hong Kong 39, 143 Horne, Donald 94, 127, 142, 268 household debt 23–24, 194–200 housing costs 196, 258, see also mortgages Howard Coalition government Asian policy 147–54 assistance payments under 213–14,

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262 attempts to liberalise agricultural trade 215 boom under 110–11 economic policy under 3 investment policy 182 on rising inequality 252–53 public service growth under 248– 49, 254 relations with Asia 22 taxation under 246–47 trade and industry policy 209–19 Howard, John growth goals 111 on Asia 150, 153–54 on farming 212 on house values 198 on poverty 259 on rising inequality 252–54 on shareholders 173 on traditional values 236 Hughes, William Morris 133–35 Human Development Index 62–63, 65 Iceland, Human Development Index 63 immigration policy, see also White Australia Policy contribution to growth 104 protectionism in 98, 100 towards Asia 142 Imperial benevolence 99 Imperial Preference system 136 import substitution policy 205 imports composition of 231 main sources 234 top commodities 233 trade balance and 229 In the National Interest 148, 210 income debt as percentage of 195 inequality in 240–41 per capita 119 required to finance debt 190–91, 193 income maintenance schemes 98

India as trade partner 129–30, 231 car industry in 226 development strategies 39 exports to 152 Gini Coefficient 260 military threat from 159 moves towards liberalisation 45 proportion of global GDP 61 Indonesia Australia supports independence of 139 Australian disputes with 149–50 economic growth of 39 military threat from 141 security agreement with 147 trade dependency of 79 industrial relations flexibility in 261 protectionism in 98, 250–51 under Howard 255–56 Industries Assistance Commission 206 industry policies 24–25, 202–35 for manufacturing 227 under Rudd 25, 220–21 industry sectors 114–19, 231 inequality, see also egalitarianism; redistribution of wealth due to globalisation 236–38 in Australia 252–55 in non-cash benefits 248–49 increases in 10–11, 240–41 international comparisons 260–61 measurement of 255–63 poverty and 260 inflation as government priority 40–41, 168–69 effects financial markets 167 under Whitlam 104–5 information technology 125–27 economic boom in 111 effect on sovereignty 46 infrastructure spending in 227 innovation in 210, 266 infrastructure spending 5, 227–28

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institutional arrangements, importance of 10 institutional investors 82–83 inter-regional trade 76–77 interest payments 197, 198–99 interest-rate derivatives 178 International Bank of Reconstruction and Development 35 International Comparison Program 60 international investment agreements 87 International Monetary Fund 35, 190–91 International Trade Organization 36 Internet 227 intra-regional trade 76–77 Investing for Growth 210 investment, see foreign investment inward FDI stocks 85–86, 186–88 iPOD Index 60 Iraq war 150 iron ore 117–18 isolationism 183 Italy 243–44 Japan as trade partner 104, 129, 135–37, 230, 231 Australian exports to 118 automotive imports from 223 capital outflow from 72 economic growth of 22, 39, 59, 125, 141 exports to 152 foreign investment by 85, 144, 184 foreign investment in 85 foreign reserve assets 83 immigration from 131–32 military threat from 134–38, 159 net liability of 244 proportion of global GDP 61 reasons for growth 66–67 sub-prime crisis in 155 trade constraints imposed on by US 78 trade dependency of 79 Jones, Barry 94–95

Karmel, Peter 205–6 Katzenstein, Peter 51–52 Keating Labor government Accord with trade union movement 258, 261 Asian policy 144–47 changes under 7–8 economic policy 2 investment policy 166, 181–82 promotes globalisation 49 relations with Asia 22 wage–profit ratios under 256–57 Keating, Paul Asian policy 146 banana republic speech 95, 106–7 on economic reform 13, 267–68 on financial deregulation 173 on foreign banks 182 on foreign debt 192 on Howard’s Asia policy 153–54 on ‘recession we had to have’ 109–10 on regional blocs 160 on rising inequality 252–53 on terms of trade 202 Kelly, Paul 268 Kenwood, AG 99 Keynes, John Maynard 7, 33–34, 36–37, 93 Keynesianism 47 King, Anthony 41 Knowledge Nation 211 Korea, as trade partner 231 Korean War 102–3, 139–40 Kraay, Aart 241 Krugman, Paul 66–67 Labor Party, see Australian Labor Party labour movement increasing power of 40–41, 43 links with protectionism 20 on wage policy 261 labour supply, global increase in 167 Latham, Mark 217, 221 Layton, Max 122 League of Nations 135

