Witty, smart, zealous for intellectual combat, Friedman enjoyed the University of Chicago classroom but reached well beyond it. Born in 1912, he was already a prominent economist by his early thirties. He won the Nobel Prize for economics in 1976, and continued to advocate his views until his death thirty years later. Through his Newsweek columns, television appearances, relentless cultivation of powerful friends, and frequent travel, he magnified the considerable influence he earned as an economic thinker. It was actually Stigler who came up with the line that “if you have never missed a flight you have wasted a lot of time at airports” but it was Friedman who most strikingly embodied the idea. Gifted with immense energy and verve, he hustled.

Readily conceding some of his big ideas didn’t work, Burns argues Friedman was nonetheless responsible for much of the shape of the world today. He created, she argues, modern central banking, floating exchange rates, and the “Washington consensus” on a universally applicable model of market economies. If she is right it was a considerable achievement for an economist who never ran a government department or held political office, and whose central theory, like that of Karl Marx, turned out to be just plain wrong.

And wrong it was. His big theory was that the rate of inflation — or more broadly nominal income — is always related to the rate of growth of the money supply. It was a claim with important implications. For Friedman, it meant a market economy was inherently stable except for variations in the money supply. If the money supply contracted it could cause a depression. If it expanded too quickly, it could cause inflation. Since the money supply could be controlled by government, it was government that was responsible for inflationary booms and deflationary busts. A capitalist economy would be stable if the money supply grew at a steady rate consistent with low inflation and reasonable output growth.

Friedman’s conviction was sustained by his 1963 finding, with Anna Schwartz, that the US money stock had plummeted during the great depression of the 1930s. Their observation stimulated debate, though it didn’t prove that a fall in the money stock caused the depression. After all, 9000 US banks had failed during the Depression, and the biggest component of money measures is bank deposits. It’s hardly surprising the quantity of money declined.

Put to the test by Federal Reserve chairman Paul Volcker in 1979, Friedman’s theory turned out to be wrong. To quell inflation, the Federal Reserve announced money growth targets aligned with Friedman’s rule. The targets proved very difficult to achieve. The US central bank did succeed in forcing up interest rates, however, creating back-to-back recessions and dramatically reducing inflation. Meanwhile the money supply continued to increase at much the same rate as before. Contradicting Friedman, interest rates mattered in controlling inflation; the money supply did not.

Though some have concluded that the swift rise in the money supply and the subsequent increase in inflation during the Covid epidemic bore out Friedman’s prediction, it didn’t. The episode was an even more telling repudiation. From 2020 to 2023 the US money supply (measured as M1, which is mainly bank transaction deposits) rose by 400 per cent, the result of the Federal Reserve creating cash to buy bonds and lend freely to banks and business. Over the same period US prices rose by 18 per cent, or less than one twentieth of the increase in the money stock.

(It is true, as Friedman maintained, that inflation is always and everywhere a monetary phenomenon. In a certain sense this must be true, since inflation is by definition about changes in the value of money. But changes in the quantity of money need not and evidently do not result in equivalent changes in inflation or nominal income.)

Once followed with eager interest by economists and market analysts, the money supply numbers these days are rarely mentioned. Friedman’s conception of the relationship with inflation survives in elderly conservative haunts (including the pages of Australia’s Quadrant magazine) and among some financial markets people.

It was still a widely discussed variable when I was working on a doctorate in economics in the US in the early eighties. Yet in later years on the Reserve Bank board I can’t recall the money supply being seriously mentioned, ever. Nor in an earlier four years as an economist in the office of the treasurer and then the prime minister. Nor yet was it taken seriously when I was working subsequently as an economist in financial markets. Though dutifully published by central banks, the money supply numbers contain no information useful for predicting inflation or nominal income growth.

But then some of Marx’s central ideas were also wrong. Demand hasn’t proved always to be less than supply, workers haven’t become increasingly poor, and the labour theory of value, which he adopted, has long been superseded by better ways of explaining prices. Yet Marx undoubtedly exerted great influence on the world. While conceding he was wrong on the central point of the “monetarism” he espoused, Burns argues that Friedman was similarly influential.

By 1979, when the central monetarist idea began to fail, Friedman had already given his famous 1967 presidential address to the American Economic Association in which he challenged many of his colleagues’ focus on a short-run trade-off between inflation and unemployment. He succeeded in reorienting economic thinking back to a long run in which there was no trade-off and therefore not much room for stabilising the economy with government spending.

More than monetarism, that address changed scholarly economic thinking. The short-run trade-off survives today in economics teaching, but coupled now with a long-run story in which there is a certain minimum unemployment rate — often disputed — consistent with stable inflation.

Intelligent, well-researched, scrupulous, balanced and clearly written, Burns’s is an excellent biography. Her archival work on Friedman’s relationships with Chicago colleagues, Federal Reserve governors, presidential candidates and presidents is thorough, fresh and deeply interesting. Even so it credits Friedman with more than seems to me reasonable.

Much of Friedman’s reputation was based on a wonderful stroke of professional luck in the late 1960s. As Burns tells it, he observed an increase in the rate of growth of the US money supply and predicted an increase in inflation. In his 1967 address he argued there was no stable relationship between inflation and employment. When people observed that inflation was rising they would increase their wage demands and businesses would increase prices, taking inflation higher. When inflation took off in the late 1960s Friedman claimed to be vindicated. When unemployment also rose in response to a slowing economy, Friedman was doubly vindicated. He had predicted both rising inflation, and unemployment, and by the early seventies both were apparent.

It was also true, however, that the Johnston Administration was financing both the war in Vietnam and its ambitious Great Society program of social spending and infrastructure. Federal spending rose from 16 per cent of GDP in 1965 to 19 per cent in 1968, with almost all of the increase funded by an increased deficit. Inflation rose from 1.6 per cent in 1965 to 5.5 per cent in 1969. During the next decade, helped along by a tenfold increase in oil prices, inflation and unemployment would increase very much more. Even so, the increase at the end of the sixties was a disorienting shock, one that burnished Friedman’s repute as an economic seer. Through the seventies, a decade of high inflation and an intermittently rising unemployment rate, Friedman’s reputation grew.

They were his best years. By the early eighties, with Volcker’s disinflation efforts demonstrating that a money supply target was a lot harder to achieve than Friedman supposed — and unnecessary to combat inflation — his professional reputation lost some of it shine. Even at Chicago, a new school of “rational expectations” pioneered by younger economists was displacing Friedman at the centre of classical economic thinking. At the same time, though, his public reputation became more lustrous with popular books and a television series lauding capitalism, markets and the freedom Friedman argued capitalism encouraged.

Friedman could claim some singular successes, as Burns points out. He was an advocate of floating exchange rates at a time when orthodoxy predicted global chaos if exchange rates were not fixed against each other and the price of gold. When the big market economies were forced to move to floating rates from the end of the 1960s, Friedman was proved right. Markets adjusted, and more importantly monetary policy could refocus on targeting inflation rather than the exchange rate.

Friedman could claim considerable credit not only for arguing in favour of floating exchange rates, which have become nearly universal in major economies, but also for several proposals that for one reason or another were not widely adopted. One is school vouchers, a government payment which would allow parents to choose their children’s school. Another is the negative income tax, which in Friedman’s version would replace other welfare payments with a single payment.

It is harder to praise Friedman alone for widely shared ideas that also proved useful. For example, Burns credits Friedman for insisting on the role of prices as the central mechanism in a market economy. But in this respect he was by no means unique. He deployed a style of economic analysis that Adam Smith called the invisible hand and was most coherently developed by the British economist Alfred Marshall in the 1890s. The technique was used by Marshall’s pupil Keynes and taught at Harvard in much the same form as at Chicago. It is still taught today and remains one of the most powerful tools in economics. Friedman was good at it, but not as good as his contemporaries and colleagues, Stigler and Gary Becker, or many other microeconomists of his era.

Friedman did successfully contest the supremacy of fiscal policy over monetary policy, a lingering legacy of Keynes’s advice for dealing with deep slumps such as the Great Depression. The fiscal emphasis was rooted in Keynes’s notion that the circumstances of the Depression and the fear it engendered meant lower interest rates would not make much difference to spending. It was the “liquidity trap” in which people conserved cash rather than buy things or invest. Direct government spending was a better option to sustain demand and jobs. This aspect of Keynes’s thinking dominated economic thought in the United States, particularly among supporters of Roosevelt’s New Deal. Friedman insisted on the important role of central banks, a reorientation that remains.

Friedman’s enduring contribution, Burns argues, was to remind the economics profession that money matters. She is certainly right, even if the particular mechanism he had in mind proved to be wrong. Even so I am not at all sure of her argument that Freidman resurrected interest in money among economists, or that it had ever ceased to be of interest. After all, Keynes wrote his Treatise on Money before the General Theory of Employment, Interest and Money, and the General Theory has much to say about money and interest rates. John Hicks’s famous simplification of the General Theory, still taught as the ISLM equations, is all about interest rates, the public penchant to hold money, and the quantity of money. Friedman himself acknowledged the contributions of an earlier American monetary theorist, Irving Fisher.

Burns also credits Friedman with an important role in creating the “Washington consensus,” the nineteen nineties notion that began as a description of a widespread change of economic policies in South America away from import replacement. Friedman made some contribution, though not as important as that of his trade theory colleagues. Japan, then Korea, then Taiwan, then most of Southeast Asia had in any case focused on export strategies decades before Chicago economists, including Friedman, advised Pinochet regime in Chile to adopt one.

Generalised with Thomas L. Friedman’s The World is Flat into a view that democracy, capitalism and economic globalisation had become the more or less universally agreed elements of human societies, it moved well beyond Friedman’s scope. Friedman certainly welcomed it, but did he create it? A world of liberal market economies had, after all, been an American foreign policy ideal since the end of the second world war. The creation of the modern global economy rested on successive GATT trade rounds, the European common market, the reconstruction of Japan and Germany and other changes Friedman may have applauded but had nothing to do with him. He welcomed China’s accession to World Trade Organization in 2001 but was not an important player in removing the US veto. China’s economic success with considerable state ownership and direction ran opposite to Friedman’s prescriptions. On the Washington consensus, there is anyway today no consensus.

As he became more involved in Republican politics, Friedman’s moral compass became unreliable. Supporting Barry Goldwater’s campaign for the presidency, Friedman opposed the 1964 Civil Rights Act. His argument, according to Burns, was that people have a right to racially discriminate if they wish. With economics, you need to know when to stop.

His fans claim Friedman’s ideas also had a big impact on Australia. According to economist Peter Swan, speaking at a Friedman tribute in Sydney in 2007, Friedman’s ideas arguably spurred not only “the demolition of the Berlin Wall, the demise of the Soviet Union and of communism [and] the rise of Maggie Thatcher in the UK” but also the “magnificent success of the early Hawke–Keating government,” which “freed up the financial system, floated the dollar, and deregulated and privatised much of the economy. And Friedman’s ideas surely laid the foundations for the great prosperity enjoyed by Australians under the Howard government.”

Putting aside his suggestions about the Berlin Wall and the demise the Soviet Union, Swan’s attribution of the success of the Hawke and Keating governments to Friedman is hard to see. Writing about those governments, researching the archive of Keating’s files, I cannot recall coming across Friedman’s name once.

The Hawke and Keating governments were indeed adherents of what was then broadly known as economic rationalism, but it is fanciful to credit Friedman. It was just regular economics. The Hawke government put in place an Accord with the trade unions which, with the cooperation of the wage arbitration tribunal, restrained the growth of wages. That idea was anathema to Friedman. The Hawke and Keating governments legislated tariff cuts, long advocated by Australian economists and drawn from mainstream economic thinking that long preceded Friedman. (Influenced by Bert Kelly, Whitlam had also been a tariff reformer.) Friedman was an advocate of the sort of privatisations effected by the Hawke and Keating governments, but so were many other prominent economists.

There is perhaps more of a Friedmanite influence in financial deregulation. Australia’s efforts were in some respects more thoroughgoing than in the United States, but somewhat later — as was the float of the currency. In Australia, as in Britain and the United States, deregulation was prompted by the increasing success of unregulated financial businesses, cross-border competition and the opportunities offered by computing and communications technologies. Friedman advocated financial deregulation but, again, so did others.

And while Australia’s Reserve Bank continued with monetary targets until 1985 the operating instrument and the real focus of policy was always the short-term interest rate. The bank anyway had no more success than other central banks in meeting its money targets. The targets were seen as aspirational projections rather than outcomes that had to be attained. Not long after the float of the Australian dollar, the bank (and the government) dropped what had by then become fictional monetary targets. As the bank’s then deputy governor, Stephen Grenville, pointed out in a canonical 1997 paper, by the late eighties it was widely recognised that the relationship between money and nominal income had broken down. He approvingly quoted a remark of the Bank of Canada governor: “We didn’t abandon monetary targets, they abandoned us.”

For all that, Burns rightly points out that Friedman could claim a good deal of the credit for many of the characteristics of contemporary central banking. One is explicit targets, though now expressed as an inflation range rather than a rate of growth of money. Another is openness, expressed as public information about the monetary policy decisions of the central bank, and its economic forecasts. A third might be the greater independence of central banks from the rest of the government. In the United States all three were in varying degrees absent from the Fed when Friedman began drawing attention to the role of money and monetary policy from the later 1950s onward. He could claim to have had a big influence on central banking, and for the better.

Freidman’s most thorough intellectual biography is the magnificent two volume study by Edward Nelson, an Australian economist working at the Federal Reserve in Washington. At over 1300 pages Nelson’s Milton Friedman and Economic Debate in the United States 1932-1972 (University of Chicago Press, 2020) demonstrates in detail the range of Friedman’s professional impact in the long-running disputes between economists broadly aligned with Keynesian views, and those adhering to the Chicago classical tradition.

As Nelson noted in 2011, some of Friedman’s views have been put to unexpected uses. The then Fed chair Ben Bernanke cited Friedman’s criticism of inactivity of the central bank during the Great Depression to justify the large-scale intervention of the Fed in the 2008 financial crisis. But it is also true that the 2008 crisis was caused by a grotesque failure of financial businesses to control risks. Alan Greenspan’s misplaced confidence that financial markets would correctly price the risks of mortgage securitisation, the most expensive error in the history of central banking thus far, had a distinctly Friedmanite or at least Chicago ring.

Perhaps Friedman’s most enduring legacy is his support for the notion that market economies usually work reasonably well. They occasionally crash but by and large the price mechanism, the invisible hand, guides efficient decisions much better than state control of prices, labour and capital. Friedman argued for this view but it was, after all, the fundamental tenet of economic theory as developed in Western Europe and Britain from the eighteenth century onward, and not a view that Friedman either invented or much improved. A brilliant advocate, an important scholar — that should be enough for one very distinguished career in economics, without also being held responsible for the shape of the world in the second half of the twentieth century. •

Milton Friedman: The Last Conservative
By Jennifer Burns | Farrar Straus Giroux | $59.99 | 592 pages

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Nearby on stage, illuminated by blue and pink lights, was a Yamaha piano and Nord Wave synthesiser, a set of drums, a double bass on a stand, and an upended tenor saxophone. Leaning against a piano leg was an open backpack full of sheet music. The 616 club has twenty or thirty tables and a standing area, with a jumble of air-conditioning ducts running overhead. Attendance was reasonable, but not crowded. The audience was mostly middle-aged or older.

The day before, Nock had learned by chance of the death of a woman who had captivated him in America forty years ago. It prompted a reflective mood. Chatting between the sets he remarked that someday soon he wanted to begin an account of his career, of his life in music, not to glorify himself but to understand his lifetime playing jazz.

Perhaps he had not been the best jazz pianist of his generation, he said, but he had never wanted to be. All the same he had been pretty good. Listening now to some old tracks he was sometimes surprised to hear how good. The best jazz pianists of his time, perhaps better than him, he thought, included Keith Jarrett, Herbie Hancock, Chick Corea. He pondered a moment. Maybe not Chick.

A few weeks earlier Nock had told me he planned to compose more and perhaps perform less. At eighty-three “my fingers don’t move the way they used to,” he complained. “My memory is not so good. I worry about myself sometimes. There is a time you have to pack it up. I would like to bow out then.”

Nock probably doesn’t expect anyone to take these melancholy thoughts seriously. Once seated at the piano, his baseball cap shading him from the stage lights, he sheds his years. Body inclined to the piano, fingers darting over the keys, head twisted towards the saxophonist, bassist and drummer on his right, eyes half closed, teeth bared, one foot tapping, singing inaudibly to himself, cackling with delight as the music builds, Nock’s lively presence resembles photos of him at the piano in Sydney before he left for America more than sixty years ago. Age amuses him. Introducing his band at a 616 performance a few years ago, he stumbled over the name of his bassist, a late substitute. “A senior moment,” he told the audience, tapping his head in disbelief, “and at my age!”

The 1 September performance marked the tenth anniversary of the opening of 616, which Nock had played with the same band in 2013. Karl Laskowski was on tenor sax, Brett Hirst on bass, and James “Pug” Waples on drums, all of them younger than Nock by many decades. They mostly played Nock’s compositions, including “Vale John,” a piece from his new Hearing album. They also played Ornette Coleman’s 1958 Jayne. It was edgy music that left plenty of room for improvisation and extended solos from Nock and Laskowski, as well as Hirst and Waples. Along with Cecil Taylor, another free jazz exponent, Coleman was one of Nock’s early musical influences.

Nock might disregard age, but even so his latest album is not a young pianist’s music. The thirteen lyrical, spare pieces on Hearing, released on ABC Jazz in July, are mostly his own compositions and all are played solo on piano. Their mood is often elegiac. They are the creation of a mature artist unconcerned by flourish and display.

Playing one of the tracks from Hearing on his Sydney 2MBS program, jazz writer and presenter Frank Presley described Nock as a piano “genius.” Even allowing for the customary overstatement of the jazz world, it is high praise. It is wonderful music, each note distinct and thoughtfully played, with Nock’s characteristic depth beneath its surface.

The album brings reminders not only of his long career, of the development of a style drawing on free jazz, bebop, hard bop and fusion, of nearly thirty years of playing in the United States when jazz was in one of its most creative phases, but also of his love of Bach. At home “I play a lot of Bach these days, the inventions, partitas, fugues — I play a lot, badly,” he says. Bach is a “compendium of stuff. As a reference tool it is the best, a great springboard.” “You might hear a bit of Bach” in his recent album, he tells me “because it is there.”

