by Peter Brain
CREDIT CODE RED
Peter Brain’s doctoral degree, completed at the University of New South Wales, was a pioneering analysis of the National Accounts statistics then becoming available in time series. In 1973, he was appointed to head the Econometric Forecasting Project at the Melbourne University Institute of Applied Economic and Social Research .
After graduation from the University of Melbourne, Ian Manning taught at one of the affiliated colleges of the University of Madras, India, specialising in the economics of banking. He returned to the Australian National University to complete a doctorate on the economics of town planning, and then worked on social-security policy for the National Inquiry into Poverty. In 1980, he joined the staff at the Melbourne Institute.
In 1984, Peter left Melbourne University to found the National Institute of Economic and Industry Research (now known as National Economics). Ian joined him a year later. For the past thirty years and more, they have both collaborated and worked independently on projects covering all aspects of the Australian economy, its industries, its regions, and its people.
Scribe Publications
18–20 Edward St, Brunswick, Victoria 3056, Australia
2 John St, Clerkenwell, London, WC1N 2ES, United Kingdom
Published by Scribe 2017
Copyright © 2017 Peter Brain and Ian Manning 2017
All rights reserved. Without limiting the rights under copyright reserved above, no part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form or by any means (electronic, mechanical, photocopying, recording or otherwise) without the prior written permission of the publishers of this book.
The moral rights of the authors have been asserted.
9781925322392 (Australian edition)
9781925548495 (e-book)
A CiP entry for this title is available from the National Library of Australia.
scribepublications.com.au
scribepublications.co.uk
To Angela and Alice
Contents
Abbreviations
Introduction
1 Economic breakdown as a threat to prosperity
2 Financial deregulation
3 Financial deregulation and household debt
4 Financial deregulation and overseas debt
5 Australia under credit watch
6 Crisis vulnerability over the next decade
7 Neo-liberalism comes full circle
8 Economic policy after neo-liberalism
Appendix
Acknowledgements: The role of financial deregulation in the accumulation of overseas debt
Notes
Abbreviations
Australian Bureau of Statistics ABS
European Commisssion EC
European Union EU
Gross Domestic Product GDP
Global Financial Crisis GFC
International Monetary Fund IMF
Reserve Bank of Australia RBA
Volatility Index VIX
Introduction
For more than thirty years, Australian governments have pursued and promoted free-market economic reforms. They have trumpeted the virtues of profitability and competition; they have asserted that productivity is bound to increase when business is deregulated. Their reforms have been guided by neo-liberal economics, the faith that ‘the free market, unimpeded by government intervention, will answer all human needs’.1 This faith claims a universal validity, and the Australian reforms were part of a surge of reform that originated in the United States and washed outwards from the English-speaking countries.
The reforms have now been in place for long enough, and in enough countries, to be associated with several adverse trends — notably, increases in the inequality of wealth and income, and increases in the incidence of severe economic crises. Are the reforms responsible for these adverse trends? Our answer is a definite ‘Yes’.
To prove the case that reform has increased inequality and vulnerability to crises, it is necessary to move beyond the neo-liberal economic theories on which the reforms were based. These theories have nothing to say about inequality and crises; they simply assume them away.
When the neo-liberal theories came into fashion in Australia we were concerned that they would generate complacency. We were not, perhaps, as concerned as we should have been about the promotion of inequality — Australia has a robust social-security system that has so far resisted the most outrageous reforms, though neo-liberal tolerance of high unemployment and failure to index benefit rates have raised the incidence of poverty. Our particular concern was that governments would neglect the need for active policies to maintain stability and underpin future prosperity, and so would sleepwalk Australia into crisis.
Over more than three decades, we have maintained an unfashionablly broad approach to economics, unconstrained by neo-liberal assumptions. This approach warns us that Australia is over-indebted; its households have borrowed too much from its banks, and its banks have borrowed too much from overseas. The neo-liberal reforms freed the banks to sell credit, and the resulting debt is becoming unmanageable. Though it avoided the Global Financial Crisis of 2008, Australia is now drifting towards economic breakdown and Depression. In this book, we hoist the Code Red signal; drastic action is required to extricate Australia from the pitfalls that neo-liberal policy has created.
When one encounters it in a first-year economics textbook, neo-liberal theory seems too esoteric to provide the foundation for a reform movement. Expressed in mathematics and expounded in academic article after academic article, it buys its internal consistency at the cost of an almost endless list of assumptions. These assumptions create an artificial world — a placid metaphysical world in which individual property-owners buy and sell their way to the common good. Neo-liberal theory has been marketed as a sophisticated account of the complex interrelationships that comprise a capitalist economy, yet it simplifies these relationships by disregarding some of the most crucial interconnections and uncertainties within such an economy. Herein lies its danger, when potential sources of economic breakdown are assumed away by those in charge of public policy.
