The 2001 Harold Clough Lecture

THE HIGH PRICE OF REFORM FATIGUE
We set up the economic conditions after 2010 today
 
12.30, Wednesday October 24
Western Australian Club
101 St George’s Terrace
Perth

Mike, Harold, ladies and gentlemen

Harold Clough
I have long admired Harold Clough. To have been asked to give this particular lecture is an honour. He has a special talent for producing things. When this is done in relatively free markets, rather than by extracting market privileges from weak and corrupt governments, Adam Smith’s ‘invisible hand’ ensures that we get the things we really want. 

These relatively free markets (and for that matter other social exchanges) depend on rules we call institutions. Some societies uphold them better than others – the free and prosperous ones. Most businessmen, especially those who don’t try to have governments legislate in their favour, tend to regard ‘institutions’ as someone else’s worry. I don’t complain about that. Businessmen are specialists in providing goods and services and most should stick to their lasts. 

However Harold went further, devoting thought, attention and resources to the institutions. Not least by his support for the Australian Institute for Public Policy and then the IPA, he did practical things to uphold them. My theme today and that of a book I have all but completed concerns the strengthening of those institutions during the 1980s and early 1990s, the considerable benefits for the whole Australian community that their restoration accomplished, and their partial decline since. Australia cannot afford reform fatigue – especially not when the world is heading into recession and, if we are unlucky, substantial resources might be needed for bin Laden and his boys. 

The state of play
Australians began the 2000s enjoying sustained economic growth of 3 to 4%. Real wages had increased by 3.8% a year since 1995-96. Inflation was around 2%. Unemployment had been reduced from around 11% to fewer than 7%, although much ‘hidden unemployment’ had to be conceded. We had recently escaped the so-called ‘Asian melt-down’ almost without a hiccup. We had a Commonwealth budget surplus of 2% of GDP.

Those benefits were associated with the partial reversal of a long downward trend in Australia’s relative living standards. When compared with other rich countries – that is, all of Western Europe, the US, Canada, Australia, New Zealand and Japan – Australia’s per capita GDP, expressed as the percentage of these, declined from 132.3 in 1950 to 99.9 in 1975. They declined further to 88.6% by the time of 1992 recession. However, since then they rose to 95.5% by 1999. That improvement was not brought about by a favourable shift in our terms of trade – the ratio of the prices at which Australians import and export. Between 1990 and 2000 these moved against us by about 7%.  The economic freedoms enacted by a period of unusual and exceptionally good government offer the only plausible explanation of the turn around of a 40-year trend. I am not guilty of mere ex-post-facto rationalising. The benefits were predicted. 

Economic freedom was then the zeitgeist of almost the whole non-African world. But Australia did better than most and made gains relative to other nations. Our achievement was uncommon but not totally exceptional. Other countries at other times had done even better by much the same means – post war Germany and Japan and the Asian Tigers despite their recent difficulties, for instance. It is worth noting as we ponder the future that the leaders of those nations had not had the benefit of a friendly zeitgeist to smile upon their bonfires of regulations. In spite of the efforts of the IPA to influence the zeitgeist here, reforming leaders will have to overcome anti-globalisation sentiment – or is it still more an organised beat up than the true spirit of our times? 

Be that as it may, Federal politicians who once led the charge for economic freedom and generously supported a reforming Labor Government are returning to bad old ways. Even though they tax at record levels, these profligates have squandered the budget surplus. It is no good Peter Costello challenging Kim Beazley to name the savings. He would do better to ask the IPA – I’m sure Mike could suggest savings of a few $ billions off the cuff and he would not be telling the Treasurer anything the Department of Finance had not already told him.

These once-were-principled politicians extended the tariff protection of the motor and textile clothing and footwear industries. They subsidised enterprises that could not raise their capital at market prices, for instance, a magnesium mine and the Darwin to Alice Springs Railway. They baled out HIH customers and guaranteed bits of Ansett. They used the foreign investment powers to prevent the commercial take over of Woodside. Trying to out-Hanson Hanson, they imposed costly requirements on Telstra that we all pay for. They subsidised the housing industry. They maintained the wheat export monopoly. Competition policy is under serious threat. 

After what was admittedly a frustrating time in the Senate, they ceased even trying to reform the labour market. In short, there are signs that we are reverting to interventionist government and Keating’s ‘big picture’ is lost. The Government has not yet reverted to all of the bad habits of the Fraser years but its recidivist tendencies are obvious. 