Nock was unavoidably absent from 616 for a while after being knocked over at a pedestrian crossing, his shin pinned underneath a heavy SUV. (“It was, like, a truck!” Nock says indignantly.) Otherwise he played there from time to time even during the pandemic. If you stopped by on one of those nights and hadn’t heard Nock before, you could find yourself listening with astonishment to the piano player on the raised platform, in the obscuring pool of blue and pink lights, shoulders hunched over the keyboard.

The quality of his playing, his musical inventiveness, his fluency and command are all out of the box, of a quality you had no reason to expect to find under the air-conditioning ducts of an office building in Ultimo.

You could ponder this and also realise with bewilderment that the pandemic meant there were just twenty or thirty people in the room, sometimes fewer. It was like being in front of a Cézanne with only one or two other people in the gallery. Nock was untroubled. Between sets he chatted to friends at the tables, beer in hand, chuckling. He is remarkably modest, though there has always been tension between his boundless musical ambition and the injunction in his New Zealand childhood that he should never skite.

It is nearly forty years since he returned from the United States. What he brought back with him, what he gave so much to acquire, what distinguishes him as a musician, was a quarter century of music-making with the best jazz musicians of his generation, with skills impossible to acquire in any other way embedded in his mind and fingers. He brought back the experience not only of listening to the best players of American jazz in the sixties, seventies and eighties, and of knowing them, but also of creating his own part in the greatest years of bebop, hard bop and fusion jazz, a time now past yet still as much a part of our contemporary culture as Impressionism.

He returned in 1985 with those skills, that knowledge, together with a long catalogue of his recorded music and plenty of his own compositions on dog-eared bundles of paper, and otherwise with a few keyboards, a Hanon piano exercise book he had been using since he was seventeen, and not much else by way of physical possessions or financial substance.

Nock’s American career followed the curve of a great phase in jazz. He landed in Boston in 1961, the year after Miles Davis recorded Kind of Blue, around the time of Hank Mobley’s Soul Station and John Coltrane’s Giant Steps. It all seemed to happen at once. Nock was playing when Mingus was still in his forties and Bill Evans and Ornette Coleman barely in their thirties. Louis Armstrong was still playing. Sidney Bechet had died in France only a few years earlier.

By the time Nock left in 1985 it was all fading away. It was the year before Miles Davis made the electronic-funk album Tutu, book-ending a jazz era that had begun not long before Nock arrived and ended not long after he left. Many love the music that came before and came after, but that wasn’t what came in between. With thirty more years of playing and teaching since, Nock has continued to explore, to move on, yet his style, his values, arise from an experience in jazz now impossible to replicate.

Born in New Zealand in 1940 and raised in the small North Island town of Ngaruawahia, Nock was introduced to the piano by his father, an amateur player. As the pianist tells it, he was soon enthralled by jazz, listening with wonder to the broadcast of the 1953 Toronto concert of Charlie Parker and Bud Powell on piano, Dizzy Gillespie on trumpet, Charles Mingus on bass and Max Roach on drums. “Here is some truth,” he thought. “Here is something that is definitely happening.” When Nat King Cole visited New Zealand two years later, the fifteen-year-old took himself to Auckland to hear him.

Shocked by the sudden death of his father in 1952, he had experienced a spiritual crisis, abandoning the Catholicism of his boyhood. Music “became my religion.” Yet formal musical training was out of reach. Unlike many of his contemporaries, including Jarrett, Hancock and Corea, Nock was entirely self-taught. “I had been playing for ten years,” he recalls “before I knew what a scale was.”

He blew out of New Zealand at eighteen, terrified by the risk that his life might be insignificant. He was, he told his biographer Norman Meehan, “afraid of being a nonentity,” a particular problem for a New Zealander enthralled by the most American of musical forms, jazz.

Talented, energetic, always learning, Nock was successfully performing in Sydney and Melbourne before he was twenty, playing piano in bands backing visitors Coleman Hawkins, Dizzy Gillespie and Sarah Vaughan, forming the then well-known 3-Out Trio and recording the album Move in 1960. “It was a huge hit,” recalled Nock, adding characteristically, “in many respects it’s been downhill ever since.” Nock’s ambition was to move to the United States, the home of jazz. “I do have a big ego,” he reflects. “I was pretty arrogant. I was single-minded to the exclusion of everything else. I think that explains my success. I was headstrong.”

At twenty-one he was on his way to Boston’s Berklee School of Music on a scholarship from Downbeat magazine. He soon dropped out of Berklee but remained in Boston four years, playing in local clubs and in backing bands for visitors including saxophonists Yusef Lateef, Coleman Hawkins, Sonny Stitt and Zoot Sims, and clarinetist Pee Wee Russell.

By 1964, he was the pianist in Lateef’s band, touring the United States and playing on Lateef’s remarkable Live at Pep’s albums. Settling in New York he played local clubs, toured with singer Dionne Warwick, and was delighted when Art Blakey engaged him for Art Blakey and the Jazz Messengers, replacing the departing Keith Jarrett. It still rankles with Nock that he was hospitalised with hepatitis after one performance with Blakey. “I was in great health — up to that moment!” he laments. The job passed to Chick Corea.

With a group led by West Coast saxophonist John Handy, Nock again toured, before settling in San Francisco in 1967. Handy’s admired album Projections, released in 1968, featured Nock on keyboard. In San Francisco, Nock formed what was widely regarded as one of the first jazz-rock fusion groups, Fourth Way. The band made several admired albums and played a celebrated appearance at the 1970 Montreux Jazz Festival, before dissolving in 1971.

Four years later Nock was back in New York, this time often playing solo. In the late seventies he reached a new peak with the Mike Nock Quartet, a band that included saxophonist Michael Brecker. The quartet’s 1978 album In, Out and Around recorded Nock at his magical best in those New York years, notably on “Hadrian’s Wall” and “Shadows of Forgotten Love.”

While there are excellent piano solos from Nock, some of the most pleasing tracks are those in which the interplay between sax and piano is most inventive. Nock also played the saxophone as a teenager, so he knows what the saxophonist wants and plays to it. That is most evident on the title track but true of all the tracks on the album. “In, Out and Around,” Nock thinks, has “stood the test of time.” He credits Becker but adds, “I was playing pretty good in those times.”

With a US bassist and drummer Nock recorded Ondas in Oslo a few years later. The album was released by ECM Germany. He wrote all six compositions on the album, so they represent both his compositional accomplishment and his style after twenty years of playing at the top level. The album includes a longer version of “Forgotten Love,” and “Land of the Long White Cloud” — both played with wistful restraint.

At a time when there were white bands and black bands, Nock was an unconcerned outsider. Yusef Lateef and John Handy are both Black. Nock mostly played with Black musicians. Even now, long after he left the United States, his language trails the culture in which he was immersed. He speaks of his “stoodents,” of having “atta-tood.” His colleagues are cats (or black cats). Good music is cool.

Nock’s engagement with music was so complete that great events of America passed him by. He arrived in the United States a few years before John Kennedy was killed, and was there for Los Angeles riots, the assassination of Martin Luther King, the freedom march from Selma to Montgomery, the Vietnam war and Robert Kennedy’s assassination. He was all but oblivious. “It is amazing,” he says, “particularly since I was working with Black musicians. I have learnt more about those events watching ABC documentaries since I’ve been back than I ever did living through it in the States.”

By 1981, still only forty-one, Nock could claim a hard-won place in the world of American jazz. He had worked with many of the greats and learned from them, including Sonny Rollins, Roy Eldridge, Lionel Hampton and Benny Goodman among many others. He had formed and led two widely admired bands in quite different jazz genres, and been part of many celebrated recordings. He had become an accomplished soloist and composer, as well as a band pianist. He had been panned sometimes but far more often praised by reviewers, including favourable mentions in Downbeat.

All the while he had been growing, refusing to stay still, refusing to be part of commercial music, developing a style that was recognisably his own. While his music is usually melodic, he doesn’t often play jazz standards. “I play them sometimes,” he says, “but not too often because, hey — why?” Even Rollins recorded “The Surrey with the Fringe on Top”; it is hard to imagine Nock doing so, although he says he has “huge respect” for standards and the American songbook. His own compositions are tuneful but not memorably so, and usually built from simple, repeated chord forms. They are the building blocks of a mostly improvised musical structure. With an average length of around thirty-two bars, a Nock composition might take less than a minute played straight through. A seven- or eight-minute track based on his melody is mostly improvisation around it.

Nock has always had an ambivalent relationship to solo performing. He seems to prefer the music made when he plays with others, even when (or especially when) they are playing his own compositions. “I was not burning to make a solo record, or to be a soloist,” he says of Hearing. He also thinks of music-making as a cooperative activity.

Refusing classification, Nock seeks “freedom of expression” using “all the elements” of modern jazz. Though an accomplished technician, Nock more commonly refers to feeling than technique when talking about jazz. “Jazz is an attitude,” he says, “it transcends style. You play who you are. The best jazz musicians are also inspiring people.” Technically skilled music “doesn’t interest me.” He wants to “communicate feeling.” He quotes the advice often attributed to Armstrong: it ain’t whatcha say, it’s howcha say it.

By the early 1980s, when Nock had been playing in the United States for twenty years, jazz had long given way to pop and rock among young audiences. Jazz record sales were on their way down to a level just above classical and just below children’s music. The internet was only a few years away, and with it would come file sharing and the long, slow and irreversible decline in physical album sales.

Always uncertain, Nock’s career became perilous. As a studio musician in New York he found work, but not always the kind of work he wanted. In Manhattan he lived in tough and scary neighbourhoods. From time to time he was mugged. Thieves broke into his apartments. Relationships crashed. Married twice and divorced twice, he wanted more stability in his personal life. He did not own a home or significant financial assets, his income was meagre. If he thought about getting by in America as he grew older, he would have been troubled.

At the end of the eighties he moved out to New Jersey to join his then partner and her children. An hour’s drive west of New York City, Basking Ridge is an affluent white community in which Nock felt alien. His income at the time was never more than $30,000 a year in today’s US dollars, not enough to contribute much to household expenses. “I was living outside the gig zone for New York,” he recalled, and work dried up.

With few bookings or prospects of them, Nock’s life hit rock bottom. He had performed at the top level in the United States but, as Meehan records, financial success, strong sales, popularity, “passed Nock by.” He had depression, panic attacks and no money. His partner left for the west coast. Across America countless jazz musicians put away their instruments and turned to other trades. Unattached, unfunded, Nock tried Europe for a while, and then left for New Zealand.

His decades in America had given Nock what he sought — the opportunities to play the piano, to be in bands with other accomplished musicians, to be of good standing in a society of other players of stature, to practise his craft, to develop his art. Money didn’t mean much to him, which was good because there was never much. “Sure it was a hard life,” he reflects, “but what’s wrong with a hard life?”

In New Zealand he played gigs and took part in TV documentaries. Then came a call from an old friend, inviting him to take a teaching residency at the Queensland Conservatorium. He found he quite liked the chance to encourage eager young players like he’d been thirty years earlier. Not long after, eminent reed player, band leader and teacher Don Burrows called to offer a job at the Sydney Conservatorium. “Are you kidding?!” Nock responded when Burrows asked if he was interested in the job. Of course he was interested! Nock would teach generations of students there for nearly thirty years, retiring at seventy-eight. It was the first time he’d had a steady income in his entire life.

The early years back in Australia were difficult. “It took me a while to think about being back here. You don’t have the stimulus here in jazz, especially compared to New York. I’ve withdrawn a lot. I was always thinking about going back.” Looking back now, though, he thinks “the most fruitful period of my life has actually been back in Australia.”

He has been in Sydney for thirty-seven years, a lot longer than he was in the United States or New Zealand. He may have missed New York, but Nock has been able to compose as well as teach, perform, and record well-received solo albums and ensemble music. For a while he also worked selecting music for the jazz division of Naxos records. Over time he became more comfortable playing and teaching jazz in Australia. It was an opportunity to “share what I learnt. Later it was a dream, with lots of opportunities to play. I got together a band, all sixty years younger than me. An unexpected blessing at my age.”

His personal life bloomed. Twenty-five years ago, a decade or so after he came back to Sydney, Nock married Yuri Takahashi, a former cultural diplomat for Japan, and a specialist in Burmese language and cultural studies. She took her PhD in Burmese Studies at Sydney University and now teaches at the ANU. A fan, they met at one of Nock’s performances.

Their home is a semi-detached brick cottage on a quiet street in the inner-western Sydney suburb of Ashfield, an area of Federation cottages and low-rise flats. It is the first property Nock has owned, ever. They have kept many original elements — kitchen food lockers, decorative plaster cornices. Nock is also a painter and his colourful abstractions decorate the walls. The rooms are heaped with musical instruments and equipment, records and CDs, sheet music, books.

A sunny Saturday morning in August this year finds the couple at home in Ashfield, Nock sitting at his Kawai piano in a living room crowded with instruments. Around him are three young players — Ben Lerner on saxophone, Nick Jansen on bass and George Greenhill on drums. The group meets more or less weekly. Today they are practising a melody Nock wrote sixty years ago.

“I wrote the song when I lived in Boston,” Nock remarks. “It’s difficult. Even I have trouble with it these days. Difficult, but a simple melody.”

“Deceptively simple,” says Greenhill.

Nock plays the tune on the piano, then the group joins in.

Nock stops. “We weren’t getting that right.”

“You don’t mind if I am a bit late for those quarter notes?” asks Lerner.

“You asked me to be very big at the start. Maybe less full on?” queries Greenhill.

“Definitely, yes,” says Nock.

Lerner suggests playing a tune for an hour “until the drumming is completely right.”

“Yeah, put it on a loop until it is fucking perfect,” Greenhill agrees.

“What is perfect in jazz — there is no perfect,” Lerner responds.

“The better people know a line, the more you can stretch the melody,” Nock observes, changing the subject and playing the melody of another composition.

Nock isn’t pleased with his own playing. “It’s a bitch, that song. I don’t know what happens. This doesn’t sound right. I have to change my technique to play that little bit. I have to keep my fingers flat.” He critically examines his fingers.

“Don’t question yourself, Mike,” urges Greenhill.

“We are in the refinement stage of this,” says Nock. “A big learning curve for us. Let’s get the melody right.”

“That’s it!” says Nock, after another try. “It’s kinda crazy.”

“Not crazy!” insists Jansen.

“It’s feeling better,” Nock agrees. “Let’s lay out the song more clearly.”

“Mike, we are here to learn from you,” Greenhill says encouragingly.

“Yes — Mike Nock and his Three Problems,” adds Lerner.

Nock has been playing the piano now for over seventy years. At eighty-three he says he is at a “funny stage of my life — a golden era” with “lots of things changing.” He finds himself “thinking about things more.” Since he is “running out of time” he is “more interested in what I am doing now” rather than planning for the future. He may play less, compose more. “I want to write more music,” he says, though his days are still “pretty full.” He practises often to keep his fingers flexible, and swims as often as he can. The road accident reminded him of “how quickly things can change.”

Sound of mind, in reasonable health, still playing, still composing, still mentoring, Nock is tranquil. “It is easier to ride the horse in the direction it is going,” he has decided. As for the ups and downs of his career, Nock judges that “it worked for me. I’ve had a blessed life.” •

The post Blessed life appeared first on Inside Story.

At 3.5 per cent, the unemployment rate is close to the lowest it has been in the forty-five years since monthly numbers began. And that isn’t because of low immigration: on the contrary, the workforce is much bigger than before the epidemic. The number of people with jobs and total hours worked are also at record highs. (In the years between the global financial crisis and 2019, by contrast, unemployment didn’t get below 5 per cent.) By the second half of last year real income per head was also at a record level.

Inflation is certainly too high, and occupies most of our attention. Yet in recent quarters it has been decelerating. Underlying inflation was running at an annualised rate of about 4.8 per cent in the March quarter, still way beyond the Reserve Bank’s target range of 2–3 per cent. To get back towards the midpoint of that band we need to see that underlying rate decelerate from 1.2 per cent for the March quarter this year to around 0.7 per cent a quarter. That’s a big move, but smaller than the decline in quarterly underlying inflation over the six months to March.

The key point here is that underlying inflation has markedly decelerated despite firm output growth and despite unemployment remaining near a record low. Wages growth remains modest.

The Australian pattern is remarkably similar to America’s. There, trimmed-mean personal consumption inflation (which removes the most extreme price changes) peaked in January with a 6.1 per cent annualised rate, and by March was down to a 3.4 per cent annualised rate. Unemployment was down to 3.4 per cent in March — the lowest rate since 1953.

On last Friday’s Reserve Bank forecasts, annual underlying inflation won’t fall below 3 per cent for two years (and even then it will only be just under). But its forecast numbers are consistent with the quarterly underlying rate (measured by the trimmed mean) coming back within the target band by this time next year. On the quarterly numbers, underlying inflation will be consistent with the band long before the headline annual rate is back within it. Once the quarterly numbers are within the band, the inflation problem is over.

We have a good chance of getting inflation down without a serious recession and perhaps, as the RBA also forecast on Friday, with continuing gains in employment and the jobless rate still below where it was before Covid.

With inflation contained, the time will have come to recognise our long-term constraints, which are considerable.

First, inflation may well decelerate without a recession, but not without two years of slowing growth and rising unemployment. The low-inflation world to which we are returning was also a world of slow growth and somewhat higher unemployment. It will likely be a world of markedly lower interest rates, a point the IMF made in its recent World Economic Outlook.

As we were reminded in those four or five years before Covid, however, low interest rates don’t necessarily spur rapid output growth. With much higher government debt and with the Reserve Bank running down rather than building up its government bond holdings, we should also expect contractionary fiscal policy for all circumstances short of a serious downturn.

Another constraint is that it is quite a while since Australia (like most other rich countries) has seen much increase in output per hour worked, or productivity growth. That doesn’t give room for real wage increases, or for real income increases more generally. With population growth through immigration likely to exceed GDP growth, Australians will be no better off in real terms in two years than they are today.

Then there is the budget, and the discretionary spending options open to the Albanese government. With revenue flattered by big increases in nominal GDP, and spending pressures eased by high employment and the withdrawal of Covid spending, tomorrow’s budget outcome and forecasts for the coming financial year will be more favourable than predicted in the budget revision of October last year. Even so, the path ahead is difficult. Last October’s budget forecast higher deficits for 2023–24 through to 2025–26, even with modest average spending increases and revenues close to previous records as a share of GDP.

Perplexed by the immediate concerns about high inflation and rising interest rates, we have not focused on these underlying constraints. By the middle of next year, all going well, they will begin to become more evident. Going into a 2025 election, after two years of slower growth and rising unemployment, they will be more evident still.