The governments of Australia did not turn to neo-liberal theory through infatuation with its intellectual beauty. Rather, they adopted it because it was heavily promoted by vested interests. Though its basic theories were developed in nineteenth-century Europe to defend capitalism against Marx and other critics, their present incarnation owes much to a coterie of American billionaires, and their counterparts in Australia and the United Kingdom, who turned to neo-liberal economics in their search for arguments to defend their wealth against pesky taxes and environmental regulations. Their fundamental contentions were that taxes, particularly those on high-income people, weaken incentives to produce and to innovate, and that regulations raise costs, with similar debilitating effects. And, further, that production foregone due to taxes and regulations is a loss to the nation as a whole, not just to its rich minority.
Neo-liberal economic theory can easily be tweaked to support these arguments, but for it to be of any political use in defending the billionaires’ interests it had to be established that the theory describes an attainable reality. It proved hard to establish the theory as realistic — its assumptions were just too restrictive — but its protagonists had considerable success with their assertion that free markets are associated with freedom from authoritarian government. It helped, too, that the seeming sophistication of the theory attracted intellectuals to the think tanks and academic posts that were founded to promote the reform program, and that journalis
ts could readily be found to carry the message into the media.
Once academics, politicians, and the elite in general were drawn into a mental world in which neo-liberal perfection was considered attainable, economic policy became a simple matter of reforming economic institutions to make them look more like those assumed in the theory — in general, by promoting competitive markets. It was argued that such reforms would guarantee increases not only in in productivity but also in incomes.
As neo-liberal theory permeated into Australian universities, we developed our critique of it, which at base was that the theory was too abstract to be reliable as a guide to policy. We were especially concerned that reform was extended to an area where the underlying theory was particularly contentious: the extension from free trade in markets for goods and services to free trade in money. In Australia, as elsewhere, financial deregulation was intended to increase the efficiency of the allocation of funds, but instead it has tempted banks and other financial institutions into the reckless misallocation of funds to finance consumption, and the reckless raising of funds by overseas borrowing.
By taking into account a much broader range of behaviours than those specified in neo-liberal theory, and by allowing for a wider range of interconnections between economic actors, we were able to foresee the disasters that would follow from the neo-liberal reforms. We were not thanked, of course, for predicting the financial crises that punctuated the past three decades: the Australian 1990 recession, the Asian financial crisis of 1998, and the Global Financial Crisis of 2008.
Happily, one of our predictions failed to eventuate — contrary to our expectations, Australia survived the Global Financial Crisis. This happened partly because the Australian government took timely action, but chiefly because the Chinese government did so, and generated a mining boom that allowed the Australian finance sector to postpone the consequences of its over-exposure to overseas borrowing.
But one happy escape does not guarantee permanent immunity. In this book, we trace the evolution of Australian economic reform in the neo-liberal era and show how it has increased Australia’s vulnerability to economic breakdown, mainly due to excessive overseas borrowing by the banks. We also show how similar reforms in other countries (notably the United States) are increasing the danger that Australia’s credit rating will tumble due to events over which Australia has no control, maybe to the point where its banks’ overseas borrowings can no longer be serviced. At this point, the Australian economy will collapse.
We chronicle, too, how the Australian financial sector has captured 9 to 10 per cent of Australian national income, more or less double the proportion it attracted during the post-war era of economic growth, and again more or less double the proportion it attracts in continental European countries today. This is not productivity: it is the cost of excessive intermediation; the cost of an insupportable burden of debt; and the cost of too much credit imprudently sold, resulting in debt that is all too likely to go bad.
Australia is a leaky ship in rough seas. We have no alternative but to hoist the danger flag and declare that, on current policies, Australia will shortly enter the Credit Code Red zone.
We raise the alarm, not only because we fear the costs of economic breakdown — the unemployment and the loss of income — but because we fear half-baked responses to the breakdown, based all too probably on misunderstood neo-liberal theories that fail to address the weaknesses which caused the breakdown. We also fear responses that go too far, and that fail to recognise the crucial role that an efficient and prudent financial system can play in maintaining prosperity and, dare we say it, in the transition to a sustainable economic system, including rational responses to climate change. This is why we devote so much space to the history and mechanics of what has gone wrong. Even so, our suggestions as to what should be done are but tentative additions to a burgeoning literature.
By what authority do we warn that Australia’s credit code is turning red? We claim, first, authority that arises from the history of economics. In particular, though the political mayhem of the 1930s is beyond living memory, the influence of the Great Depression lingers in economics. Those were the days of unemployment and moonlight flits and of bad names, including those of Hitler and Stalin. Yet there were also good names. Among contemporaries who attempted to understand the maelstrom of the times, one good name stands out — that of John Maynard Keynes.