It is hard to know what to believe of any Opposition but, to the extent that Labor rhetoric is be believed, it is worse. Fortunately, very few Governments are quite as bad as they sound in Opposition.

The politicians who once believed that economic liberty would best give us the prosperity to look after the underdog; improve our health care, environment and schools; and to be simply secure in a dangerous world, are nowhere to be heard. Who today are the equivalents of Hawke, Walsh, Keating as Treasurer, and Button whose corporatist methods I often disagreed with but who nevertheless struggled bravely to raise productivity. Who today is the equivalent of Howard when he was Opposition Leader or Hewson? 

In most States the scene is even more depressing.

The retrogression is not just an Australian phenomenon but I repeat that not all economic reformers have always had the advantage of times that favour reform. 

I have written the story of the rise and partial decline of the ideal that I believe is responsible for our present relative prosperity. By showing that the ‘Good Fight’ can be won and explaining some of the means that succeeded or failed, my hope is to encourage others to take up the task of defending the institutions upon which prosperity depends. 

New Zealand’s one-time reforming Finance Minister, Roger Douglas needs little encouragement to tell of how New Zealand Governments that made what he calls ‘quality’ decisions won elections and how when they ceased to make them they lost. That was true also of the Tory Party in the UK. In Australia only Kennett lost while he was still, on substantial balance, making those quality decisions. Reform requires leadership, and in a democracy, it is almost all of the explaining, cajoling and teaching kind. It is not just the responsibility of politicians. As Douglas put it pithily, ‘The dog has to see the rabbit’. 

The case for the economic institutions can, of course, be made in different ways. To some it is appropriate to talk in terms of efficiency but, since the most fundamental rules are widely appreciated and almost universally professed, we can also talk of ‘economic rectitude’ – Bert Kelly’s expression. At Jeremiah 3 vi there is a passage that I once used, possibly unwisely, on the Uniting Church in my electorate with whom I was disputing interest rate policy. 
Hast thou not seen what backsliding Israel hath done? She has gone up upon every high mountain and under every green tree there hath played the harlot.  – 
The quotation over emphasises my case, but I like it. I am not predicting for Australia anything as dramatic as that of which Jeremiah presciently warned Israel. Nevertheless, why court any risk. Economic strength underpins national security.

In summary my story is that: 
•	Before 1983 Australian opinion and practice were well behind Europe and the US, and the Australian economy was going fairly badly. 
•	From 1983 into the early 1990s we lived through unusual and exhilarating times. The Hawke and Kennett Governments and the Howard-Hewson Oppositions, putting nation before party, did momentous things to reverse the decline.
•	The rewards of sound economic policy, particularly policy affecting investment, may be lagged by as much as a decade. It was not until after ‘the recession we had to have’ in 1991 that we began really to enjoy the benefits of what was done in the 1980s.  
•	After Keating cast aside Labor’s virtue to defeat Hewson and Fightback, the Coalition in Canberra also lost much of its enthusiasm for reform, although reform was by then proceeding at a cracking pace in Victoria. 
•	There is reform fatigue but it was not the prime cause of the rise of One Nation. That was the alienation of rural and upper blue-collar people who were sick of being talked down to by, especially, the politically correct. In the case of Victoria, Kennett had done so many things to offend the electorate, that he would have suffered a landslide had voters not appreciated that he had rescued the Victorian economy. 
•	Howard is looked increasingly like Fraser and Beazley most unlike Hayden, Hawke or Keating. 

Liberalism is an unsettling doctrine that has several times since the 1700s seemingly been defeated by its own success. There is a concept of long – that is, 40 to 50 year – economic waves referred to as ‘Kondratieff cycles’ that enthuse some economists.  When all is well, as in the long boom of the nineties, people avoid the inconveniences of economic rigor and after a considerable lag find themselves in the next long-wave downturn. 

Corruption and Public Choice
Before taking a quick look at the record I have a definition of political corruption for which I am indebted to the late Paddy O’Brien and he to the one-time Marxist philosopher Jean-François Revel. And I will raise for your consideration what is for me the most convincing explanation of why governments betray their trust. 

Revel goes like this:
In a civilised efficiently alert democracy, you have to be a fool to commit the major felonies punishable by the law: breach of trust, peculation, embezzlement, influence peddling. So in order to gauge the extent of corruption in our own kinds of liberal society, we need to look beyond the classic offences.