For the Albanese government, the appealing story will have to be about the next term, not this one. That story will need to include the balance between fiscal and monetary policy over coming years, a topic elided in the recent review of the Reserve Bank. It will also need to include measures to stimulate productivity growth. Getting productivity up will be harder than getting inflation down — a good reason to elevate the search for ways and means to the centre of national attention. •

The post Inflation and beyond appeared first on Inside Story.

If she is right, countries will import less than they otherwise would, export less, and make more of the things they consume in their own territory. They will invest more at home and less abroad. Manufacturing in America may expand faster than otherwise, while China’s economic expansion will be blunted. Foroohar thinks all this is a very good thing.

It is not just globalisation to which she objects. She also dislikes big farming in the United States, what she says is the “financialisation” of American business, and the role of the US dollar in international transactions. She warms to the “beauty of localisation” evident in her Brooklyn neighbourhood. Her views, as she says, are akin to those of the old trade union left in the United States. There was much about the Trump administration she admired, particularly its trade policies.

Foroohar is not alone in her view that economic globalisation is reversing. McKinsey and Boston Consulting have in recent times made similar predictions. In January the IMF issued an alarmed paper on what it calls “policy-induced geoeconomic fragmentation,” or GEF, lamenting tendencies that threaten “the future of multilateralism” and introducing a new acronym.

If Foroohar is right, this trend is of the utmost consequence not just for the United States but also for the rest of us. Our accustomed ways to think about the world, our work and play, our financial and career choices will all have to change, and quickly.

Australia is a good case in point. With more exports and more net offshore investment compared to GDP than China, its prosperity is built on global trade and investment. If cross-border trade and cross-border investment flows are dwindling, which is what “deglobalisation” means, Australia will need to remake its economy.

So, too, will most other countries. Exports are now just short of 30 per cent of world GDP, two and a half times the share fifty years ago. That means nearly a third of global GDP will cease to grow or grow only slowly, throwing the burden on the remaining two-thirds of demand to power output. Instead of being distributed around the world according to technologies, labour costs and natural resources, production will be “onshored” to the home market, protected by subsidies and tariffs. The price of manufactured goods will rise, hurting wage earners.

And while Foroohar offers a substitute world in which cross-border trade and investment take place only among like-minded countries — those with what she describes as a “common moral framework” — it would not suit Australia, or its region.

Australia’s total goods exports to its closest security allies, the other members of the Five Eyes intelligence pact, total less than a fifth of Australian exports to China. Australian exports to the entire membership of the NATO alliance are of roughly similar magnitude to those to the Five Eyes. Add in Japan and South Korea and the sum is closer to the total of exports to China, but Japan and South Korea are both nearly as strongly linked to China as Australia is.

If globalisation is reversing, particularly if it means the decoupling of China from the United States and its friends, Australia has a very big problem. It would not be a world in which we would do well.

Nor would it suit the region. A third of world output is from the Asia-Pacific, a region composed of countries that are closely integrated economically without sharing a common moral framework.

But is deglobalisation really happening, as Foroohar asserts? Homecoming is strong on colourful anecdote but weak on data. Despite the many predictions, deglobalisation is not in the numbers — or at least not so far.

If it were, then we would expect to see cross-border trade and investment falling. Yet cross-border trade has never been higher than it was last year, on numbers published by the Netherlands Central Bank. It is true that exports as a share of world GDP peaked in 2008 and then fell dramatically in the economic slowdown following the financial crisis. But since then trade has recovered as a share of world GDP and on the most recent World Bank numbers was only a little below the 2008 peak.

Global cross-border direct investment did indeed fall during Covid, as one might expect, but not in ways consistent with a deglobalisation story. Direct investment flows into the United States fell sharply, but those into China increased.

And for all the talk of decoupling of the world’s two biggest powers, goods exports from the United States to China in 2021 were higher than ever and were running at an even higher level last year. China’s goods exports to the United States in the past two years have matched those of recent preceding years. A recent study by the Peterson Institute’s Chad Bown found no compelling evidence of US–China decoupling.

It may be that global exports will no longer grow markedly faster than global GDP, as they did in the twenty years to 2007. But rather than deliberate deglobalisation, a large part of the stabilisation of the ratio of world exports to GDP is related to the rebalancing of China’s economy. Its exports peaked at well over a third of GDP in 2006 and now, with policies favouring domestic demand, are down to less than a fifth. The stabilisation of exports-to-GDP after decades of dramatic growth also reflects the faster growth of the less export-intensive services sector compared with manufacturing in world GDP.

The most one can say based on the numbers is that globalisation, measured as the share of exports in global GDP, may have flattened out.

US policy to “reshore” industry may eventually make a difference, but what it has done so far will have a negligible impact on the numbers. By subsidising the construction of local semiconductor chip foundries, the United States will be able to replace some chip imports from Taiwan and South Korea. It will also subsidise the production of solar panels and other new energy technologies, again perhaps substituting for some imports.

Important as they are to the industries involved, these shifts are nonetheless tiny compared with the total flows of goods and services across world borders.

Foroohar is strongly critical of the half century of economic globalisation, mostly from an American point of view. But has the experience of globalisation been so bad?

World GDP has, after all, tripled since 1980, the year after China opened to the world. Since China joined the World Trade Organization in 2001, an event Foroohar deplores, its economic output has more than quintupled, vastly increasing the living standards, health and life prospects of its 1.4 billion people. China’s growth accounts for over a third of the four-fifths increase in real world output since 2001.

Even for the United States, the aggregate outcome has been pretty good. Its output has increased by 50 per cent since China joined the WTO, a strong performance over a couple of decades. Over that period US exports to China have increased at a faster rate than China’s exports to the United States. Foroohar complains of the impact of trade on US manufacturing, but over the twenty years following China’s WTO entry US real manufacturing output actually rose 42 per cent, a not-discreditable performance.

Globalisation as an economic phenomenon is not just the growth of China but also the earlier rapid growth of Japan, Germany, South Korea and Taiwan, and now most of the Southeast Asian economies, all of which have focused on exports. Of this wider globalisation, and of the increases in living standards, health and life expectancy that have come with it, Foroohar has little to say.

Her focus is on China, which she blames for job losses in American manufacturing. It is true that US manufacturing employment plummeted in the years after China joined the WTO, and that imports of manufactures from China rose. But it is also true that US manufacturing output rose quite strongly over the same period, indicating a big role for automation in driving US manufacturing job losses. (In the six years from 2001 to 2007, just before the slump caused by the global financial crisis, US manufacturing output rose by a little short of one-third.)

In fact, US manufacturing employment began to decline after 1978, more than twenty years before China joined the WTO — though the decline accelerated after 2000. By 2010 US manufacturing employment had stabilised and has since increased.

Foroohar rightly points out that real wages have barely increased in the United States over the past couple of decades (by 6 per cent, from 2002 to 2022, using US Bureau of Labor Statistics numbers), a period coinciding with the rapid growth of China’s exports. It is also true, and lamentable, that income inequality in the United States is very wide and much of the gain in income and wealth over the last couple of decades has gone to the already wealthy.

But is this the result of globalisation? Australia, Canada, Japan, France and Germany are among advanced economies similarly open to the global economy, and to which China has become an important trade partner. In all these countries income inequality is markedly less than in the United States, according to OECD numbers. This suggests that domestic policy is the place to look for remedies, not cross-border trade and investment. It is also relevant to Foroohar’s story that on these OECD numbers income inequality in France, Germany, Canada, Japan and Australia hasn’t increased in the past decade, and it has actually narrowed in the United States.

Homecoming is spirited but unconvincing. Complaining of the “financialisation” of US business, for example, Foroohar tells us that the US “financial economy” had become “larger than the real economy,” a statement I find hard to interpret. But I do know that US Bureau of Economic Analysis numbers show the value-add of finance and insurance as a share of US GDP (or total value-add) was 7.5 per cent eighteen years ago and 8 per cent just before Covid.

That is not much of a change. More than nine-tenths of US GDP comes from activities other than finance and insurance. This was true shortly after China joined the WTO, and it is true now. Even though manufacturing had declined as a share of US GDP over the period, in 2020 it was still a markedly bigger share of GDP than finance and insurance, and remains so today. •

Homecoming: The Path to Prosperity in a Post-Global World
By Rana Foroohar | Crown | $60.99 | 400 pages

The post Is this the end of globalisation? appeared first on Inside Story.

Menand’s account of contemporary central banking is not entirely convincing, and his remedies for its problems are specific to the United States and unlikely to be adopted. But in focusing on the change wrought in central banking by the global financial crisis and the pandemic he identifies the most important issue in central banking.

Compared with the implications and consequences of this change, many of the monetary policy issues we are debating today in Australia — issues now the subject of a government-initiated inquiry — are interesting but not fundamental. Should the Reserve Bank of Australia be charged with targeting a certain band of consumer price inflation, or some other band, or even a different measure of economic activity? Should more professional economists sit on the Reserve Bank board? Should interest rates have been even lower in the years before the pandemic? Should Reserve Bank governor Philip Lowe have been more ambiguous in his “forward guidance” on interest rates during the pandemic? All these are worthy questions, but no longer the main point.

For Menand — and his argument applies equally outside the United States — the main point is that in 2008 and (to a vastly greater extent) in 2020 central banks busted conventional expectations of what they could do, with consequences as yet unknown.

Menand, a former Fed official and a senior Treasury official in the Obama administration, brings to his task an understanding of financial structure and economics, law and history, as well as a clear and logical mind. He reminds us that the pandemic’s first economic effect was a global financial crunch. That crunch was so quickly quelled by the Fed and other central banks (including Australia’s) that we have almost forgotten the grave danger of financial collapse in March 2020. This was what triggered central bank intervention, though that support was soon extended much more widely during the pandemic.

Startled by the unknown consequences of the emerging pandemic, financial markets sold off assets. In just six weeks, US shares fell by nearly a third from their peak at the end of January 2020. Investors who had borrowed money to buy shares were forced to sell bonds and other financial assets to meet demands for cash repayments. Bond prices fell and interest rates rose, spooking markets that had expected to see the opposite happen. Suddenly everyone, remembering 2008, wanted cash rather than securities.

US primary dealers, who borrow cash to buy bonds, using the bonds as security, discovered lenders wanted their cash back. Already falling, bond prices fell more as dealers sold bonds to meet those cash calls. The panic spread rapidly through other financial markets in the United States and elsewhere.

Taught by the experience of 2008, the Fed responded by providing cash to the market and accepting bonds and other financial assets in return. Even compared with 2008, the Fed spent big: between September 2008 and the end of that year it acquired assets of US$1.3 trillion; from February to May 2020 it acquired US$2.9 trillion.

The central banks’ response to the pandemic came in two major phases, both of them extending the usual perimeter of their activity. The first phase aimed to stop an immediate financial panic by sharply lowering interest rates and lending cheap money to financial businesses that needed it. The second phase aimed to support household and business demand through the long pandemic in two ways: directly, by keeping interest rates very low and freely lending money to banks and then to a wider category of businesses that needed it; indirectly, by buying government bonds issued to finance deficit spending.

Whereas the cash splurge from the Fed peaked at not much more than US$1.3 trillion during the global financial crisis, by February 2022 it had spent close to another $2 trillion. Its assets were now nearly four times bigger than at their peak in 2008.

In Australia, where shares fell just as sharply (and by a little more) in early 2020, the Reserve Bank spent much more as a share of GDP. In the second week of March 2020 it held $89 billion in Australian dollar assets. By the fourth week of May that amount had more than doubled to A$200 billion as the bank grappled with similar issues of financial instability and also began supporting fiscal policy by purchasing Australian government bonds. At the peak, in March 2022, the Reserve Bank would own more than six times the value of Australian dollar assets it held at the beginning of the pandemic, a total of well over half a trillion dollars.

This enlargement of the role of central banks matters to Menand for reasons that don’t necessarily matter to us in Australia. He is bothered because the US Federal Reserve is doing things Congress didn’t intend when it set up the federal reserve system. In this respect, he is taking an “originalist” approach. Congress is supposed to control tax and spending, yet the Fed is commanding resources by issuing money without congressional authorisation.

Menand wants Congress to be more active in responding to crises. That would be more democratic, he says, and also more egalitarian. Interest rate cuts stimulate increases in asset prices, helping rich people. Government spending, by contrast, can be targeted in a fairer way to support demand.

All of that is true, but a financial crisis doesn’t wait around while parliaments debate the proper response. Nor is the role of central banks in creating money to buy bonds during downturns necessarily inegalitarian. In principle, bond purchases facilitate government spending, with the character of that spending determining its distributive effect.

The legal remit of the central bank concerns us less in Australia because the federal government has the authority (never used, but there) to instruct the Reserve Bank to pursue, or not pursue, specified policies. Moreover, the Treasury secretary sits on the bank’s board and could convey a government view if he or she chose to do so, and by convention the governor of the bank and the treasurer of the day make a point of staying in close touch. Legally, the Reserve Bank is closer to being the monetary policy arm of government than its US counterpart. Its independence is conferred upon it, not required.

Had the Reserve Bank refused to buy bonds during the pandemic in the same way its predecessor, the then Commonwealth Bank, refused to finance deficit spending by the Scullin government beyond a certain point during the Great Depression, the consequences would have been fascinating. Central bank thinking has moved on and the issue didn’t arise. So has the legislative framework for central banking, partly reflecting Labor treasurer Ben Chifley’s determination in 1945 to prevent the central bank acting as it did during the Depression.

Menand rightly blames the shadow banking sector for the US financial crises of 2007–08 and early 2020. These institutions borrow cash to buy higher-yielding securities, or lend money with limited supervision and without a government guarantee for depositors. In the run-up to the 2007–08 crisis, investment banks like Bear Stearns and Lehman Brothers were borrowing in the overnight money market to buy home mortgage securities and other higher-yielding assets. When the crisis made the value of these home mortgage securities difficult to determine and hard to sell, overnight lenders wanted their money repaid rather than allowing it be rolled over. The Fed was forced to support these shadow banks by lending them cash and acquiring mortgage securities, but not before Lehman went down and plunged American and European financial markets into years of grief.

Australia’s financial crises in 2008 and 2020 were quite different. Shadow banks play a much smaller role in the bank-dominated Australian financial market (though in 2009 the Reserve Bank and the government found they had to support the market for bundled or securitised home mortgages and prop up lenders in the car loan market).

The Reserve Bank’s big job in 2008–09 was to protect Australian banks when, at the height of the crisis, they were no longer able to roll over their substantial US dollar-denominated loans from offshore institutions. The bank provided liquidity, including in US dollars. When other central banks guaranteed domestic bank deposits and other borrowing, the Reserve Bank was obliged to follow suit.

Though the circumstances were different in each country, the 2008 crisis greatly extended the scope of central bank actions. When a similar flight to cash began in February 2020, central banks knew what to do.

The central bank’s response to these two crises has left us with questions we are yet to work through. For example: the Reserve Bank of Australia now owns more than a third of the net debt of the Australian government. It is paid interest on that debt, amounting to something in the order $3 billion a year. As it retires its Australian government debt holding, the federal government will need to sell additional bonds to the private market (or increase taxes — not a live option) to finance its repayments.

Over time, the government will need to repay more than $200 billion (by redeeming bonds) to return the bank’s balance sheet holding of official debt to its pre-Covid size. That will mean higher interest rates than otherwise, higher taxes than otherwise, and less spending than otherwise on other things like nuclear submarines or disability support. How much of that $3 billion or so in interest payments should the Reserve Bank return to the government as profit on central banking operations? Even at the most ordinary of times, that question opens up a tense conversation.

And given that the bank bought those bonds with cash it created out of nothing but expects to be repaid out of taxpayers’ pockets or by the issuing of additional bonds to the private market, will governments begin to find the obligation inconvenient and seek to negotiate their way out of it? Will they ask why the bank needs — and what it will do with — all the cash it gets from government in return for its bonds? Treasury might find itself discouraging the bank from running down its bond inventory, or even encouraging the bank to add to it.

In tough times, these possibilities will all come to mind. The Reserve Bank is, after all, another arm of government, another agency of the Crown. Central banks can destroy as well as create money so the Reserve Bank could choose to extinguish payments from Treasury, at the same time extinguishing the corresponding accounting liability. But to extinguish payment from taxpayers looks odd.

The bank might well argue that it will need the cash from the redeemed bonds to buy bonds during the next downturn. Cash would then move from the Treasury to the Reserve Bank in good times, and from the Reserve Bank back to Treasury in bad times, confirming the bank’s new role as a participant in fiscal policy.

If the next downturn is far enough away, that might be a useful and workable reimagining of fiscal and monetary policy. The bank would assume a responsibility for fiscal stabilisation while the Treasury assumes a responsibility for economic stabilisation, the opposite of their declaratory roles in past decades. If it was to work, however, it would need to be discussed and agreed and publicly known, all of which is unlikely.

That issue is one aspect of the changed relationship between fiscal and monetary policy consequent on the changed role of the central bank. For decades, economic policy in Australia has been run on the official understanding that the Reserve Bank would smooth the ups and downs of the economy using interest rates while the government’s budget would be designed to achieve balance “in the medium term.”

During the pandemic Treasury secretary Steven Kennedy pointed out that the Reserve Bank cash rate was near zero, the effective limit of what the bank could do to stimulate demand using interest rates. While the government had spent a vast amount in pandemic support, Kennedy suggested, it could certainly spend a great deal more if necessary. The implication is that fiscal policy could become the active arm of economic stabilisation while the Reserve Bank slowly recovered its interest rate flexibility.

In the event, recovery from the pandemic was stronger than expected, and fiscal and monetary policy have been tightening at the same time. Whether or not fiscal policy emerges as the preferred stabilisation tool, a transfer of the focus of day-to-day economic policy from the Reserve Bank in Sydney back to the Treasury in Canberra waits on the character and timing of the next big downturn. •

The Fed Unbound: Central Banking in a Time of Crisis
By Lev Menand | Columbia Global Reports | US$16 | 176 pages

The post Central bankers unbound appeared first on Inside Story.

Of course, opposition parties have held commanding leads three or four months before an election on earlier occasions, only to see their advantage vanish in the weeks before the ballot. The 2019 election was a case in point, 1993’s another. Yet today’s political circumstances suggest the Morrison government may have trouble turning opinion around. Typically the Coalition runs on a program of fiscal rectitude, accusing Labor of plans to tax, spend and run up big deficits. But with a deficit this year running second in Australian history only to last year, making that theme work will be harder. Unlike in 2019, Labor won’t be proposing big tax increases.