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leftist political parties 243 Liberal–National Coalition 24–25, 209 liberalism, see also economic liberalism economic impact of 41–42 economic policy under 55 egalitarianism and 13 ‘embedding’ of 35 in early 20th century 31 liberal–market economies 17 retreat from 32–33 shift to 40–45 Liebfried, Stephan 53–54 Lindert, Peter 11–12, 30 living standards 254–55, see also inequality; poverty Loans Affair 181 Lougheed, Alan 99 low-carbon economy 123 low-interest bonds 72 ‘Lucky Country’, Australia as 94, 267–69 Lundberg, Mattias 241 Luttwak, Edward 46 Macarthur, Douglas 138 Macfarlane, Ian 5, 126, 212 Malaysia 39, 141, 231 manufacturing sector government support for 205, 213–14 imports from 125, 230 in Australia 102, 104, 114–15 in China 64–66 international comparisons 67 world trade in 79 market forces legitimisation of 49 myth of self-regulation 17 reliance on 42–43 under capitalism 46–47 Marshall Plan 35–36 mass society 31 Mazda 222 McClelland, Robert 121 McEwen, John 140, 180, 205 McLean, Ian W 1, 10, 94

McMahon Coalition government 180 measurement of globalisation 243 of inequality 255–63 media ownership restrictions 182, 217 Meere, Frank 205 Menzies Coalition government 103, 141, 180 mercantilism 29, 74, see also protectionism middle-class concerns 259 Middle East, car industry sales to 223 mineral exports 104 minimum wage levels 250–51 mining sector 114–15, 118–19, see also resources Minsky, Hyman 90–91 Mitsubishi 212–13, 222 MNCs 84 Mohammed, Mahathir 146 Moller, Stephanie 242–43 monetary policy 170–72 Moore, John 210 mortgages debt due to 192 foreclosures on 89 securitisation of 88–89 stress due to 199–200 Mortimer Report 210, 222 most-favoured-nation clauses 36 multilateral trade negotiations 207–8, 218–19 multinational companies 84 Mundell, Robert 169 nation-states 45–55 National Australia Bank 179 ‘national champions’ 182 National Party, see Liberal–National Coalition nationalisation of capital 33 nationalism, rise of 30 NATSEM study 258 neo-corporatism 52 net equity, decline of 185, see also equity ownership

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net income 194, see also income Netherlands, trade surplus with US 218 New Car Plan for a Greener Future 225 New Guinea 138 New South Wales 203 New Zealand as trade partner 231 Australian investment in 186 car industry sales to 223 trade agreements with 151, 153 Nixon, Richard 143 non-cash benefits 248 non-conforming loans 200 non-tradability of services 79 ‘normal’ behaviour in financial markets 166–67 North America, car industry sales to 223 Norway 63, 243–46, 248 Obama administration decisions of critical 93, 264 multilateralism by 159 on redistribution of wealth 10 trade policy 57 O’Brien, Richard 45 O’Connor, James 41 O’Connor, John 122 OECD countries Australian attitudes to 182 financial crises 238 Gini Coefficients 260–61 growth in 113 inequality in 241 Ohmae, Kenichi 45 oil price rises 40, 168, 181, 207 oil suppliers, trade surpluses 69 OPEC oil shocks, see oil price rises open economies 51–52, 180, 241–42 options (financial instruments) 90, 178 Organization for Economic Cooperation and Development, see OECD countries originate to distribute model 89 Orsmond, David 122 Ottawa Agreement 136 outsourcing 61, 248

outward FDI stocks 85–86, 187–88 Palley, Thomas 32 panic 88 paradox of thrift 93 Paris Peace Conference 135 partisanship 52 Pasminco 171 Peacock, Andrew 143 pension funds 83 petro-dollars 181 petrol exports 79, 104, 230 Pettis, Michael 72 Pharmaceutical Benefits Scheme 217 Philippines 39 Polanyi, Karl 17, 27–55 political economy approach 14–18, 27, 45–55 portfolio investment 81 by Australians 186 in Australia 184 switch to 180 positive political action 15–16 positive supply-side shocks 167 postwar period 139–41 pound, trading in 82 poverty in Australia 39, 239–40, 252–55, 258 inequality and 260 power, politics and 16 PPP 59–60 primary products, see agricultural trade; mining sector; resources principal–agent problems 88 private vs. public debt 192 privatisations, under Howard 255 Productivity Commission 210, 221 profit levels vs. wages 256–57 profitability in car industry 223 property and business services sector 115 protectionism 1–2, see also free trade against Japan and US 137–38 as response to Great Depression 32 covert methods 78