Being ‘corrupt’ means somehow misapplying political or administrative power, whether directly or indirectly, outside its proper sphere, for one's own financial or material advantage or in order to distribute the gains among one's friends, colleagues, relations, or supporters. When a minister grants a subvention to an association of dubious utility, even when he observes all the rules in doing so, he is committing an abuse, especially if it turns out that the beneficiaries of the subvention are his personal or political friends. A subvention of a million Francs, for example, is the equivalent of a year's profits for a thriving business. Multiplied by some thousands of instances (and by sums mostly very much greater), this act amounts to a levy imposed on the labours of the producers, in favour of the occupants of the power structure. The further the system extends, the heavier the hidden tax on production and the less profit and employment. Even if legal appearances are saved in these transactions, it may be assumed that democracy is not. The national inheritance is diverted into private or partisan uses, causing a pernicious drain on the general economy. No doubt the good Minister who performs this little service for his henchmen has no sense of being dishonest – and that is the most serious thing about it....the greater the role of the State the more numerous the opportunities for corruption. 

You might think such a definition of political corruption unrealistic – Ministers of the Crown, you say, will never cease to misapply political or administrative power to distribute gains among supporters or potential supporters. Maybe not, but virtue is something one aspires to. If Revel’s standard is so unrealistic as to be irrelevant, how come that for 10 or 12 years politicians in some parliaments made a better fist than before or since of resisting the temptation to win votes by misusing authority. I’m not talking of the frequent situations where Governments are unsure of what they ought to do. I am concerned with the occasions when, knowing what they ought to do, they don’t do it for political reasons. 

Australian politicians don’t accept personal bribes. A few may have sold privileges for campaign funds – that seems to have been the case of WA Inc – but neither is that form of corruption a major problem weakening our economy. The systemic rottenness is caused by exchanges of privileges for the blocks of votes that interest groups can deliver and/or to avoid the politically-damaging lies that lobbies resort to. Governments can buy-off vested interests whenever those who bear the cost (such as purchasers of cars and clothing) are too dispersed to run an effective counter campaign. The process is explained by the public choice theory that earned James Buchanan a Nobel Laureate in 1986.

That concentrated interests so readily prevail over dispersed interests is the bane of democratic politics. Because consumers are many and dispersed, they cannot organise as readily as can producers. This gives rise to a ‘supplier bias’. Concentrated interests prevail because only they have enough at stake to let one issue influence their vote or to cover the cost of mounting a political campaign. 

An example usually helps to make the point. Consider the straightforward instance of a tariff such as that on textiles. It may transfer $1 billion per year from 19 million consumers to, say, 100,000 producers organised in 100 companies. Each consumer has $53 per year at stake; each worker has $10,000 and each company $10 million. It is relatively easy for the unions and company executives to organise to make life difficult for a government that reduces tariffs. And I assure you the textile industry of my time in politics recognised no equivalent of Queensbury’s rules. 

Enforced transfers such as are made via tariffs produce dead-weight losses that any government mindful of living standards would wish to avoid, but only the concentrated interests can deny it votes. However, if public choice theory, powerful as it is, were all there was to be said about government, the nation would be ungovernable and, incidentally, there would be no point in an IPA.

We are not ungovernable. Not all electors are so selfish or all politicians so weak. We now enjoy the predicted lagged response to reforms that politicians made and the public accepted. 

Conventional wisdom has it that an Aussie dollar bringing only US$0.50 does not reflect economic fundamentals. Could the currency traders be factoring in the political fundamentals? Might they be saying to themselves, the economic fundamentals won’t last? Can you imagine any current polly making say Keating’s Banana Republic Statement or Hawke’s  March 1991 statement to Parliament in response to the Garnaut Report in which he spelt out the need for an open economy? Can you imagine one of our current ‘leaders’ signing off on Fightback? Our current leaders are not espousing doctrinaire socialism -- that battle remains won. But backsliding Australia is played the harlot, avoiding tough decisions and again lying down with vested interests if not yet under every green tree. 

Now I’ll remind you of just a bit of history.

The Fraser Years
On 14 December 1975 we awoke hung over and full of resolve after the Great Gough’s wing ding of a party. We had elected Malcolm Fraser who promised economic rectitude but instead he returned to pre-Whitlam McEwenism. In 1982 Fraser tried to buy office with a disgraceful budget. Although Howard’s budgeting is so far much better than it, he is doing the same.  

From 1979 a group of backbenchers, who were dubbed ‘Dries’, mounted an, at the time, unsuccessful campaign to have the Government mend its ways. I won’t recount the efforts that Peter Shack, Ross McLean, Jim Carlton, Murray Sainsbury, I and others made on your behalf. We didn’t get it all wrong, but that will keep. The important point is that we were far from alone. 