Likewise climate change and China. How we reduce carbon can be debated, but the government is committed to reduction targets, concedes climate change is a real problem, and accepts that coal is on the way out. Portraying China as the enemy helps consolidate the Coalition vote but unless and until Labor takes the bait it is limited in effect, and Anthony Albanese and his colleagues are resolutely refusing to take the bait.

Labor still faces a big challenge in winning the additional seven seats necessary to govern in its own right. The Coalition’s bastion is Queensland, where it holds twenty-three of thirty seats. Queensland out, and Labor holds a majority in the House; Queensland in, and Labor is seven seats short of a majority. Compared to the 2019 election result, which admittedly was a calamity for Labor in that state, the party needs a state swing of more than 3 per cent just to pick up one seat in Queensland, more than 4 per cent to pick up two and nearly 5 per cent to win two more. Still, it is a volatile electorate and a big swing to Labor in Queensland is suggested by the most recent Morgan polls.

So Labor has a chance in what will be a hard fought contest. What kind of economy would it (or the Coalition) face after it is elected and the pandemic’s impact wears off?

Last week the International Monetary Fund offered the cold thought that once the Australian economy has fully recovered, growth will slip to a long-term rate below the average of the twenty years before the pandemic. Output growth next year will be 4.1 per cent, it says, but will then slip to 2.6 per cent, a rate the IMF evidently thinks is as fast as it can go in the long term. Growth in employment will account for more than half of that 2.6 per cent. The rest will come from the long-term growth in output per worker, which the IMF evidently thinks will be around 1.3 per cent, or a little less. This is below the 1.5 per cent Treasury assumed for its recent Intergenerational Report, and a little lower than the Australian experience of the ten years before the pandemic. It is pessimistic but consistent with what is happening in other wealthy economies.

According to this IMF forecast the forthcoming election will be fought in a brightly recovering economy, obscuring the likelihood that the growth of living standards will then fall significantly — and stay that way for many years to come. It will also be an economy in which both fiscal and monetary policy are on long-term tightening paths — that is, interest rates will slowly be increasing and the budget deficit will be narrowing as a share of GDP. Short of recession, the budget and interest rates won’t be deployed to stimulate growth.

When the serious electoral contest resumes in February, much of the debate will focus on spending, taxing and the deficit, and much on our energy future, China and so forth. But the economic issue that really matters for our future is unlikely to be debated at all. This is a pity because whether Josh Frydenberg is still in the job post-election or has been replaced by Labor’s Jim Chalmers, it will be among the priority long-term issues Treasury presents in its post-election briefings.

This issue is productivity, or output per worker. One reason productivity won’t be much debated in the run-up to the election is that it no longer fits into the contesting narratives around which elections are typically fought.

Over the two decades to 2020 productivity growth was slower than in the 1990s, contributing to slower output growth, slower growth in wages after inflation, and slower growth in living standards. Productivity gains account for most of the growth of after-inflation wages, and of living standards.

In its recent report the IMF staff looked closely at productivity and came up with some surprising results. It found the decline in both business investment spending and productivity in the years before the pandemic may be related to the increasing concentration ownership of Australian businesses, and the associated decline in competition.

The IMF recommends Australia spend more on encouraging research and development spending by business. It argues that investment in research and development is associated with faster gains in output per hour worked, and that Australia invests less than the average wealthy economy and very much less than the leading economies.

Similar points were made recently by Reserve Bank assistant governor Luci Ellis. In an appropriately tentative way she argued that the slowdown in productivity growth in Australia and other wealthy economies in recent years may have something to do with increasing concentration of business ownership.

In its Intergenerational Report Treasury argued that the slowdown in the growth of output per worker may be linked to the increasing share of output accounted for by sectors in which there are only three or four big producers who can make it difficult for new players to enter. It may also be related to a slow take-up of new digital technologies. “Declining dynamism” is evident, it said, impeding the flow of resources from less productive to more productive firms. “Australian firms appear to be slower to adopt world-leading technologies” with the result that “non-mining businesses in Australian have fallen further behind the global frontier firms and appear to be catching up more slowly.”

Hardly a whisper of this shift in thinking among economic advisers and policymakers reaches the general media or comes through in the election contest. For Australia’s economic future, however, it is becoming an issue too big to ignore. •

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Doshi makes much of what he describes as a “social science” approach to analysing China’s plans, drawing on Chinese Communist Party documents published over many decades. He cites documents identifying the United States as China’s principal opponent in world affairs, and others urging that China should “become a leading country in comprehensive national strength and international influence.”

China’s grand strategy, Doshi infers, is to replace the United States as the dominant world power and create a world order more congenial to its interests. I say infers because, on my reading and for all his effort, Doshi has not found a Chinese Communist Party leadership document that actually says so.

Let’s accept for a moment that China does indeed plan to supplant the United States as the dominant world power, and this intent can be ascertained by a reading of Communist Party documents. If true, what should the Americans do about it? What should Australia do about it? And can China achieve the global dominance Doshi says is its grand strategy?

Doshi recommends a strategy that (as he says) largely replicates China’s. China has blunted American naval power in its region by erecting missile defences, laying mines, deploying submarines and creating military facilities on islands. Doshi suggests the US counter-blunt by deploying carrier-based unmanned aircraft, hardening air and sea facilities on Okinawa to resist Chinese missiles, and developing greater mine-laying capacity to increase the cost of amphibious operations across the Taiwan Strait.

On the economic side, Doshi wants the United States to make it harder for Chinese businesses to acquire Western technologies. The United States should also crack down on China’s participation in US research projects. And he argues the United States should thwart China’s use of new multilateral institutions such as the Belt and Road Initiative and the Asian Infrastructure Development Bank by joining them and diluting Chinese control.

These suggestions would surely be unlikely to stop a truly determined China from ousting the United States as top dog, assuming that’s what it wants to do. Doshi’s is a program for a second-rate power to annoy a first-rate power.

If China really was planning to supplant the United States as the dominant global power, the most important part of the American response is not what Doshi suggests it do now, but what it has been doing for decades.

The United States spends three times as much on its military as China (and more than the combined total of the next twelve countries, China included). It has 750 military bases abroad in eighty countries, compared with China’s one (in Djibouti, jostling side by side with French, Italian, Japanese and US military bases). It has more than 5000 nuclear warheads to China’s 350. With its allies (Western Europe, Japan, Korea, Australia, and so on), it has long banned weapons sales to China and long maintained a policy of doing what it can to keep China one or two techno-generations behind the leaders. The United States has formal military alliances with many powerful countries; China has none.

By contrast with what the United States already does, the striking thing about Doshi’s program is its marginality. It is an implicit recognition that China’s size, success, strategic gains and integration in the global economy cannot now be undone. It cannot be bombed, invaded or disarmed — or not without the corresponding destruction of the United States. China’s biggest “blunting” of US strategic advantages occurred sixty years ago when it developed nuclear weapons.

China could conceivably be isolated economically through import and export bans and financial sanctions. But America can’t do that alone, and who else would support it? The disruption to the world economy doesn’t bear thinking about. China is now one-tenth of the global economy. It is the world’s biggest exporter of goods and services. Its household consumer market is considerably smaller than that of the United States, but much bigger than any other country’s.

Decoupling? Rightly, Doshi doesn’t recommend it. Last year US goods exports to China were higher than they had ever been, 2017 excepted. So far this year US goods exports to China are even higher than over the same period last year. While foreign direct investment around the world tumbled last year, foreign direct investment in China actually rose.

And is China’s threat to the world order one that now requires a novel response? China’s rise relative to the United States won’t continue inexorably. At market exchange rates China’s GDP is two-thirds of the United States’ GDP. It may well surpass the United States in economic size in a decade or two, though it may not. With all its troubles the US economy has done quite well overall, while China’s “miracle economy” phase is long over. Its workforce is declining, and productivity gains are harder to find. By the time it matches the United States in economic weight its growth rate will highly likely have slipped towards that of the United States. They will be roughly evenly matched in economic weight and in growth rate. China’s income per head will be one-quarter of the United States’.

Doshi has gone to immense trouble to collect and translate documents. But it should surely come as no surprise that China finds US global dominance unsatisfactory. This is how great powers behave, and always have. Whether or not China has a grand strategy, we can infer from its conduct that it seeks to exert its weight in regional and world affairs. It would be a historical exception if it did not. No surprise either that this pressure should grate against America, the current top dog.

Yet given that China’s immense economic success has occurred within what Doshi describes as the US-led liberal world order, and given it is very heavily invested in a world economy not unlike the one we have today, is a fundamental change in the global order in China’s interests? If an American-led world order exists, is not China its greatest economic success? •

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But before we look at the criticisms of the RBA, it’s worth considering a few points about what has happened since I left.

Whatever might be alleged about the RBA’s caution in the decade to 2020, it has undoubtedly been very bold since then. At the end of last month it held almost $251 billion in Australian government bonds — a little under a third of their entire value, and eighteen times the value of those it held just before the coronavirus struck. In the first sixteen months of the pandemic, the RBA bought bonds equal to 70 per cent of the vast federal government deficit created by the pandemic. Among other actions, it also set the overnight cash rate at practically zero.

The Reserve Bank’s boldness was matched by that of the federal government. Even now, emerging from the pandemic, the federal budget deficit is the second-highest on record, exceeded only by last year’s. Before the pandemic Treasury expected the budget to be in surplus by now; on its latest projections, we will still be in deficit forty years hence.

But the revolutionary expansions, fiscal and monetary, are over now. Year by year the federal budget deficit will be reduced as a share of GDP. Year by year interest rates will go up. Tightening will be the backdrop of the economy and the political contest.

The tightening has already begun. The Reserve Bank has rightly given up on its attempt to hold the three-year bond rate steady. At its February meeting the board is likely to agree to phase out bond buying. When it comes, the next interest rate move will be up. This year’s projected budget deficit, meanwhile, is less than last year’s, and the figure is projected to fall each year over the next three financial years. By 2023–24, with spending cut by 1.4 per cent of GDP and taxes rising by a bit over 1 per cent of GDP, the deficit is projected to be half the share of GDP it is today.

But the vast household savings accumulated over the pandemic — savings we are now spending — mean we probably won’t feel the tightening for quite a while. Borrowing rates are so low compared with what we became used to before the pandemic that it will be a while before the contraction bites.

During the pandemic monetary and fiscal policy became far more closely connected. When both monetary policy and fiscal policy are tightened over a long period, there is a serious risk of miscalculation. The Reserve Bank needs to know what fiscal moves the government plans, and the government needs to know what the RBA plans.

If monetary and fiscal policy will be contractionary for some time, we need to think about other ways of lifting living standards. Increases in productivity — in output per hour of work — ultimately determine most of that rise, and on this measure Australia was already slowing, as were most wealthy economies. The big question is what we can do to speed it up.

But what of the years 2011–16, when I was a participant, like all other members of the board, in the RBA’s decisions on monetary policy? This was a period when the unemployment rate rose, and inflation — while mostly within the target band of 2 to 3 per cent — was generally closer to the bottom of the band than the top. An inquiry might well conclude that interest rates could have been lower without risk of serious inflation, and employment and GDP accordingly higher.

But critics sometimes overlook the fact that we were cutting interest rates throughout that period from 2011 to 2016, and quite vigorously. The cash rate was 4.75 per cent in June 2011. By July 2016 it was 1.75 per cent. That’s a pretty big cut. At 1.75 per cent, the cash rate in the middle of 2016 was lower than it had ever been.

Most of the time those rate cut decisions were sharply criticised. The Australian Financial Review was usually unhappy, arguing that tax and industrial relations changes were needed instead. The cuts generally went against the public advice of a “shadow” board of academics and others claiming expertise in monetary policy. The RBA cut a lot faster and deeper than most outside commentators expected, or preferred.

Nor were the cuts without effect. Mining investment was falling dramatically as projects were completed, and interest rate cuts in Australia couldn’t change the plans of global mining businesses. But what monetary policy could do, it did. The Australian dollar’s exchange value tumbled. Exports did well. Housing construction boomed. Household consumption growth remained firm. Overall, GDP growth averaged only a little under 3 per cent.

It is true there were no further rate cuts between August 2016 and May 2019, a nearly three-year period. But it is also true that the cash rate, by then 1.5 per cent, was the lowest on record. When output growth slowed into 2019 the RBA resumed cutting rates. By the end of 2019 the cash rate was just 0.75 per cent.

With perfect foresight the RBA might have cut a bit faster. But surely the main point is that in the circumstances of those years monetary policy could never be quite as effective as some of the bank’s critics — internal and external — believed.

An inquiry could be interesting. But it is hardly relevant to where we are now. What does deserve examining is what is happening to productivity. This is an issue about which we don’t know enough — not the RBA, not Treasury and not the Productivity Commission. A conference of local and international experts would be a good place to start. Productivity is the most important question for our future, not the pace of interest rate cuts before the pandemic. •

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The striking conclusion is that we can get by, and quite well. This is despite net Australian government debt doubling since the pandemic, and despite deficits projected to add to net debt for the entire forty-year projection period to 2060–61. On the assumptions used in the report, Australian living standards measured as real income per head will be twice as high in forty years as they are today. We will be able to pay for sharply increasing health and aged care costs, for the projected cost of other current spending programs, for aged pensions and superannuation tax concessions and for increased defence spending, and yet end up with a net Australian government debt-to-GDP ratio markedly lower in forty years than it will be over the next few years.

We will be able to do all that with a ratio of taxes to GDP that doesn’t rise above a ceiling of 23.9 per cent — significantly lower than the average of the years when Peter Costello was treasurer. We can do it despite an ageing population, despite slowing population growth, despite a fall in the worker-to-population ratio and the workforce participation rate, despite an assumption that net migration is brought back up to pre-pandemic levels but is then capped, and despite a marked increase in the interest rate on government borrowing.

And while we face deficits for decades, the IGR numbers also show that if government spending is cut by 1 per cent of GDP from the share it will otherwise reach by 2061, while the revenue ceiling is raised to a tax share of 24.9 per cent from 23.9 per cent, the deficit disappears. Changes of that magnitude have been frequent in Australia’s fiscal history over the last four decades. It is a choice, but not one with significant economic consequence.

The remarkable significance of this report is that it officially frees Australia of the politics of debt obsession. It clearly isolates Australia’s long-term economic challenge not as government debt, not as rising healthcare or aged care costs, not as a growing tax burden, and not as an ageing population and slower population growth. We can cope with these. The outstandingly crucial issue, it shows, is the growth of productivity, or output per hour worked. In this report Treasury has shifted the fundamental economic debate from spending and taxation to productivity.

It has shifted the debate — and not just to productivity itself. The IGR also contributes to a wider discussion of the causes of the slowdown in productivity evident over the past few decades, not only in Australia but also in most other advanced economies.

Most of the productivity discussion in Australia in recent years has been about industrial relations and changes in the tax mix, a stale argument that is really more about shares of the pie than its size. More recently it has been argued that the productivity slowdown reflects insufficient investment. The IGR knocks that argument on the head. The slowdown in output per worker, it argues, is not because of insufficient investment but because of a decline in the growth of the efficiency with which labour and capital are used, or “multifactor productivity.”

The causes, the report speculates, may well include the increasing share of the workforce in services, the increasing share of output accounted for by sectors in which three or four big producers can make it difficult for new players to enter, and a slow take-up of new digital technologies. The report argues there is evidence of “declining dynamism” in industries, impeding the flow of resources from less productive to more productive firms. There’s evidence, too, that “Australian firms appear to be slower to adopt world-leading technologies,” with the result that “non-mining businesses in Australian have fallen further behind the global frontier firms and appear to be catching up more slowly.”

To the extent this is true, many of the members of the Business Council of Australia now posing as the hampered victims of governments cowed by “reform fatigue” are themselves the source of the productivity slowdown of which they complain. Once productivity as opposed to spending and revenue is isolated as the major economic issue, it becomes a widely shared responsibility.

It is quite true that the IGR’s ruling assumption of average productivity growth (and thus growth in living standards) of 1.5 per cent a year for forty years is right at the top of plausible outcomes. The GDP forecast of 2.6 per cent is accordingly also at the top of the range. The productivity assumption is rationalised as a projection of the average outcome over the last thirty years. But it can also be thought of as a target. If it can be achieved — and the IGR is candid enough not to assure us it will be, or to confidently tell us how it could be — Australia has a bright economic future.

If productivity growth remains markedly less than 1.5 per cent a year on average, though, the expected outcomes begin to deteriorate. If productivity growth averaged 1.2 per cent, the IGR shows, the deficit in forty years would be twice as high as a share of GDP than it would be with 1.5 per cent productivity growth, debt would be significantly higher, and real GDP nearly 10 per cent less. If this IGR succeeds in shifting the political debate to how to achieve productivity growth of 1.5 per cent, year after year, it will have done great service. •

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Abrupt, frightening, savage — but also short and unexpectedly shallow. It was a deliberate recession, one brought about by government and by people’s fear of infection, and yet important parts of the Australian economy kept working. Mining and farming continued. So did manufacturing and major construction work. Electricity, gas and water utilities kept operating. Public servants were still working, often at home. Tradespeople, cleaners and gardeners were working more often than not. Most health workers remained on the job, busier than ever. Schools and childcare facilities remained open in most places, continuing to employ their staff. Office workers found that new technologies enabled them to work as productively from home. Media staff struggled to keep up with the demand for news and entertainment.

It may have been the case that many service workers who remained in jobs couldn’t produce as much as before. Yet so long as they were paid, they could sustain their usual spending and were counted in Australia’s total output. All up, and notwithstanding that Australia was often reported to be in “lockdown,” most of the Australian workforce kept working, either from their usual place of work or from home.

The economic collapse, such as it was, centred on discretionary retail such as clothing and furniture, local and foreign travel, and sports, entertainment and the arts. When the numbers for the three months ending June 2020 were published, they revealed that the big drop in GDP for that quarter was almost entirely caused by a fall in household consumption spending. There was a correspondingly huge increase in household savings. Government payments meant that income was actually up in the quarter. The fall in consumption — and the corresponding fall in output in industries including food services, medical services, transport, sports and recreation, administrative services and so forth — was not the result of a financial crisis, or a turn in the business cycle, or the failure of an export market, or any of the usual causes of recession. It was due, as the Australian Bureau of Statistics remarked, to “movement restrictions” in response to the pandemic.