The economists of the time, the progenitors of today’s neo-liberals, practised as they were in the defence of idealised free markets against the vituperations of socialists and communists, were nonplussed by the Depression. In their theoretical world, such disasters simply couldn’t happen. Keynes offered an alternative vision in which free markets, while essential to the working of productive economies, provided no guarantee of full employment. In a flurry of intellectual activity, previously puzzled scholars and practitioners developed, corrected, and elaborated his insights. Professors of economics continued to ask the same questions on their exam papers, but diametrically changed the answers.
We were too young to participate in this burst of creative thinking; that was the privilege of our teachers and mentors. However, we lived through the challenge that a revived free-market economics, now termed neo-liberal, posed to the simplified policy-Keynesianism of the 1960s. We contributed, as well as we could, to the Australian Keynesian response to this challenge. Here lies our second claim to authority.
We took the criticisms of the neo-liberals seriously, adjusted our Keynesian framework to take them into account, and tested the results by preparing economic forecasts. As time passed, we were able to check our short-term forecasts — and, in due course, our medium-term forecasts as well — against what actually happened. We learned from the successes and failures of our predictions, and updated the Keynesian framework so that it not only provided accurate forecasts but also generated the best policy answers of the day.2 At the heart of this updated policy framework is a recognition of the need for active and, in some cases, big government.
Contra to the neo-liberal paradigm, we believe that Australian governments should use all the policy instruments at their disposal to maintain control over the finance sector, constraining its size and hence the level of debt, and aim for moderate current-account surpluses to avoid balance-of-payments crises and defaults on foreign obligations. They should aim for a stable or slowly evolving exchange rate between the Australian dollar and overseas currencies so as not to undermine industry competitiveness, and should use a range of industry-assistance instruments to ensure that the structure of the economy is compatible with sustainable long-run prosperity. They should also recognise that sustainable prosperity requires the maintenance of reasonable equality in the distribution of income via appropriate wage, tax, and social-security policies.
Our predictions from the 1970s onwards proved accurate, made as they were on the basis that governments would ignore the activist policy framework that we recommended, and would remain stuck in the neo-liberal rut. We saw in the mid-1970s that the oil-price shocks would lower the long-term Gross Domestic Product (GDP )growth rate to well below previous trend levels; we predicted in 1984 that within five years there would be a recession as a consequence of financial deregulation and indifference towards the current-account deficit; we predicted the Asian economic crises of 1998 from the indicators available in 1994; and we predicted the Global Financial Crisis of 2008 from trends developing nearly ten years before. In 1999, we clearly saw that the continued adherence of the Anglosphere countries to the neo-liberal model which they had adopted in the 1980s would result in economic instability and difficulties in adapting to the rise of knowledge-based industries, and the economic, social, and political pressures that this would create:
The increasing inequalities both between and within economies will make it clear that things have to change. Change will come after 2006. The only question is whether it will be forced by depression and the sei
zure of power by anti-democratic radical alternatives with similar violent consequences as in the 1930s or whether change can be planned and managed to spread opportunities for growth more evenly throughout the world.3
However, accurate prediction by us and others has made no difference. Neo-liberalism had closed the minds of the policy establishment. Despite its hegemonic status in the decades following the Second World War, Keynesian economics never completely supplanted its predecessor. For some, chiefly academics, the Keynesian approach called into question too much of the intellectual capital that had been built up over the preceding century; they concentrated on reconciling Keynes with the classics, and in the process relinquished most of Keynes’s distinctive insights.
For others, such as Friedrich Hayek and Milton Friedman, who were more politically engaged, the guidance that Keynesian economics gave to active government of the market raised the spectre of authoritarianism; they could not accept the Keynesian approach as a via media between ungoverned capitalism and over-governing socialism. This group expended great effort in modernising the traditional defence of free markets against socialism, and gave it sophisticated mathematical garb, in which dress it became known as neo-liberal economics. With considerable financial aid from American billionaires interested centrally in tax minimisation, this group became the pundits of neo-liberal reform, of a return to pre-Keynesian policies by implementing an economic-policy program that became known in due course as the Washington Consensus. They sold themselves as the champions of freedom, yet the policies they advocated have led to accumulations of debt that degrade freedom as surely as authoritarian government does — the difference being that the dictator is no longer home-grown, but a junta of overseas creditors.
We argued, to no avail, that active governance is a necessary but not sufficient condition for sustainable prosperity. Active governments should be guided by realistic theory based on accurate statistics and behavioural assumptions, and they should be honest — serving general, not sectional, interests. Instead, rather than recognising the need for informed yet disinterested government action, the neo-liberals constantly repeated the simplistic message that since some governments are incompetent, all governments should be cut back to the minimum. Many countries, but not all, heeded this message, and we are now in a position to compare and contrast the results.