It was during these years that the IPA, under the directorship of Rod Kemp, rediscovered its raison d’être and the Centre for Independent Studies grew to influence. John Stone was Secretary to the Treasury, and at the Reserve Bank Austin Holmes ran the research department and Bob Johnson was Governor. It was when David Trebeck, as director of the National Farmers Federation, knocked respect for the national interest into the farmers' lobby. The Modest Member, Mavis, Clarkson and Eccles, the characters of Bert Kelly’s witty newspaper columns each weak explained the better rules by which an economy might function. Alan Wood circulated the Syntec newsletter. It was when Hugh Morgan began making speeches directing public attention to the public interest. Western Mining, MIM, CRA, Renisons and Cliffs – the gang of five – took on the Federal Government over tariffs. The Campbell report into the financial markets was written. Bill Hayden quietly converted the Federal Labor Party into a party fit to govern. Even the Liberal Party produced a remarkably dry platform, although I doubt that any minister more than glanced at it. Toward the end of the Fraser years an intellectual ferment was under way but nobody that I am aware of then recognised its potency. 

The IEA in London and several American free-market think-tanks had been feeding dry ideas into public consciousness for in some cases more than a decade. In 1979 Margaret Thatcher was elected British Prime Minister. Nevertheless, the climate of opinion in Australia that allowed the Hawke Governments to change so much so quickly, required the efforts of Australians. 

Hawke
The Labor Government elected early in 1983 inherited a mess – a projected budget deficit of $9.6 billion, serious wage pressures, 10% unemployment, a public-sector borrowing requirement of 7% of GDP, annual inflation of some 7.5%, liability to service foreign debt of 1.3% of GDP, and a currency in long term decline. 

Although Hayden had made it determined not to repeat the Whitlam mistakes, it had gone to the people with what was then the usual grab bag of irresponsible promises. Scenting victory, Hawke told the National Press Club that if Fraser’s budget deficit proved bigger than expected he reserved the right to modify his undertakings. His ‘modification’ proved both radical and beneficial. Since it is not the promises that politicians break but those they keep that most often break economies, we should excuse the tactic. 

On the positive side for the incoming Government, the recession had almost bottomed, it inherited a body of semi-established ideas, of which the Campbell Report was the most important, and it faced a chastened Opposition. 

In the socialist tradition Labor would, no doubt, have liked to ease the economy out of recession by increasing demand with public borrowing and reducing real costs with unanticipated inflation. However, that was ruled out on two counts. One was that after ten years of substantial public deficits the markets were awash with government paper so that more could be sold only at interest rates that would depress activity. The other was that Australian inflation, which was already above that of our trading partners, was anticipated. There was thus no possibility of monetary illusion and only policies that addressed costs could work. Treasury was firmly anti-Keynesian. 

Supply side reforms – tariff reduction, deregulation and privatisation – would in time raise productivity reducing unit costs and permitting higher living standards on a sustainable basis, but those policies have long lags. 

Neville Wran, one of the better supporting cast at the highly theatrical ‘Economic Summit’, said the agenda was jobs, jobs and jobs. Maybe, but only real wage reduction could achieve those in the shorter term. 

To that end Hawke tried a corporatist agreement to limit wages and prices. It didn’t work for him, as it had not worked for Mussolini or James Callaghan, and I have no intention of defending it or anything like it. However, it will stand to the everlasting credit of Hawke’s three Governments that they began reducing and improving the quality of government expenditure and removing government-imposed barriers to efficient production. That is, they set about achieving decent levels of productivity growth by every important means except that of reforming the labour market.

By 1988 they had implemented all of the many significant Campbell Committee recommendations to liberate the financial markets including the big steps of floating the currency and deregulating interest rates. 

The 1987-88 IAC Annual Report had quantified the taxation effect of protection at 6.2% of household expenditure. The Hawke Governments eliminated quota restrictions and began the orderly gradual reduction of tariffs. 

They deregulated airlines, got rid of quite a lot of rural regulation and the superphosphate bounty, reduced taxpayer support for film making, means tested over 70s’ pensions, and caused university entrants to pay a little bit for their valuable education. Taxpayers were saved $1000 million annually by requiring dole recipients to collect their payments in person. Unemployment benefits for 16 and 17 year olds were abolished. 

Keating failed to introduce a 12.5% broad based consumption tax like Hewson’s and Howard’s GST but he ended the double taxation of company dividends. 