Australia’s extraordinary three-decade economic expansion was over. Yet compared with the countries to which it usually likens itself, Australia had a good pandemic. When the rich countries’ international economic agency, the OECD, published its forecasts in June 2020, it expected Australia to experience a milder economic contraction over 2020 than any of the OECD’s thirty-seven members except South Korea. At 5 per cent, the expected shrinkage was less than half that forecast for Britain, a little over half that forecast for the eurozone, and less than those forecast for the United States, Germany and Canada.

When it met via video conference on 2 June 2020, the Reserve Bank board agreed that it was “possible that the downturn would be shallower than earlier expected.” So it would be. When it published a new set of forecasts on 6 November 2020, the expected peak unemployment rate was down to 8 per cent in the fourth quarter, thence falling gradually to 6 per cent two years later. What these figures revealed was that the Reserve Bank believed Australia’s annual GDP at the end of 2021 would be about the same as at the end of 2019. Soon enough, that forecast too proved pessimistic.

Although that was a more cheerful scenario than the earlier forecasts, the great economic cost of the pandemic wasn’t in doubt. Even with good recovery, Australia would have lost perhaps 6 per cent of GDP by the end of 2021 — the amount by which it may well have risen without the pandemic. Measured as real GDP per head, living standards at the end of 2021 would still be below the level reached at the end of 2019. Employment would be considerably higher than it had been at the end of 2020, but probably still a little lower than at the end of 2019. Unemployment at the end of 2021 could still be around 6 per cent of the workforce, or more than 900,000 people. And by then, Australian government debt would be beyond what anyone could have imagined as the bushfires raged through southeastern Australia two years earlier.

The full recovery of the Australian economy would depend partly on the global economy, many parts of which were in dire trouble. After a precipitous decline in the first three months of 2020, production had resumed growing in China, though it was far from the level projected before coronavirus. Japan, South Korea, Taiwan and Singapore had also gone back to work, but with many areas of activity still disrupted and intermittent episodes of reinfection. Jobs and output had dropped vertiginously in Spain, Italy and France and were only slowly recovering. The east and west coasts of the United States, the location of much of its industry, were still grappling with the aftermath of an epidemic far more severe than China’s.

Governments lifted their spending without much argument or political dispute. In advanced economies, the increase in government discretionary expenditure by October 2020 was just short of a tenth of GDP. The various forms of liquidity support — emergency loans, bank funding facilities and so forth — totalled another tenth of GDP. In January 2019, US current government spending was a third of GDP; less than eighteen months later it had risen to over half. The US federal government deficit was a little under US$1 trillion in 2019; the Congressional Budget Office expected it to be three times higher, at more than US$3 trillion in 2020.

Like the health impact, the economic impact of the pandemic didn’t spread as expected. The greatest damage was not in China, where it had begun, or in the poor countries of Africa. It hit hard in wealthy countries, and particularly in America, Britain and Western Europe, where the health damage was also greatest.

But the most unexpected economic aspect of the pandemic was that its impact was not as great or as enduring as first feared. In many wealthy countries, output collapsed in the second quarter of 2020 but was recovering by the third quarter. Income support sustained sales to households, often by package delivery. In the United States, retail sales from June 2020 were way above pre-pandemic levels despite new Covid-19 cases running at three times the level reached in April, when economic activity had plunged.

Even as Donald Trump fell behind Joe Biden in vote counting in the crucial state of Pennsylvania, the Bureau of Labor Statistics reported that the United States had added 638,000 jobs in October 2020, the sixth straight monthly increase. Of the twenty-two million jobs lost in March and April, half had been regained. Even so, US output in the fourth quarter of 2020 was expected to be markedly lower than in the fourth quarter of 2019. At 10.7 million, the number of workers without jobs in the United States in November 2020 was nearly double the total in February.

In China, output plummeted by nearly 7 per cent in the first quarter of 2020 compared with the first quarter of 2019. But output was growing again by the second quarter, and that continued in the following quarters. Both exports and imports swiftly increased. China’s economy, the International Monetary Fund predicted in October 2020, would be among the few to achieve growth over 2020 as a whole. Its recovery was strong enough, warned the Financial Times in late November, to put at risk China’s carbon reduction targets.

By the end of 2020 it was evident that, with a few exceptions, East Asia had handled the pandemic better than most other regions, and the economic growth gap between East Asia and the rest had widened. For Australia, which exports predominantly to East Asia, that mattered. Despite the impact of travel bans on foreign students and tourists, Australian exports were less affected than earlier feared. By November 2020, goods exports were down just 4 per cent on a year earlier.

By October, the IMF assessed that the global economic impact had been very bad indeed, but not as bad as earlier expected. The forecasts, while still bleak, had also improved. The United States and Europe had been stronger than expected and global trade was recovering faster than expected, especially China’s trade.

Even so, on IMF projections, the difference between the increase in global output in 2019 and the fall in 2020 would be equivalent to a global loss of output of around US$6 trillion, or more than three times the total annual output of an economy the size of Australia’s. Global trade was expected to fall 10 per cent in 2020. Comparing the second quarter of 2020 with the fourth quarter of 2019, the International Labour Organization calculated that the world economy had lost the equivalent of 400 million full-time jobs, disproportionately among women, low-wage earners and young people.

The cost to government budgets was also huge. In the fiscal year ending 30 September 2020, the US budget deficit tripled to US$3.1 trillion — more than 16 per cent of GDP. Spending increased 47 per cent over the previous year. US federal government debt to GDP ratio rose to over 100 per cent, and kept going up. The IMF expects 2020–21 budget deficits of one-fifth of GDP in Canada and the United States, a twelfth in China, and a tenth in Australia.

Australia’s post-pandemic circumstances are in some respects typical of all countries recovering from the pandemic, and in some respects atypical.

The economy was growing again. After output fell by 7 per cent in the second quarter of 2020, it rose 3 per cent in the third quarter. Output was then only 4 per cent lower than before the pandemic, in the December quarter of 2019. With a strong fourth quarter in 2020 and again in the first quarter of 2021, Australia might find that by mid 2021 output has returned to the pre-pandemic level — six months ahead of the Reserve Bank’s estimate last November.

Yet almost a million people were still out of work, and many of them will remain unemployed for a long time. With employment growing more slowly than output, it could be towards the end of 2021 before the number of jobs was back to where it was in December 2019 —leaving 700,000 people, or 5 per cent of the workforce, searching for jobs. Meanwhile, many new jobseekers will have joined the search.

In the first sustained fall in living standards most Australians have ever experienced, average real income per person (as opposed to the national total) will probably not regain the level of 2019 until 2022. After increasing rapidly since 1991, household wealth slipped in the first half of 2020 — though those losses have since been mostly recouped with resilient home prices and rebounding share prices.

If all goes well, the additional debt can be managed over the decades to come. Because ultra-low interest rates are expected to continue well into the future, the October 2020 budget projected the net cost of Commonwealth debt as a share of GDP to decline slightly, even though the amount of debt was increasing. Nor will the interest cost be large: just 0.9 per cent of GDP even for 2020–21, and 0.8 per cent of GDP by 2023–24.

But those figures are perhaps a little misleading. Before the pandemic, the interest the Australian government paid to its debtors was around 4 per cent. During the pandemic, the ten-year rate fell dramatically, allowing the government to refinance its debt at much lower interest rates while locking in a decade of low rates for the bulge in new debt between 2019–20 and 2023–24. Largely as a result, the government’s net interest payments, both as a dollar amount and as a share of GDP, were higher in 2018–19 (when debt was much smaller) than they are expected to be in any of the four years from 2020–21 to 2023–24.

The government bond rate will almost certainly increase over this decade, but borrowing costs will only rise sometime later. Treasury projects net interest payments to decline as a share of GDP in 2030–31 compared to 2020–21, despite net debt rising by nearly 8 per cent of GDP — and despite its projection that the bond rate will rise to 5 per cent in the next decade. Because it ends in 2030–31, Treasury’s projection doesn’t take account of the impact of gradually refinancing much higher debt during the next decade at an interest rate five times higher than the rate in this decade. The most constraining impact of the 2020 pandemic may not hit the Australian government for another ten years.

Timing the reduction of deficits and the control of debt will require good judgement. Although treasurer Josh Frydenberg says the federal government won’t try to stabilise the growth of debt until unemployment is comfortably under 6 per cent, the scenario offered in his October 2020 budget was quite different. On Reserve Bank forecasts, unemployment won’t drop to 6 per cent until the end of 2022, yet Treasury forecasts the budget deficit falling to 4 per cent in 2022–23. Well before unemployment falls to 6 per cent, in other words, the budget will have turned contractionary. And it will continue to be contractionary, with the deficit projected to fall to 3 per cent of GDP in 2023–24. That, at least, is the plan.

Treasury projects a relatively small increase in tax revenue over the four years from 2020–21 to 2023–24, the result of bringing forward personal income tax cuts and business investment write-offs. To reach the deficit target of 3 per cent of GDP in 2023–24, spending will have to fall by 8 per cent of GDP — a cut of a magnitude not evident in half a century of data. Treasury assumes that the private economy will come back strongly and quickly enough to replace the government stimulus.

It is true that the net debt-to-GDP ratio continues to increase over this period (peaking in 2023–24), but that is because the starting-point deficit is so big, not because it is being reduced slowly. The treasurer and Treasury have suggested the government’s policy may need to be adjusted, depending on the strength of the recovery. The projected settings underline just how much skilled judgement will be involved in fiscal policy over this decade.

Managing debt will preoccupy Australian governments for years to come, though it’s important to remember that the Commonwealth’s net debt, at 38.3 per cent of GDP in 2030–31, will still be far lower compared with the size of the economy than that of Japan, the United States, most of Western Europe and Britain.

The initial political battleground will be unemployment — and especially the speed with which Australia can be expected to reach the Reserve Bank’s new informal target of 4.5 per cent unemployment — and how to pay for reducing the deficit. Growth, and the automatic rise in tax revenue that results, will help. The Reserve Bank will help by keeping the government bond rate lower than it would otherwise be and by continuing to buy a share of additional government bonds. But there will also be pressure to raise tax revenue where it will have the least impact on current demand. As the IMF now argues, that might well include higher taxes on high incomes, capital gains and wealth. •

This is an edited extract from an new Lowy Institute paper, Reconstruction: Australia After COVID, published this month by Penguin.

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Creating a regional anti-China coalition may be in America’s interest, and the Biden administration, like its predecessors, certainly thinks of China as America’s number one strategic competitor. But it is not necessarily in Australia’s interest. China’s continuing economic success is good for Australia; policies designed to obstruct that success are not. If America succeeds in hindering China’s technological progress, for example, one of the losers will be Australia.

This is not just because more than a third of Australia’s goods exports go to China. It is largely because China accounts for a little more than half the output of the entire East Asia and Pacific region. It is by far the largest economy in a highly integrated economic region of which Australia is a part, a region that accounts for three-quarters of Australia’s goods exports and nearly two-thirds of its goods imports. In Australian planning, China’s regional predominance should be assumed to persist and perhaps increase. It will continue to be the indispensable economic partner for most countries in the region, including Australia. This is the region in which Australia finds itself, now and forever.

In the Trump administration’s trade war, prime minister Scott Morrison declared Australia a neutral. Since the president wasn’t keenly seeking Australia’s support, that position was uncontroversial. With the new administration, neutrality is unlikely to be enough.

The best guide to the Biden administration’s approach to China was made public by its top Indo-Pacific official, Kurt Campbell, in early January. In a co-authored Foreign Affairs piece, Campbell wrote that China’s deployment of new weaponry (and the creation of weapons platforms in the South China Sea) increases the vulnerability of US aircraft carriers near China’s coasts. The US needs instead to deploy more long-range conventional missiles, unmanned aircraft, submarines and high-speed strike weapons.

In deploying these weapons, Campbell writes, the US should work with regional allies to disperse US forces around the region. This ambition fits well with Australia’s long-range submarines program and willingness to host American military facilities. At the same time, Campbell suggests, military deterrence of China should be enhanced by expanding defence arrangements between the US, Japan, Australia and India — the “Quad.”

But military arrangements will not be enough. Campbell believes the US should join or initiate China-related discussions among its friends in relation to “supply chains, investment regimes, and trade agreements.” He assumes the US will continue its “managed decoupling” from China. Tellingly, he complains of the recent EU–China investment agreement because it will “complicate a unified transatlantic approach under the Biden administration.” Separate negotiations between American allies and China will evidently be discouraged.

A “unified” approach to China by Europe and America will be complemented by a wider coalition, including Asian regional partners. Campbell favourably instances the D-10, proposed by Britain, which would include the G7 of big rich democracies plus Australia, India and South Korea. These coalitions, writes Campbell, “will be most urgent for questions of trade, technology, supply chains, and standards.” Under this proposal, Australia would be a member of a regional coalition whose members will presumably be discouraged by the Americans from making bilateral deals with China.

Australia will have no problem with joining discussions about China, sharing information or even attempting to agree a common list of complaints. But there is every problem with a joint negotiation with China, which is what Campbell appears to want. Such negotiations would inevitably be under US leadership, and pursue US priorities. Australia could find itself pressing China to open up to Alphabet, Amazon and Facebook, while at the same time complaining that these corporations pay little tax on their Australian revenues, have too much market power, and retain vast quantities of information about Australians. It could find itself pressing for a freely floating renminbi and a complete deregulation of China’s financial system, though Australian regulators may have strong reservations about both. It could find itself part of a coalition to retard China’s advanced industries, an objective directly contrary to Australian economic interests.

Other than the emphasis on coalitions instead of unilateral action, the Biden administration’s approach is similar to his predecessor’s. In a National Security Council document declassified and released as the Trump administration was leaving office, the US was determined to “maintain US strategic primacy in the Indo-Pacific region and promote a liberal economic order while preventing China from establishing new, illiberal spheres of influence and cultivating areas of cooperation to promote regional peace and prosperity.” The Biden administration would no doubt agree.

The document also asserted that China “seeks to dominate cutting-edge technologies, including artificial intelligence and bio-genetics, and harness them in the service of authoritarianism. Chinese dominance in these technologies would pose profound challenges to free societies.” Again, the Biden administration probably has the same view. Matthew Pottinger, who wrote the document when he was on staff at the National Security Council, wanted to “strengthen the capabilities and will of regional allies,” including Australia. The aim was to “align our Indo-Pacific strategy with those of Australia, India and Japan.” Campbell says much the same.

The Biden administration’s resolve to create anti-China coalitions coincides with a low point in Australia’s bilateral relationship with China. Before the pandemic, the increasing antagonism between America and China bothered Australia, though it was way beyond Australia’s capacity to influence. It threatened to change the global economy in a way we might find inimical to our interests. By contrast, the recent direct antagonism between Australia and China poses problems of much greater immediacy and severity.

These are problems only Australia and China can deal with. They are beyond spin, beyond culture wars, beyond the help of great friends. Resolving them depends almost entirely on us, and on the professionalism, skill and judgement of the Australian government and its advisers. They could well be the gravest problems the Australians involved have ever met, or are likely to meet. They may influence Australia’s destiny for decades. This is a test of the seriousness of purpose and the quality of Australia’s political leadership. Incidental to others, it is central to us.

Geoff Raby’s insightful new book is directly pertinent to these acute difficulties in Australian foreign policy. Raby, a former Australian ambassador to China, is a longstanding critic of the drift in Australian attitudes towards China. “Australia’s policy of the past four years, of joining the US in competition with China,” he announces, “has been a strategic miscalculation” damaging to Australia not only in China but also in the region. Australia “will be taken less seriously and be less respected by regional partners,” he argues, “if it is not able to manage its relations with China.”

Though his title promises to explain China’s “grand strategy” and Australia’s future in the “new global order,” Raby is too experienced, too worldly-wise, too much of a realist, to believe that China has acquired a grand strategy very different from the old, or that a “new” global order has actually emerged.

He discusses in some detail the Belt and Road Initiative, which is often supposed to be the key component in China’s program to create a new global order. He points out that its achievements so far have not contributed much to China’s security. It is certainly an expensive initiative, one taken very seriously by Beijing, one that has on the whole been helpful to the recipient countries, but it has not augmented China’s power, either soft or hard, and it has not created a new world order. Nor is it likely to.

What has changed is that brief period of American hegemony following the collapse of the Soviet Union, which ended with the disaster of the second invasion of Iraq, the concurrent rise of China, and the shattering of America’s domestic political consensus on the rocks of extreme and widening inequality. The world has become multipolar once again — with two leading powers competing for the fidelity of the rest.

In Raby’s account, China’s grand strategy is conditioned today, as ever, by neighbouring and regional powers that have sometimes been enemies and sometimes friends, all of them formidable. Russia, India and Japan are the biggest of them, and among smaller neighbours China has also been in fights with Vietnam, Taiwan and South Korea.

Another enduring element of China’s grand strategy, as Raby points out, has been sustaining its territorial unity. It has long had to deal with separatist forces in Xingjian, in the Tibetan regions of southwest China, in Hong Kong and of course in Taiwan. When these imperatives are provisioned, China has little left over for exerting force beyond its own region. Thus, says Raby, China is unlikely to become a “regional hegemon” or pose “any threat to Australia’s security.”

The Biden administration not only wants to sustain the Quad as an alliance to contain China. It also wants to expand it, presumably by adding South Korea. Raby’s chapter on the Quad group is particularly pertinent and illuminating. Its explication requires the kind of analytic skills Raby has developed in his diplomatic career — undogmatic, attuned to nuance and informed by an understanding of each party’s interests and intentions. Though presented by Canberra as a dialogue among Indo-Pacific democracies, the Quad doesn’t include South Korea and the Southeast Asian democracies. It is clearly intended — at least by Australia and the US — as a military formation directed against China. Indeed, this is the way it was described by former US secretary of state Mike Pompeo.

As Raby points out, the Quad’s military value to its participants is in fact very limited. India and Japan have distinct issues with China that often do not overlap with the interests of other members. And while the US, India and Japan are formidable military powers, Australia is not. What the Quad represents, Raby suggests, is an attempt by the US and perhaps Japan to draw India into a military understanding against China. As a nuclear weapons state with a large army and a formidable navy, India doesn’t need this understanding, and probably neither wants nor would reliably abide by it. Australia’s eager support for the Quad alienates China but gathers no redeeming security advantage.

More than three years have passed since China permitted high-level contact with Australia. Over the past year it has imposed penalties on Australian exports of barley, wine, beef, coal and wheat — penalties usually ascribed to Australia’s March 2020 advocacy of an independent inquiry into the Chinese origins of the pandemic. In fact, they are more probably related to Australia’s prominent public role in not only refusing Huawei access to Australia’s telecommunications market but also advocating that Britain, India, Europe and for that matter the United States also exclude the company.