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financial regulation 172 in agricultural trade 44, 76, 204–5, 208 in Australian history 20–21, 95, 98–99, 202 in early 20th century 31 under GATT 36 under Menzies 103 public sector, see also state power, politics and welfare states debt levels 100, 243–45 grows under Howard 248–49, 254 private vs. public debt 192 trade and 51–53 purchasing power parity 59–60 Pusey, Michael 259 Quan Li 241–42 Queensland 99 racism, effect on immigration policy 131–32, 135, 139 rationality of regulations 17–18 Rattigan, Alf 206 RBA, see Reserve Bank of Australia recessions, see depressions and recessions redistribution of wealth importance of 10 in 19th century 30 in capitalist democracies 47, 243 via fiscal policy 249 via protectionist policy 203–4 regional institutions 160 regional trade 76–77, 145–47 relativity of poverty 260 renminbi, dollar falls against 176–77 research and development allowance 210 reserve assets 186 Reserve Bank of Australia interest rate raises 4 monetary policy 169–72 on financial markets 199–200 powers legislated 102 response to crisis 168 resource booms 3 cycles of 96–97

revenue from 115 under Fraser 105 under Howard 111, 213 under Menzies 103 resources, see also commodity prices demand for overestimated 121–22 dependence on sale of 9–10 foreign investment in 85 pessimism about 95 ‘super-cycle’ theory 122 Reuveny, Rafael 241–42 Rieger, Elmar 53–54 risky investments, pursuit of 87–89 Roberts, SH 131 Rodrik, Dani 52 royalties from mining sector 118–19 Rudd, Kevin 56 affinity with China 155 Asian policy 152, 160 on executive bonuses 249–50 on globalisation 263 on trade policy 221–22 supports social democracy 14 Rudd Labor government Asian policy 154–62 broadband policy 227 debt concerns 190–91 economic policy 3–5 Emissions Trading Scheme 124 industry policies 25 inflation as priority of 168–69 relations with Asia 22 response to globalisation 263–67 trade policies 219–28 Russell, Don 109 Russia 39, 66, 134 Saunders, Peter 258–59 Say’s Law 33 Scullin Labor government 101–2 SEATO 141 Seattle APEC meeting 146 securitisation 72, 88–89 self-interest of lending institutions 6 self-regulating markets, myth of 17 Senate Inquiry into Poverty 259

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services sector 79, 114–15 shareholders 173, 184–86 Sheridan, Greg 145 Shonfeld, Andrew 38–39 short-term investment 81 Simmons, Beth A 32 simply transformed manufactures 104, 115 Sinclair, WA 97 Singapore as trade partner 153, 231 economic growth of 39 sovereign wealth funds in 84 trade dependency of 79 single women, disadvantage of 99 SIVs 89 Skocpol, Theda 47 Smeeding, Timothy 242 Smith Family study 258 social coalition 253 social constraints on liberalism 50 social democracy electoral constraints on 48 financial markets under 165 limits of 41 processes of change in 7 role of regulation in 265–66 Rudd’s support for 14 social services ‘appropriate’ levels of 53–54 effective 26, 262 importance of 11–12 in 19th century 30 income maintenance schemes 98 relation to trade policy 53 spending on 247–49 social sustainability 12 socialism 29–30, 44, see also communism South Australia 213–14 South East Asia Treaty Organisation 141 South Korea 39, 143, 152 South Pacific, immigration from 132 sovereign wealth funds 83–84 Soviet Union, see Russia Special Advisory Authority 205

Spender, Percy 140 Squire, Lyn 241 stagflation era 18, 40, 43 state power, politics and 45–55 Stevens, Glenn 164–65, 168 stimulus package 4–5 Stone, John 105 Strange, Susan 46 structural change, see economic reform structured finance 88 structured investment vehicles 89 Sturm, Jan-Egbert 53 sub-prime crisis, effects of 6, 58, 87–92, 155 sugar industry 99 Suharto regime 147 ‘super-cycle’ theory 122 superannuation funds 82–83, 173 surplus countries 70, 93 surpluses, see current account balance sustainable globalisation 18, 27–55, 236–69 SUV vehicles 213 Swan, Wayne conservatism of 264 on foreign investment 183–84 on inflation 169 on sub-prime crisis 4, 155 swaps 90, 178 Sweden, social services spending 247–48 SWF 83–84 TAC 151–52 Taiwan 39, 143 Tariff Board 204, 206 tariffs, see also protectionism in Australia 101–2 in car industry 222, 224 in GATT 74 revenue raised by 203–4 under Hawke and Keating 25, 110, 144, 207 under Howard 212 under Rudd 220 under Whitlam and Fraser 206 taxation