The budget deficit was turned to substantial surpluses in 1987/88, 88/89 and 89/90, only for that advantage to be squandered at the end of the decade. By1989, Commonwealth outlays had been reduced from 29.9% of GDP at the time of the last Fraser budget to 24%. By the time of the 1987-88 budget $2.5 billion, net of new commitments, had been cut from outlays. 

The rhetoric was changed from ‘look what we have done for you’ to principled defence of what was being asked of the public. 

There was no room for the Liberal Party on the collectivist side of Labor but to note only that would be unfair. Like Labor, it was ashamed of its most recent performance in government. Despite considerable indecision about leadership, and some lapses it was not a political harlot for vested interests. Few Oppositions are so virtuous -- Beazley is not.

Its direction can have been determined only by relatively few dries often led by a more principled John Howard than we know today. 

In the 1980s and early 1990s an exceptionally good Opposition allowed an exceptionally good Government to achieve more than it otherwise could have done. It was not just that Labor could get most of its legislation through the Senate. The Government did not have to worry about an Opposition wooing vested interests that would see it defeated. The Greens, Democrats, and One Nation had no such reservations and, in my view unfortunately, gained at the expense of the majors.

The Keating and Kennett years
Good things end too soon. In 1993, with a barrage of lies, Keating defeated Hewson and Fightback the most liberal, driest economic package that Australia had seen, or it seems now will ever see. Even so, the loss of the package itself was trivial compared with the damage done to the belief that Governments could win elections with quality policy. The slow but steady rise of populism in the major parties dates from Hewson’s defeat. 

Nevertheless, two and a bit important areas of new reform were to come. One was the Kennett revolution in Victoria and another was Keating’s Competition Policy. The bit is tax reform – how public revenues are raised is less important than how they are spent. 

The Kennett Government halted the exodus of capital and people from a stagnant declining Victoria. I don’t have time to tell it now but it is a grand tale of political daring do, of courage, obstruction and flawed heroes. His defeat in 1999 seemed to finally brake dry political resolve.

The Hilmer Report to which National Competition Policy owed its form had observed:
The greatest impediment to enhanced competition in many key sectors of the economy are the restrictions imposed through government regulation or government ownership. 
Competition Policy addressed the monopolies and instances of price fixing that were excluded from the reach of trade practices law as it then was – the professions, electricity authorities, statutory marketing authorities, railways etc. Most were the responsibility of State Governments. 

Despite the regrettable omission of industrial law, Competition Policy does for internal trade what reducing protection has done for external trade. Like tariff reduction, it is inimical to privilege. The protests of vested interests from lawyers to farmers to doctors more or less matched those of the motor and textile industries in the 1970s. 

By 1999 electricity prices on the Eastern Seaboard were down by a quarter, WA industrial gas prices by a half, Perth-Melbourne rail freights were down 40%, conveyancing fees in NSW by 17%, air traffic services by 40% and so on. Such huge cost reductions made substantial contributions to Australia’s competitiveness but there is far to go and today competition policy is under serious threat.

Politicians are again more prone than they were at their best to, as Revel put it, misapply political or administrative power outside its proper sphere. 

I am not claiming that Cabinets never have hard calls to make. I am saying that decisions such as the extent of backing for the US in its fight against terrorism are harder than they would be if Australia were still among the four or five wealthiest nations in the world. That decision was made harder by past low-quality decisions, not least recent spending. 

We had climbed only a small way back up the table of relative wealth when our Governments began reverting to type, again governing for the organised few against the many and again filling the arteries of the economy with the equivalents of fatty material. We still enjoy excellent economic health but today’s self indulgences bring on tomorrow’s illnesses. 

There is much talk of reform fatigue but it is our leaders who are tired. It is true that voters have turned to populist parties but that owes as much to alienation, to being left outside the loop, to being talked down to by the politically correct, as it does to economic freedom or even to change itself. The electorate would again listen to Liberal and/or Labor leaders who led as they did in the 1980s and early 1990s. But first they must pay the dissident voters the respect of addressing their opinions, rather than either dismissing or feigning agreement with them. Pollies too easily assume that electors’ votes can be purchased whereas many individual voters pocket the bribe and despise the briber.

We can’t afford reform fatigue yet our leaders seem even more fatigued than the public. They are no longer explaining what they and we must do to ensure that the next decade is as satisfactory as the last. People and parties that once led are no longer leading. They are again harlots to those concentrated vested interests as we slide into the next long-wave downturn. Call their failure fatigue; call it political corruption – I don’t care. What we should care about is Australia in 2010.