To a realist like Raby, no simple or easy response exists to Australia’s China problem, or its companion US problem. Australia cannot and will not abandon its future in a region economically dominated by China. Nor will it abandon its long security relationship with the US. Indeed, both a strong economic relationship with China and a strong security relationship with the US suit Australia well. The same combination suits South Korea, Japan and much of Southeast Asia. The policy job is to sustain the relationships when they are in conflict.

To that end, Raby offers a series of sensible principles to guide Australia’s response. Rather than being a flag-waver for the US, Australia should work harder on coalitions with like-minded regional countries — including Japan, Korea and especially governments in Southeast Asia — to clear a path between the competing pressures of the two great powers. It should be guided by a clear-headed identification of national interest rather than traditional links or kinship with the US, or humanitarian impulses or cultural affinities. Foreign policy should be carried out with discipline and professionalism, premised on a recognition that Australia’s interests are different from those of the US and China. It is not a novel agenda and not an easy one, but of those on offer it is the one that may work. •

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It amounts to a case that the growth slowdown in the US economy in recent years, and perhaps the slowdown in other advanced economies like Australia’s, reflects a slowdown not in demand but in supply. Specifically, a slowdown in the growth of labour and capital, and a parallel slowdown in productivity growth. Vollrath argues these slowdowns are pretty well inevitable and arise from success, not failure. If he is right then it doesn’t matter much what central banks or governments did or didn’t do because the slowdown would have happened anyway.

His case can be summed up in a few straightforward propositions.

The first is that output per head in America has grown more slowly on average in the twenty-first century, compared with the preceding twenty years.

The second is that a surprisingly large share of the slowdown is due to a slowdown in the growth of the quantity and quality of the workforce, or “human capital.”

The third is that the diminished contribution from human capital to per capita income growth can be thought of as an American success. Because they are richer, Americans have fewer children, and because their health is so good they live longer.

With fewer children, the rate of growth of the workforce has slowed. And with longer lives come more old people who consume but don’t work and therefore drag on income growth per head.

Part of the slowdown in human capital growth also reflects the fading influence of earlier successes. There is only so much formal education people need for their jobs, and Americans today are much closer to that frontier than Americans of a couple of generations ago. The rate of increase of education levels and of experience in the workforce has slowed, so the quality of workers is not improving as rapidly as it did before.

Women joined the workforce in a big way in earlier decades. This was partly because machines lightened household work, and partly because of birth control, which allowed women to choose how many children they had, and when. That trend, another success, has now crested.

Compared with the slowing contribution from human capital, Vollrath finds the change in the contribution from physical capital to be less significant — not least because the slowdown in physical capital growth started long before the twenty-first century.

Yet Vollrath accepts that not all of the slowing growth in output is the result of a slowing contribution from labour. The change in output that is not attributable to either human capital or physical capital is what we call “productivity.” That, too, has slowed. Vollrath argues that the slowdown in productivity growth reflects the increasing share of services in the economy, and services in the United States have lower productivity growth than manufacturing. The expansion of services, he argues, is largely because of the fall in the price of manufacturing, which frees up income to buy services. The expansion of the services sector and the associated slowdown in productivity growth is thus another instance of American success.

Part of the interest of this “growth accounting” approach is that by implication it queries other explanations for slower per head income growth in the United States. It implicitly rejects explanations based on insufficient demand, such as “secular stagnation,” or a claimed tendency for intended saving to be higher than intended investment. The slowdown can’t be blamed on excessive debt, China or globalisation.

Using the same techniques of simple quantification, Vollrath shows that while the expansion of government activities may or may not have hindered growth, the overall impact is probably very small. So, too, the increase in corporate market power in the United States may have increased output growth or lowered it, but either way not significantly. Though it is often said (and in Australia as much as in the United States) that an increase in research and development spending would increase productivity, Vollrath shows that research and development spending has increased but productivity has not.

There is a lot to reflect on in Vollrath’s approach, though to my mind it is a little too dependent on long-term averages. The slowdown of GDP per head from 2000, for example, is demonstrated by changes over ten-year periods converted to annual growth rates. The effect is to smooth the GDP per head data and produce what appears to be a clear turning point at the beginning of the twenty-first century.

In the annual data, however, we can observe the impact of the recession of 2000–01, from which the United States then recovered. Later we see the huge impact of the 2008–09 recession on real income growth per head, from which the United States has again recovered. Together these slumps go some way to explaining the downturn in trend growth of income per capita, yet they are demand- rather than supply-driven changes. This is the typical problem of a growth accounting approach. It needs long periods and smooth data, but the longer the period being smoothed, the more information is lost.

Nor can the slowdown be described as “stagnation,” though this is what his title suggests. Using World Bank constant US dollar data, GDP per head in the United States increased 22 per cent between 2000 and 2018. That is not as good as the 58 per cent increase in the eighteen years to 2000, but it is far from stagnation.

Vollrath treats the decline in the contribution of human capital as a major success for the United States but doesn’t deal with an obvious signal of unsuccess. From 2000 to 2020, the period he examines, the participation of Americans aged fifteen to sixty-four in the workforce fell by over four percentage points.

Had participation remained at the 2000 share, the US workforce would now be 5 per cent bigger than it is and the contribution of human capital correspondingly higher. Far from signalling success, some of the fall in the participation rate more likely signals a failure to equip workers no longer employed in manufacturing for other jobs. Some also reflects the lingering impact of recessions in discouraging workforce participation.

These criticisms aside, Vollrath sets up a clear framework and expounds it lucidly. While the analytic approach is useful in looking at the Australian experience over the twenty-first century, the American pattern is not replicated here. Australian per capita income growth (in constant Australian dollars) has exceeded America’s over the last twenty years. Per capita income growth has certainly slowed in recent years, but a slowdown in human capital growth doesn’t seem to be an important cause.

Participation in the Australian workforce has risen to a historic high, as has the ratio of employment to population. On Australian Bureau of Statistics numbers, the quality of the workforce has continued to improve. While the unemployment rate is higher than in the United States, overall hours worked have continued to increase firmly (until the virus struck).

Australian growth has been far more affected by a slowdown in investment (and the associated slowdown in the rate of growth of capital stock) and by a slowdown or stagnation in productivity growth. But the latter doesn’t appear to be caused by increasing output of services. Vollrath reminds us of useful ways of analysing our own problems, but they are not America’s and America’s are not ours. •

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Curtin wanted exactly what the Reserve Bank of Australia and the Morrison government are now doing in response to the coronavirus pandemic. He was way ahead of his time. Only Ted Theodore, the first Scullin government treasurer, shared his understanding of the Depression, but he had been forced from office by a mining scandal at the critical time. Neither Scullin’s Labor government nor the opposition-controlled Senate would accept Curtin’s views, though a devaluation could hardly be resisted, and budget deficits proved hard to contain.

After nearly a century Curtin’s views have become orthodoxy, but we have yet to acknowledge one element of his thinking. During the Great Depression he frequently made the point that conservative governments (which in his mind included the Scullin government) refused to adopt during peacetime slumps the policies they readily adopted in war. They would spend on armies and weapons, and borrow to do so, but not on dams, roads and bridges during slumps. As leader of the opposition from late 1935 he continued making the same point. It was remarkable, he told the House, how the Lyons and Menzies governments, stern upholders of financial orthodoxy, were spending vast amounts on armaments as war with Germany approached and cheerfully running up debt to do so.

It was this insight, widely shared, that informed the full employment white paper and postwar planning during Curtin’s wartime prime ministership. It was the same elsewhere. Clement Atlee’s postwar Labour government in Britain; the Marshall Plan under US president Harry Truman and the national highways program under his successor Dwight Eisenhower; the vast state-driven national reconstruction programs in France, Germany and Japan — all these maintained the wartime mobilisation of resources into the subsequent peace. As a result, the world averted the kind of global slump that had followed the end of the Great War.

The contrast Curtin pointed to back then is analogous to the policy choice Australia will soon face. Prepared to spend stupendously vast sums on what it perceives to be a “war” on the virus, will the Morrison government maintain an expansionary policy in the more normal but fragile economic circumstances to follow? Prepared to buy any quantity of government bonds necessary to maintain his declared 0.25 per cent interest rate ceiling on three-year government bonds, will RBA governor Philip Lowe be willing to keep buying when his bond holdings are many multiples of what they were a month ago and the nation is back at work? Both the Morrison government and the central bank have responded well to the demands of a global pandemic. Having done what they have done, in what circumstances and with what speed will they set about undoing it?

Australia is likely to come out of this crisis before the end of the year. Asian economies were first into the pandemic, and will be first out, and East Asia is the market for three-quarters of Australian goods exports. Iron ore and coal prices have held up surprisingly well. Locally, travel, tourism, accommodation, restaurants, entertainment and sports, and discretionary retail have all been devastated. Even so, large parts of mining, manufacturing, construction, the whole healthcare sector, electricity, water and gas utilities, land and sea transportation, most of the public service, much of the finance industry and professional services, and most of the media have all in one way or another continued to work. When the number of new infections turns convincingly towards very small numbers, the Commonwealth and the states will presumably encourage a staged reopening of those parts of the economy now shuttered.

That is when the policy choices will become more conflicted.

The federal government’s deficit will be a tenth of GDP or more — the biggest deficit in modern times, and more than twice as big (as a share of GDP) as the biggest of treasurer Wayne Swan’s deficits when Australia was successfully riding out the global financial crisis. Government gross debt, today equal to two-thirds of Australian GDP, will be over four-fifths and still rising.

Much of the government’s additional spending will fall away as the economy returns to normal. But revenue will be well down (as will GDP) and spending will remain elevated by lingering higher unemployment and healthcare costs.

The economy will be fragile. Households and businesses will become more indebted during the crisis, and probably considerably longer. They will emerge cautious and intent on rebuilding savings and controlling debt. After an initial bounce, household consumption is likely to slow. Business investment plans may well be even more modest than before the crisis began. With increased debt, households and business will be extremely sensitive to interest rates.

In this new world the RBA will be dealing with two difficult issues.

One is the future of its new ceiling on bond rates. Private market interest in buying Australian bonds may be only modest while the RBA has capped their yields. Because the price of a bond and its yield move inversely, investors will reckon there is every chance of a bond losing value when the RBA eventually stops supporting the ceiling. Without strong private buying, the RBA itself will have to buy sufficient bonds to maintain the ceiling, building a balance sheet several times the current size.

In just the week or so after Lowe announced the yield cap on 19 March, the RBA’s holdings of Australian dollar investments, mainly Australian government bonds, doubled to $157 billion — the highest total by far in the twenty-six years of the statistical series. Although some of that reflects operations to calm an agitated bond market, this is the beginning of what will probably be a prolonged increase in its bond holdings. To finance its immediate deficit, the Australian government will need to issue at least another $300 billion in bonds. The RBA may well find itself with half of them, and perhaps more — after all, that is a large part of the point and purpose of capping bond yields.

What is not actually a problem for the government and the RBA is the much-lamented problem of financing the government’s vast spending increase. Much of it can and will be resolved by a couple of keystrokes and a bit of creative accounting. What is really happening at the moment is that the RBA is creating money to give to the government in exchange for bonds, not directly but via the secondary market in bonds. The government will pay interest on the bonds, most of which the RBA will then give back to the government as part of the profit it pays to its owner, the Commonwealth. To the extent that the government’s spending is financed by this roundabout money creation by the RBA, it is free. There will be no bill to pay, ever.

If an inflation problem arises with the unexpectedly large increase in the money supply at a time of reduced output, the RBA could and would sell some of its bond inventory to the public, and allow interest rates to rise. Rising inflation, however, is not the immediate risk.

The real problem arises because the RBA can’t buy government bonds forever, and therefore can’t sustain a bond rate ceiling forever. When it withdraws the ceiling, bond rates will probably rise. It is certainly not beyond the wit of RBA officials to figure out the least damaging way of exiting the commitment, but whichever route they choose is sure to be unpleasant — witness the US Federal Reserve’s late-2017 attempt to sell down its bond inventory, reversed a year or so later.

As for the RBA’s cash rate, the one that determines the rate on most home mortgages and most business loans from banks, it is now as low as it will go. With markedly higher household and corporate debt the economy will be very sensitive to the smallest increase, or even the suggestion of one. Lowe has said the cash rate will remain at the current level until such time as inflation is back in the target band and unemployment is on the way down. That is probably some years away. Until such time, the RBA will be on the policy sidelines, its monthly meetings of diminishing interest. It has a useful role to play in smoothing or avoiding credit crises, but the next big monetary policy challenge will be to judge when the low cash rate can safely be increased.

The treasurer and Treasury have a similar but even bigger problem of exiting their crisis strategy. Unless the epidemic is prolonged, much of the additional spending announced over the past few weeks will fall away before the end of the year. The budget deficit will shrink rapidly, but not to pre-crisis levels. Tax revenues will be well down, spending on unemployment benefits, healthcare and interest servicing well up. The central bank will have no additional capacity to offset a fiscal tightening, as it did from 2011. Household consumption and business investment will be weak. If the Morrison government is sensible — if it continues to respect Treasury advice — it will allow a much bigger budget deficit to run a lot longer than it would have accepted before February of this year.

With extremely low interest rates likely to prevail for years, superannuation funds and other investors will find themselves in a similar position to three months ago, but more so. The returns on cash will be minuscule. So, too, the returns on bonds — with a serious risk of taking a capital loss on bonds when the RBA withdraws its rate ceiling, as one day it must. Investors must therefore pile back into shares. Super funds, looking to long-term retirement funds for their members, will be driven even more into shares, infrastructure and other illiquid investments.

The issue that then arises is whether running a large deficit and very low interest rates will be enough to get the economy on to a path of firm growth. Having busted all the orthodoxies about central bank deficit financing and vast government spending initiatives, will the Morrison government soon feel a little ashamed of itself, and want to return to respectability? Prepared to win the war, will it lose the peace?

Even before the epidemic, the Australian economy was merely drifting along. Business investment was flat, productivity growth barely apparent. We had experienced the slowest ten-year growth of real per capita incomes for more than half a century. Output growth was less than 3 per cent, and unemployment more than 5 per cent. Output will likely fall in the second and perhaps the third quarters of this year, and unemployment will rise. We will certainly come out of this downturn, but with an economy weaker than it was last year. It will need considerable support, especially for investment and productivity growth. The RBA will have done everything it can. It will be up to the Morrison government and its advisers to continue the fiscal revolution they have so splendidly begun. •

A NOTE ABOUT SUPERANNUATION

As an independent director on the board of the construction industry superannuation fund, Cbus, I might be thought to have a biased view of the government’s offer of time-limited tax-free access to up to $20,000 of superannuation savings to a very wide range of claimants. But my duty as a trustee is to the best interests of our members, and I have no doubt the announced policy is not in their best interests. This is the one policy among those announced that seems to me very poorly designed. In effect, the government is asking people to supplement their income out of their own savings, otherwise preserved for retirement. The time limit obliges superannuation fund members to withdraw cash precisely when their balances have sharply dropped. It will force many superannuation funds to sell shares into a falling market to finance the cash payouts at a time when they would be looking to buy shares at bargain prices. All their members are disadvantaged by this sudden cash demand.

A far better result could have been achieved by giving qualified contributors tax-free access to $20,000 of their retirement balance, but with no time limit. The money would then have been available if and when needed, but would otherwise remain within the fund earning returns for the member. It would be a savings back-up, which a very much smaller proportion of people would likely tap.

Senator Jane Hume, the relevant minister, has declared that though there was no warning or discussion, superannuation funds ought to have been prepared for this. That is another way of saying they must be prepared for it to happen again. If funds are obliged to provide for the contingency that every now and then governments will offer tax-free access to fund members’ retirement balance, the funds must redesign their portfolios to have more cash and fewer illiquid investments, like infrastructure, that governments usually encourage them to buy. The result must be lower returns, and a poorer retirement. It would be a different system, but not in a good way.

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Nor is the gloom entirely unwarranted. Exports are doing well, but the growth in business investment is flat. Home building, which has supported jobs and incomes over the last five years, has topped out and will soon fall. Slow wage growth and high mortgage debt are inhibiting household spending. Government investment has helped, but even at today’s high levels it is less than one-twentieth of GDP.

The result is slow growth in overall economic output. It’s true that jobs growth has been quite good, more or less keeping pace with the rate of increase in output, but that also means there has been little increase in output per hour worked or labour productivity over the last few years. Without an increase in output per hour worked it is difficult to sustain an increase in income per hour worked; thus, low wage growth. And without productivity growth, output can’t increase much faster than the growth of labour supply.

These circumstances don’t suggest a recession is imminent, but they do present a picture of disappointingly low growth in living standards. The Reserve Bank is responding with lower interest rates, and the government with tax cuts. What difference will these responses make?

After a long period of no change the Reserve Bank has cut its cash rate by 0.5 per cent over the past two months. It may well do more. We now know that the bank would like to get down to 4.5 per cent unemployment, from 5.2 per cent today, so long as inflation “is not a problem.” If inflation is below the 2.5 per cent target and not markedly accelerating, and if unemployment is above 4.5 per cent — which probably won’t happen for quite a while — the bank could in principle be prepared to cut further.

Somewhere, however, there is a floor to the rate commercial banks charge on loans, and therefore a limit to their capacity to hand on rate cuts. This is largely because banks pay a zero or near-zero rate of interest on a large part of the funds they hold on behalf of households. Those deposits are always roughly equal to the stock of owner-occupied home lending, and most of them pay little or no interest. The cost of holding these deposits is not reduced by a lower Reserve Bank policy rate because the funding is nearly free anyway. If the banks cut their lending rates further they are cutting profits. The lower the policy rate, the more unwilling commercial banks will become to reduce loan rates in response.

The lowest likely cash rate is therefore said to be 0.5 per cent. Whether that is the actual floor we might discover in coming months. If it is, the total possible cash rate cut in this easing episode is 100 basis points, or 1 per cent, and we are halfway there.

The Reserve Bank also has the capacity to reduce long-term fixed interest borrowing rates by purchasing longer-term securities. It did so during the 2008 crisis. But that was more in the nature of balance sheet and liquidity support for institutions in a frozen market. The bank recognises that, other than borrowing by governments, most Australian loans are priced using short-term interest rates. Reducing long-term borrowing rates won’t have much impact, particularly given that government bond rates are already at a record low.