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as percentage of GDP 247–48 centralisation of 205 goods and services tax 262 international comparisons 246–47 limits of 53 of mining sector 118–19 shift to indirect 255–56 Uniform Tax Agreement 102 TCF industries 209–10 technology boom 111, see also information technology telegraph link to Australia 31–32 terms of trade 21, 193, see also current account balance in 1970s and 1980s 107–8 in 2000s 119–22 in Australia 95–96, 98, 103, 120, 169 in Great Depression 100 international comparisons 120 long-term trends 125–26 textiles, clothing and footwear industries 209–12 Thailand as trade partner 231 car industry in 226 economic growth of 39 imports from 214 trade agreement with 153 The Bulletin 142 The Economist magazine 60, 268 The Lucky Country 94 third world 61, 70–71 total factor income 256–57 tourism sector 230 Toyota 222–23 trade deficits 25, 52–53, 229–30, see also current account balance trade dependence 79, 228–29 trade policy 24–25, 202–35, see also protectionism 1980s and 1990s 207–9 public sector and 51–53 ‘trade diversion’ policy 137 with Asia 128–62 with Japan 137–38

trade union movement, see labour movement trade weighted index 176 Trading with the Enemy Act (Cth) 138 Treaty of Amity and Co-operation 151–52 Tsumori, Kayoko 258 Tweedie, Sandra 145 two-party systems 50 unemployment 100–102 decline in 199 during Great Depression 33 poverty and 261 under Fraser and Hawke 106 Uniform Tax Agreement 102 union movement, see labour movement United Arab Emirates 84 United Kingdom, see Britain United States, see also Bush (GW) administration; Obama administration $AU falls against $US 176–79 abandons Gold Standard 34 after World War Two 34–36 as trade partner 104, 129, 231 Asian dependence on 68–69 Australia–United States Free Trade Agreement 183, 217–19 Australian investment in 155–56, 186 bailout commitments 90–91 ‘Buy American’ clause 75 calls for FIRB to disband 183 car imports from 214 current account deficits 69–70, 194 dominates financial markets 80–81 Federal Reserve cuts interest rates 169 foreign investment by 85, 179–80, 184 foreign investment in 85 foreign reserve assets 83 imposes trade constraints on Japan 78 interwar growth of 32

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manufacturing sector 64–66 proportion of global GDP 61 protectionism in 57, 208 reneges on Bretton Woods agreements 40 share market in 92 shift of power away from state 46 social services spending 247 ‘special relationship’ with 134–35, 139–40, 143, 148, 150 supports globalisation 43–44 supports liberalisation 43–44 trade blocs proposed by 215–16 trade dependency of 79 trade imbalances 70, 72, 218 Ursprung, Heinrich 53 Uruguay Round of GATT 76, 208 US dollar, trading in 81–82 US Treasury bonds 73 Vaile, Mark 219 Victoria 203 Vietnam 39–40, 44, 142 Vietnam War 141 wage levels 100, 250–51, 256–57 Wakefield, Edward Gibbon 131 Walsh, Peter 221 wealth, see redistribution of wealth wealth effect 198 Weiss, Linda 52 welfare states 34, 37–38, 51, see also social services; state power, politics and Weller, Christian 241 Western Europe, see Europe; European

Union Western states 37–38, 68, 70–71 White Australia Policy 1, 22, 132–33 after World War Two 139 Asian objections to 142 sugar industry and 99 White Paper on Full Employment 102 Whitlam Labor government creates Industries Assistance Commission 206 financial deregulation 172 inflation under 104–5 investment policy 181 recognises China 143 relaxes White Australia Policy 142 Wilson, Woodrow 135 wool booms 97, 102–3, 131 Woolcott, Richard 161 WorkChoices 256 World Bank 35, 60 world trade, see global trade World Trade Organization 75, 182, 209 World War One economic effects of 30–31 effect on protectionism 204 gold declines in importance after 97 support for White Australia Policy after 133–34 World War Two economic effects 18, 34–35 exposes British weaknesses 138 state power demonstrated in 102 Wriston, Walter 46, 125 yen 82, 175–77

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