Would a rate cut of 1 per cent make a discernible difference to economic activity? The rate cuts will make little difference if the commercial banks don’t reflect them in lower lending rates. Even if they do, the magnitude of the feasible cuts is quite small. From 1.5 per cent to 0.5 per cent is 100 basis points. In the earlier phase of this episode the bank was able to start off from a cash rate of 4.75 per cent at the end of 2011 and bring it down to 1.5 per cent by August 2016. This 325 basis point cut not only raised household disposable income but also stimulated a boom in house prices and then in house construction that significantly contributed to offsetting some of the downturn in mining investment. It also took the Australian dollar down from US$1.10 to US$0.70, considerably helping Australian exports. Yet business investment fell, inflation fell, and wage growth fell — all issues to which the bank is now responding. If 325 basis points didn’t stimulate wage growth and inflation, 100 basis points won’t either.

The earlier rate cuts were associated with a faster rate of jobs growth from early 2014. But that faster rate has continued. The additional rate cuts might help, but as the bank itself says, jobs growth is pretty good anyway.

This new round of rate cuts cannot match the earlier round, either in size or in the type of impact. No new upswing in housing construction is likely in a market that is well supplied for the moment, and with migration slowing. In the year to May, approvals for new private house construction fell by nearly a third. It is already the case, as Reserve Bank governor Philip Lowe spelled out in his statement announcing last week’s cut, that “borrowing rates for both businesses and households are at historically low levels” and the Australian dollar is at the “low end” of its recent range. The change in the value of the currency after his announcement was very modest.

It is true that household borrowing is higher now than it was in 2011, magnifying the impact of the rate cuts on household income available for other spending. Yet even the impact on household spending of a 100 basis point cut in total (assuming we see two more 25 basis point cuts) would be fairly modest. Contrary to the widespread belief, most households are not stretched by mortgage payments. Despite the rise in household debt, interest payments as a share of household disposable income are no higher today than they were in 2003, and much lower than a decade ago. Housing interest rates have gone down more than borrowing has gone up.

The stock of variable rate owner-occupied loans is roughly equal to annual household disposable income. If the banks passed through to existing loans the whole of a one percentage point cut in the cash rate, household disposable income (that is, net of mortgage interest) would increase by something like 1 per cent. This is not an insignificant increase, though some of it would be matched by a corresponding fall in rates paid on household deposits, some of it might be saved, and any increase in consumption would anyway be spread over a year or two. The 325 basis points in cuts from 2011 to 2016 do not seem to have had any marked impact on household consumption, though it’s true they may have prevented it slowing more than it did.

As for the tax cuts, at $7.2 billion for this year they are roughly equal to a 0.6 per cent addition to household disposable income. This might make some difference to the rate of growth of household consumption this financial year. But we need to bear in mind that the federal budget papers show that personal income tax as a share of household income will increase despite the tax cuts, that personal income tax per head will increase, and that government tax revenue will increase faster than government spending. Overall the budget stance remains contractionary. The tax “cuts” are really a reduction in the rate of increase of tax revenue. Even with them factored in, the budget forecasts that tax revenue will increase $18 billion or 4 per cent this year — somewhat faster than the likely growth of household disposable income. The overall impact of tax this year will be to moderate any increase in household consumption.

As Phillip Lowe explained, a rationale for the new round of rate cuts is the bank’s discovery that unemployment could fall to 4.5 per cent without “inflation becoming a problem.” Although it may be wondered whether senior bank officials ever really thought 5 per cent unemployment was as low as it could go without accelerating wages growth, this is a perfectly good rationale. After all, if inflation is quite low, if wages growth is low, and if home prices are no longer rising, why not see if even lower interest rates make a difference? This at least conveys a sense that the bank is doing its best to help. But what really matters, as the bank once used to say, is not the change in the rate but the level. At 1.5 per cent, the policy rate was already very low indeed. The main contribution monetary policy can now make it to keep the rate low until it becomes inconsistent with rising inflation.

The basic problem for the bank is that the causes of Australia’s slow growth are beyond its influence. It can ameliorate the impacts but it can’t solve the problem. It could not stop the big decline in mining investment from 2012 to now. It can’t solve today’s underlying problem, which is low growth in output per hour worked, or labour productivity. That these indicators are low is probably due partly to declining business investment in recent years, partly to the relatively rapid growth of jobs in industries such as health and education with relatively slow productivity growth, and partly to either a slowdown in technological change or its mismeasurement.

This is a problem we share with most advanced economies, and it has so far proved beyond the wit of central banks or governments or business leaders. Spending on transport infrastructure to ease bottlenecks would help, as Dr Lowe frequently suggests. Doing more on workplace skills and on the quality of education would help, as the Productivity Commission suggests. So would sorting out the healthcare system, another Productivity Commission suggestion. But these reforms would make a difference over many years, not the next few. Meanwhile we should be wary of touted changes in the tax mix and the industrial relations framework, almost all of which are designed to advantage one group of Australians over another without adding to the common prosperity.

For all that, some good things have been happening, largely unnoticed, in the Australian economy. One is that two-thirds of Australians over fifteen, a bigger share than ever in our history, are either working or looking for jobs. Jobs growth has been strong. Another is that not only is Australia running a surplus on trade with the rest of the world, it is running the biggest-ever trade surplus and also the lowest current account deficit for quite a while.

Nor have the twenty-eight years of growth passed without consequence. On average, Australians command four times the real wealth per head they commanded in 1991, when the long expansion began. Our real income per head is two-thirds higher. Output has much more than doubled. So long as employment is increasing, a spell of low productivity growth that neither the Reserve Bank nor the government can fix is something we can manage. •

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For contemporary Australian politics, and for thinking about Australia’s place in the world, an inquiry into Australian exceptionalism is timely and pertinent. Political rebellions in Britain and the United States have raised questions about the inevitability of growing trade, migration and globalisation. Growth in the major advanced economies has slowed. Is Australia, gliding tranquilly into its twenty-sixth year of uninterrupted economic expansion, merely behind the trend? Is it possible that this country’s exceptionalism is an “indulgence of simplicity and fancy, made possible only by lenient economic circumstances,” as Coleman darkly asks, and that the “hour of severe depression” is “nigh”? Or is there something about Australia’s exceptions that contributes to its unusual success and might shield it from the rebellions evident in otherwise similar economies?

The debate with which the new book engages is about not only where we are now and where we are going, but where we have come from. Drawing on the historian Keith Hancock’s Australia, journalist Paul Kelly argued in his early Australian political chronicles that Australia was built on a Federation “settlement” of high tariffs, the White Australia policy, wage arbitration and “imperial benevolence.” According to Kelly, the settlement weighed on Australian development for decades, until it was undone by the Hawke and Keating government in the 1980s and early 1990s. In Kelly’s account, Australia had indeed been exceptional, but not in good ways. By the 1990s much of the exceptionalism had gone, permitting Australia’s long run of prosperity.

To this “Australian settlement” view of Australia’s peculiarities, Adelaide economic historian Ian McLean provided a compelling alternative in his 2013 book Why Australia Prospered. Much of what was said to have been agreed at Federation, he wrote, already existed in the colonies. And much of what was important in Australian economic history, especially the relentless rise of Commonwealth authority, wasn’t part of any Federation compact and only emerged through High Court decisions, two world wars, and big changes in the global economy.

Nor was it evident that tariffs, arbitration and racially restricted immigration weighed on Australia’s prosperity. In the quarter century following the end of the second world war, for example – a period in which Australia had high tariffs, wage arbitration and the White Australia policy – real GDP increased by 230 per cent, just short of twice the gain of the celebrated upswing of the past twenty-five years. Real income per person increased 157 per cent, well over twice the increase of the past twenty-five years. The productivity gain was around 150 per cent, nearly three times faster than in the upswing of the past twenty-five years.

It’s true that arbitration and high tariffs were proving poisonous by 1971, and White Australia had been largely abandoned. But it is surely hard to argue that Australia would be a better place if it had permitted entry of the cheap labour the squatters demanded, had accepted the low wages and racial apartheid that would inevitably have followed, and had remained dependent on mines and farms.

This is the debate William Coleman and his colleagues have entered. In his introductory chapter, Coleman appears to agree with Paul Kelly that a settlement was struck at Federation that set Australia on its peculiar path. But he disagrees with Kelly in arguing that the settlement described by Hancock in 1930, and revisited by Kelly more than half a century later, still exists. And he differs from McLean not only in assuming there was such a settlement but also in thinking – though here Coleman is not entirely clear – that it is a very bad thing.

Coleman’s central claim is that “Australia is the country that won’t move on, which is stuck in its way.” Australia’s character, he writes, remains “egalitarian, collectivist, dirigiste.” And while Australia is “stuck,” other countries are moving ahead. In the early twenty-first century, he writes, “Australia appears to be drifting from the tendency of the English-speaking world in matters of economic and social policy.” Australia is following a “special path… laid down more than a century ago.” Moreover, there is a “silence” on the subject that this book will “breach.”

Australian exceptionalism is evident, he writes, in a tightly regulated labour market, a tax–transfer system heavily reliant on direct taxation and means testing, a mere appearance of federalism that belies the reality of a unitary state, the lofty prominence of an “official family” of senior bureaucrats and independent statutory bodies, and certain electoral peculiarities. He challenges the view that Australia changed course when the Hawke and Keating governments deregulated the financial system, floated the dollar, scrapped tariffs and eventually switched from the arbitrated national wage increases of the Accord to enterprise-based bargains.

The “cited shifts,” Coleman argues, “are more a matter of form than nature.” The White Australia policy has gone but the “nature” of the White Australia policy “remains unchanged” because Australia regulates immigration on economic grounds. Tariffs have fallen but budgetary assistance has “ballooned.” And while enterprise bargaining may have replaced wage arbitration, “bargaining remains the legal monopoly of ‘registered’ trade unions.” He concludes that “it is Australia’s much-vaunted period of ‘microeconomic reform’ of the 1980s that has been temporary and passing,” while “Australian exceptionalism is better described as enduring.” By contrast, Sweden and Switzerland have made a deeper and more enduring shift to the market since 1980, as has New Zealand.

In a related contribution, Henry Ergas supports Coleman’s view, writing that by “echoing Hancock’s three pillars of the Australian settlement” Paul Kelly had “prematurely” declared it over in the 1980s and 1990s. On these points, Coleman is not entirely convincing. There is surely more than a cosmetic difference, for example, between a migration policy that rigidly excludes non-whites, skilled or not, and a policy that readily accepts people of all races if they are skilled.

In writing that “tariffs have fallen” but budgetary assistance has “ballooned,” Coleman implicitly suggests the fall of one has been compensated by the rise of the other. Not so, according to the Productivity Commission. It calculates the total effective rate of industry assistance as the sum of tariff protection, tax concessions and budgetary support, and finds that assistance to manufacturing has fallen from 35 per cent of value added in 1970–71 to 5 per cent on the most recent number, 2014–15. In agriculture, the proportion fell from 25 per cent to around 4 per cent. Since 1991, the effective rate of assistance has fallen by two-thirds. In recent years, according to the same report, budgetary assistance has declined.

In industrial relations, Coleman writes, the change is illusory because “bargaining remains the legal monopoly of ‘registered’ trade unions.” Again, not so. Provision for non-union agreements was legislated over twenty years ago. Under the current legislation, employees may choose the bargaining agent they please, including themselves.

I take it that Coleman’s contrasting of Sweden, Switzerland and New Zealand to Australia is intended to suggest that those countries have gone further in free-market principles than Australia has. Perhaps in some respects they have. But all of them have markedly higher ratios of tax to GDP than Australia’s, and markedly higher ratios of government spending to GDP. That would make them, I would have thought, more dirigiste and collectivist than Australia.

On World Bank numbers, tax in Australia in 2014 was 22.2 per cent of GDP, and government spending 26.5 per cent. In New Zealand, tax to GDP was 26.7 per cent, four percentage points higher, and government spending to GDP 32.6 per cent – very much higher. Sweden’s tax to GDP was 26.4 per cent, and spending 33 per cent. Calculating them a different way, the OECD gives bigger numbers for both tax and spending to GDP, but the order of countries remains the same. In the OECD numbers, Australian government spending to GDP is not only markedly below the rates in New Zealand and Britain but also below that of the United States.

Nor is Coleman completely persuasive on other aspects of Australia. In social policy, he contrasts Australian state-run public schools with charter schools in the US and academy schools in Britain. This difference is, he writes, the “best illustration” of Australia’s tendency to keep pressing along its path. But even there he has to contend with the fact that Australian schools score well above their counterparts in the US and Britain (and a bit better than in New Zealand) on the OECD’s PISA tests. One might understand why Americans would want to experiment with charter schools without agreeing that Australians should do the same.

There is a tone in his work that suggests Coleman thinks Australia’s path is errant or dead-ended, but he doesn’t pursue the argument. Instead, he says “the aim of this book is to get an understanding of this situation” rather than to inquire whether it has made Australia richer or poorer, or fairer or less fair. How one could get an “understanding” of Australian exceptionalism without inquiring about its economic and distributional effect is mysterious. It’s a major weakness in the book.

But if Coleman did go there, he would be presented with some problems. One of them is the uninterrupted prosperity of the past twenty-five years, despite Australia’s being stuck in the alleged rut of dirigiste collectivism. Growth has been markedly faster here than in either the US or Britain, the countries to which Australia is unfavourably compared.

Coleman’s is the plight of the Right. A sensible public policy argument is difficult unless participants recognise that Australia has done quite well, and in recent decades very well indeed, compared to other advanced economies. Once recognised, this changes the debate. If Australia is doing a lot better than Britain or the US, for example, it doesn’t follow that we should do as they do. If, indeed, we are “drifting from the tendency of the English-speaking world in matters of economic and social policy” and “following a special path,” that might be no bad thing. It would at least require that public policy arguments should be well informed by detailed and quite specific data.

Perhaps attempting to escape the plight of the Right, Coleman creates a new “long boom” that begins in 1979. This dates its origin to well before the float of the Australian dollar, the big tariff cuts or replacement of arbitration with bargaining. Happily, it also credits its initiation to Malcolm Fraser (or perhaps his then treasurer, John Howard) instead of Hawke or Keating. There is, however, some cost in plausibility. Coleman’s “long boom” includes the two worst recessions Australia has experienced since recovering from the Great Depression eighty years ago. It certainly could not, as he suggests, be based on favourable terms of trade, since for most of that time Australia’s terms of trade were flat or declining. Nor could it be based on a favourable world economy, since it would include not only the global financial crisis, the 2000 “tech wreck” and its aftermath, the 1997 Asia Crisis, and the 1994 bond sell-off, but also the global downturns of 1989–90 and 1979–80. And it could not be based on China, since for most of the time China was a relatively small (though fast-growing) economy and for three-quarters of the period Australia’s exports to China were quite modest.

Another strategy to deal with the plight of the Right is to claim Australia’s economic success is an illusion, one based on favourable export prices and China’s growth, and is about to vanish. “Looming over public discourse,” Coleman writes, “is the apprehension that Australian exceptionalism amounts to an indulgence of simplicity and fancy, made possible by lenient economic circumstances.” He asks, “Could the hour of severe depression be nigh?” Well, it could be. It is, after all, a world of infinite possibility. But it is difficult to engage an argument that doesn’t proceed beyond the question. I would call it an indulgence in simplicity and fancy.

Yet there are some strong pieces in the volume. Coleman’s own essay on “Theories of Australian Exceptionalism” is a thoughtful survey of some interpretations of Australian peculiarities (though in a very long list of references he omits Ian McLean’s book).

In a remarkably wide-ranging and clever contribution, Henry Ergas compares de Tocqueville’s Democracy in America with Keith Hancock’s 1930 Australia. As Ergas points out, Democracy in America is still published today and still widely discussed, while Australia has not been republished for decades and is rarely discussed. The reason, Ergas supposes, is that “Australia lacks a foundation myth that shapes political culture and political controversy,” so that discussion of the “Australian settlement” is less likely to turn up in an actual contemporary political discussion.

Another reason, Ergas supposes, is that Hancock criticises the Australian pursuit of “fairness,” which does not “sit easily” with the “dominant tendency” to “rehabilitate that ‘settlement’ and, with it, at least some elements of the radical-nationalist view of Australian history.” He writes that “the declining prominence of Australia reflects the renewed acceptance of the radical-leftist view of Australian history,” a view that “glorifies the continuing validity of the settlement’s underlying goals.”

Those two reasons seem to me to sit uneasily together – Hancock is forgotten because we have no foundation myth and don’t discuss the “settlement,” and Hancock is forgotten because he criticises that settlement and there is a “dominant tendency” to rehabilitate it. Ergas is at least aware of McLean’s work, instancing it as the (only) example of this “dominant tendency.”

Political scientist John Nethercote writes on Australia’s “talent for bureaucracy” and “the atrophy of federalism.” A “quest for equality” comes at “the expense of federalism,” he says, and encourages Australia’s “talent for bureaucracy” and thus “uniformity and standardisation.” He critically notes the recent Australian government green paper on federalism, which poses the question, “what is the problem we are trying to solve?” but doesn’t answer it. I’m not sure Nethercote does either. At the end of his interesting and well-written account I was left wondering what exactly he objects to, and why.

Similarly, another of Coleman’s contributions may well become the classic account of Australia’s “electoral idiosyncrasies,” especially compulsory voting, preferential voting, and the persistence of a distinct country party. But it is not at all evident how the puzzles and curiosities he describes support his conclusions that “the Australian sense of democracy is undeveloped,” that there is “poverty of the democratic spirit in Australia” and (most severely) that “Australian democracy smacks too much of the polling booth and not enough of the parliamentary chamber.”

Adelaide economist J.J. Pincus contributes a sensible piece about the state and railways. Canberra academic Phil Lewis takes us through the Australian industrial relations framework, asserting without explanation that the system is today “more regulated” than it was following the Keating government reforms. The industrial relations system “has now gone into reverse and is falling behind other countries.” Without example or amplification, it’s difficult to discuss.

While Coleman might not be persuasive in his argument that Australia didn’t really change in the 1980s, I think he is quite right in arguing that some aspects of Australian exceptionalism remain, and some of them have a long history. Industrial disputes might no longer be arbitrated, and we no longer attempt to calculate a “basic wage” or “margins,” but Australia still has high and legally enforceable minimum wages, especially compared to the United States. It is still possible for workers to unionise relatively easily if they wish, and to strike collective bargains with their employers. In practice, most workers are paid either at or over the award, with no formal enterprise bargain, but the existence of a right to unionise, to strike during a bargaining period, and to reach enterprise agreements is a useful check on the boss.

Coleman is also right to see a passing resemblance between today’s skilled migration program and the old White Australia policy. Quite a few White Australia proponents were outright racists, but many more thought of it as a policy to keep out cheap, unskilled labour. A skilled labour migration policy achieves the same effect, without the racism.

And while they are not so much historical remnants as more modern creations, Coleman is also right to detect some other exceptions to the trend in other English-speaking economies. Australia does rely more heavily on a progressive personal income tax than many other advanced economies, its value-added taxes are certainly lower than those in Europe, Britain or New Zealand (but not the US), and it does means test government benefits more than most countries. The result is a progressive tax and transfer system with a reasonably high level of benefit payments, but smaller shares of tax and government spending to GDP than the countries to which Coleman compares us.

There is a sense in Only in Australia that these exceptions are not only at odds with trends elsewhere but also inimical to Australia’s success. In a recent Lowy Institute analysis, How to Be Exceptional: Australia in the Slowing Global Economy, I argue the contrary. Many of Australia’s peculiarities are entirely consistent with and facilitate Australia’s engagement in the global economy. In the US, the median income has only just climbed back to the level it last reached seventeen years ago. In Britain, income inequality has dramatically widened. Little wonder rust-belt states swung to Trump, who promised to cut migration and cheap manufactured imports. Little wonder the old and the poorly educated in Britain voted against an open European labour market.

By contrast, even households in the lowest income quintile in Australia have experienced an increase of nearly 60 per cent in their real disposable income over the past twenty years. The twenty-five-year upswing explains some of that, but the relatively fairer income distribution also depends precisely on those elements to which Coleman and his colleagues are most hostile. The combination of high minimum wages, skilled migration, and a progressive tax-and-benefit structure help ensure a less unequal society than the US. Australia has been able to run a far larger migration relative to its size, has a larger trade share, and is quite as engaged in the global economy as the US, without the political fractures now evident there and in Britain.

For the coming decades Australia has an immense demographic advantage that can underpin stronger growth in living standards than is likely in most other advanced economies. Realising this advantage depends on a continuing large immigration program, which in turn depends on sustaining political consent through a reasonably fair spread of prosperity. In Australia today, there is plenty of distress, plenty of rural annoyance with Chinese investment, and widespread objection to rorting 457 visas, but no rebellion against the openness to trade and migration which has supported Australian development for well over 200 years. That is another aspect of the plight of the Right: what we have retained of Australian exceptionalism works. •

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The three previous IGRs – in 2002, 2007 and 2010 – came and went. They got dutiful attention, elicited thoughtful head-shaking, and provoked salutary editorials prompting us to think more about future hazards. Each of them depicted a difficult fiscal situation, forty years in the future.

This IGR is very different. It is an analysis not only of the future, but also of the present. It portrays where we end up, but also how we might get there, year by year. And it does this in the unusual context of a political debate almost entirely about choices for Australian government spending and revenue.

My reading of the IGR suggests that far from Australia’s becoming ungovernable we might well find ourselves making reasonably rational choices, informed by more pertinent analysis and debate than usually attaches to the great spending and revenue issues at the core of Australian politics.

To do so, however, we need to get beyond the hype and misrepresentation and see what the IGR is actually telling us. When we do so we make the surprising discovery that resolving Australia’s fiscal problems might not be all that hard. The IGR also shows us that we will have a federal election or two to choose between rival solutions.

But before turning to the IGR it will be useful to consider the economic context in which it is presented.

The Australian economy

It is sometimes supposed that the problems in the federal budget are reflections of a wider problem in the Australian economy. Though there is a despondent tone to much of the commentary, the Australian economy is actually in pretty good shape. Public demand is weak and likely to remain so. Mining investment is falling. But exports last year set a new record high, in both values and volumes, and have continued strongly into this year. Gains in iron ore and coal have been important, but farm exports are also doing well. Service exports have increased spectacularly, especially tourism and education but also professional services such as finance, construction services, architecture and so forth. Manufacturing export volumes have increased in each of the last three years. Exports will get another significant lift when LNG shipments ramp up over the next few years.

Dwelling construction, too, was quite strong last year and likely to be even stronger this year. The sector is being helped along by low interest rates and a decade in which the population increased by over a tenth but dwelling construction stayed much the same from year to year. Household consumption is not dazzling, but is growing consistently faster than GDP as a whole.

It is widely thought that the mining sector has begun dragging the economy down, but the real case is the opposite. Mining as a share of GDP is bigger today than it has been at any time in the last quarter century. By volume, mining exports are higher now than ever; by value, last year they matched the peak year, 2011. It is certainly true that mining investment is well down and has quite a lot further to fall. But it is also true that the gain to GDP from the increase in coal and iron ore exports since the mining investment peak in 2012 is twice as big by volume as the loss to GDP from the fall in mining investment. And while mining investment has been falling, so too have capital equipment imports. Last year their volume fell by about half of the fall in mining investment, a ratio that probably reflects the general estimate that about half of mining investment spending is on imported equipment.

It would help to have stronger non-mining business investment. Even there, however, there are encouraging signs. Last year, in the Australian Bureau of Statistics category that includes finance and insurance, wholesale and retail trade, water, power and gas, construction, transport, and professional scientific and technical services, business investment increased in volume or real terms by 17 per cent. Investment in these industries is now eight times bigger than manufacturing industry investment. It is getting close to the level of mining investment, and sometime this year will likely exceed it. Last year the wider national accounts measure of business investment (which also includes private health and education investment, and farm investment) continued to drift down – though if mining is excluded it did pick up in the fourth quarter of last year.

Stronger household consumption might do it but otherwise it is unlikely we will see output growth reaching 3 per cent until non-mining business investment picks up further, or the decline in mining investment slows, or both. But there are good reasons to think that the expansion of non-mining business investment will continue. Meanwhile, the global economy is a little stronger. The expansion of the US economy is solidly based and likely to continue, growth has picked up in Germany, Britain and (a little) in Japan, and China has a pretty good chance of attaining its target of 7 per cent growth for another few years.

Interest rates, meanwhile, are at record lows, and the Australian dollar has come down (though not far enough). Without much remark, labour productivity has increased by an annual average of more than 2 per cent for the last three years, and wage increases are running at around the same rate. The combination of relatively high productivity growth and relatively low wages growth means that the labour cost per unit of production is stable or falling. In combination with the declining Australian dollar, these influences are making Australia more competitive in the world economy.

All that said, output growth at around 2.5 per cent, the average for the past five years, is not enough to keep unemployment from rising, let alone reduce it. Australia still has high net migration and a quite high rate of growth of the workforce. With current levels of productivity growth and workforce growth we need output to grow at 3 per cent or better to stop unemployment rising. This means there is a pretty high risk that while output growth will be quite firm over the next year or two and may even pick up, the unemployment rate will continue to slowly increase through this year and next. This is the most pertinent political implication of the current economic trajectory. In the fifteen months or so before the next election, the prime minister and his treasurer must find a way of talking about the economy that is consistent with the evident fact of rising unemployment.

Whatever narrative the prime minister develops also needs to be consistent with the government’s fiscal circumstances. While real output growth is likely to be firm and may even strengthen, the growth of wage incomes and profits, and thus of Australian government tax revenue, is likely to remain slow. Much of this is already built into published Treasury revenue forecasts, and some of it will be offset by a lower rate of growth in age pensions, disability support payments and other indexed payments. Even so, the very slow growth of revenue (and the periodic downward revision of revenue forecasts) is a major constraint on political choices. The likelihood of a revenue boost is remote. All the risks are that revenue will be less than forecast, rather than more.

These fiscal circumstances also constrain the opposition. They mean that for both major parties net tax cuts are pretty well impossible for the next few years, and so is any new program spending not offset by an equivalent cut.

The economic context dictates that the deficit should be reduced gently. That is the pattern already indicated in the most recent Mid-Year Economic and Financial Outlook, or MYEFO. (The IGR suggests that the deficit reduction path will be even gentler.)

The 2015 Intergenerational Report

As the former head of the prime minister’s department, Michael Keating, has pointed out, this year’s IGR is distinctive. Earlier IGRs used a single set of projections, based on present policies, to reveal how much additional spending as a share of GDP would be attributable to ageing in forty years’ time. The new IGR is quite different. It is essentially a year-by-year projection of budget outcomes for three different sets of spending policies over forty years. The three share the same economic forecast or projection, and each assumes that tax revenue rises to 23.9 per cent of GDP in 2020–2021 and is then held there for the rest of the forecast period.

The effect of using a single economic scenario over three different spending projections is to focus attention on the different trajectories of the spending projections and draw attention away from the economic projections, which are based on trends in population, workforce participation and labour productivity. Part of the national conversation prompted by previous IGRs was about how to get workforce participation or productivity up. This time round, such conversation as we are having is almost entirely about the fiscal choices implied by the three spending scenarios.

One scenario, labelled “previous policy,” purports to project the evolution of deficits under the policy in place prior to the changes to taxes and spending in the 2014–15 budget. But although the previous budget was brought down by treasurer Wayne Swan before the Coalition took office, three-quarters of the 2013–14 fiscal year was presided over by his successor, Joe Hockey. The incoming government could and did make changes to the budget, so even the polemical point of this “previous policy” comparison is obscure.

The second scenario is more useful, at least as a point of comparison. It shows how the deficit would evolve if all of the Abbott government’s proposed spending and tax proposals in the 2014–15 budget were adopted.

The third scenario is the most interesting because it comes closest to what is likely to happen and what that might imply. It shows the evolution of the budget balance given the spending and tax changes already legislated, or able to be implemented without legislation. This is the timeline that matters most to Tony Abbott and Bill Shorten.

None of the three outcomes has much to do with ageing. The biggest difference between them is the rate of debt accumulation, of which more below. Other differences involve funding for schools, defence and foreign aid, none of it related to ageing. Differences in health funding emerge but, like earlier IGRs, this IGR points out that health spending pressures mostly arise from technology and the demand for better services, not from ageing. Certainly there are differences in age pensions, but they do not account for a large share of the divergence of the three trajectories.

(Ageing does effect the Australian government budget indirectly through a changing rate of workforce participation. But since all three scenarios share the same economic assumptions, this aspect of ageing doesn’t affect the distinctions between the three trajectories. Nor does participation make an enormous difference because the IGR assumes that better education, better health and changing work patterns will increase the participation rate of older workers.)

The IGR forcibly demonstrates that the big driver of deficits, and of government spending as a share of GDP, is not an ageing society at all. Nor is the budget balance driven by defence or childcare or education. The main driver of deficits is deficits, and of debt, debt. The IGR is far more about the effect of compounding debt on political choices than it is about the effect of ageing.

The IGR shows that currently legislated policies lead to a 2054–55 deficit of 6 per cent of GDP when net interest is included, and 2.4 per cent of GDP when net interest is excluded. More than half of the deterioration in the fiscal position is thus due to the cost of additional debt, in turn due to the sequence of deficits. By 2054–55, under current policies, net interest costs would account for something closer to 10 per cent of budget spending compared to around 1.5 per cent today.

An implacable conclusion for either major party is that the sooner the deficit is eliminated, the sooner government will have more discretion to spend on what it thinks is important.

Most importantly, the projections show that managing the fiscal challenge is not too difficult so long as the groundwork is done sometime during the next five or six years. Under current legislation, and excluding debt interest costs, the projected federal deficit of 2.4 per cent of GDP for 2054–55 is much the same as the deficit currently projected for this year, 2014–15.

Using similar methodology, the 2010 report projected a deficit of 2.75 per cent of GDP forty years on, and the 2007 report projected 3.5 per cent. The 2002 report, the first, projected a deficit of 5 per cent of GDP.

The conclusion must be that the budget gap, excluding debt servicing, is narrowing rather than widening – at least in the long-term projections. The stability of the revenue assumption across four reports released for Labor and Coalition governments over thirteen years demonstrates a broadly similar outlook between the major parties.

The revenue assumptions are similar in all four IGRs (although Peter Costello’s 2002 and 2007 IGRs netted out the GST). In all cases revenue, including GST, is held at just over 25 per cent of GDP. Wayne Swan’s 2010 IGR assumed a tax ceiling of 23.6 per cent of GDP; in Joe Hockey’s it is 23.9 per cent of GDP. Non-tax revenue is typically 1.5 per cent of GDP.

All this means that the long-run budget challenge for both major parties is to implement a set of revenue and spending changes that will together amount to 2.4 per cent of GDP in forty years’ time. They must be implemented soon enough to prevent accumulating debt from taking over as the deficit driver. Weighing the choices depends to a large extent on what is included in or excluded from the “currently legislated” trajectory in the IGR, a question I address below.

In the meantime, government is faced with a short- or medium-term budget problem. Basically, the IGR shows the deficit will get better before it gets worse, a pattern that influences political choices over the next few years.

The short-term fiscal problem

Thinking about the fiscal problem through the next two elections is clouded by the big gap between what the government says it is doing and what it is actually doing. In particular, the importance of increased tax revenue in reducing the deficit over the next five or six years is occluded. It is now the essential element in the Abbott government’s fiscal strategy.

The Abbott government was in office and making budget decisions for three-quarters of the fiscal year 2013–14. The current budget, 2014–15, is entirely its own. In the outcome of the 2013–14 budget and the projected outcome for this year’s budget, spending as a share of GDP has increased. Part of the increase in 2013–14 was due to a capital payment to the Reserve Bank, but this year spending as a share of GDP is likely to be markedly higher than it was in the previous budget. At a projected 25.9 per cent of GDP, spending would be a whisker below the recent record set by Wayne Swan’s 2009–10 budget, which included the crest of the spending measures in response to the global economic downturn. Leaving that budget aside, spending has not been as high as a proportion of GDP as it is today since 1993–94, when Australia was pulling out of recession.

Another way of seeing the real fiscal circumstances of the Abbott government through the haze of declaratory policies is to look at the evolution of the deficit since the last completed budget before its election. Comparing the 2012–13 budget outcome with the prospective outcome for the current budget shows that the deficit has increased by 1.3 per cent of GDP. The increase is not due to a collapse of revenue: it is the outcome of an increase in spending-to-GDP of 1.8 per cent, offset by an increase in revenue-to-GDP of 0.5 per cent. The Abbott government has increased spending as a share of GDP, even on a 2014–15 projection that assumes most of the savings measures in the last budget are implemented. It has offset part of the increase with an increase in tax revenue.

As the prime minister and treasurer rightly say, this deficit will be wound back over the next few years. But spending cuts make only a small contribution to deficit reduction. Last December’s Mid-Year Economic and Financial Outlook depicts the deficit declining from 2.5 per cent of GDP this year to 0.6 per cent of GDP in 2017–18. Most of the improvement comes from increased revenue rather than decreased spending. On the MYEFO figuring, increased revenue accounts for nearly two-thirds of the fall in the deficit between now and 2017–18. Of the increased revenue, nearly two-thirds is increased personal income tax.

In reality, personal income tax will probably contribute a higher share of a smaller improvement, because the MYEFO includes some spending cuts that won’t happen. In the IGR projections covering the same period, the goal posts seem to have shifted. On the basis of “currently legislated” policy, the deficit in 2017–18 is around 1 per cent of GDP. This deterioration probably reflects the removal of spending cuts and revenue increases in MYEFO that still require legislation to implement. These would include the Medicare co-payment, the beginning of state school funding cuts, and the beginning of the freeze on the real value of age pensions.

The impact of increasing tax revenue in cutting the deficit continues for many years, a trend that recasts the future budget problem. MYEFO shows the deficit declining through to and including 2017–18, the last year of the forward estimates period in the current budget. The IGR shows that in the “currently legislated” path, the deficit will continue to narrow as a share of GDP until around 2021–22, when it peaks and then begins to slowly deteriorate. Tax increases will again account for most of the improvement. On this scenario, the deficit appears to be around 0.4 per cent of GDP by 2023–24, an improvement of 2.1 per cent of GDP over 2014–15. The tax-to-GDP ratio will then have reached its assumed ceiling of 23.9 per cent of GDP. Adding the usual 1.5 per cent of GDP for non-tax revenue, we can say that in 2023–24, when the deficit will be 2.1 per cent of GDP lower than today, revenue will be 1.8 per cent of GDP higher than today. Between now and that fiscal year, higher revenue thus accounts for more than four-fifths of the reduction in the deficit under current legislation. All of the revenue increase as a share of GDP is additional tax.

The politically crucial point for both the government and the opposition is that the deficit reduction through to 2021–22 will occur without any new taxes or legislation. According to the IGR projections, it will occur without most of the nasties proposed in the 2014–15 budget. It will occur without a Medicare co-payment, without freezing the real value of pensions, without cutting federal funding for state schools, and without deregulating university fees.

These are the numbers the prime minister and the treasurer are looking at, probably thoughtfully. They are now at the core of Tony Abbott’s political strategy for the next election. They will also be at the core of the political strategy for opposition leader Bill Shorten and shadow treasurer Chris Bowen. The government and the opposition share the same forecasting framework, and will see the same constraints and opportunities in the evolution of spending and deficits over the next six or seven years. The opposition’s policy-costing advice from the Parliamentary Budget Office will use much the same data and the same methods as the advice Treasury will give the government.

As Abbott has indicated, the May budget will not be especially tough. It doesn’t need to be. The deficit will continue to narrow over the next six or seven years, with no increase in tax rates and no spending cuts beyond those already legislated or not requiring legislation.

Under existing policy, according to the IGR, the narrowing of the deficit will halt in 2020–21 and then begin to slowly widen. This is mostly because revenue from that year forward is constrained to grow at the same rate as GDP, while spending continues to grow a little faster than GDP. But that development falls outside the forward estimates of the coming budget and the next. Each budget includes four years of estimates, the first two of which are forecasts and the last two projections. Estimates in the May budget this year will go through to 2018–19; in next year’s budget, likely to be the last before the election, they will go through to 2019–20. On IGR figuring, and without any new spending cuts, each budget will show a path of steadily falling deficits.

This will be true even if the government dumps its proposal to eliminate real increases in the pension, as it is highly likely do. It will be true if it also dumps or postpones its cuts in the forward estimates of school funding, and if it dumps university fee deregulation.

The deterioration of the deficit will not be in the forward estimates until the first budget of a government elected in late 2016, assuming it adheres to the normal timetable and brings its first budget down in May 2017.

The prime minister can abandon cuts to the pension, put off cuts in school funding and forget about Medicare co-payments, but he does have one medium-term fiscal problem. Treasury and Finance have included in both the forward estimates and in the IGR’s “currently legislated” path quite big cuts to hospital funding, from 2017. These cannot now be taken out without a marked deterioration in the forward estimates to be presented in next month’s budget. The advisers to Abbott and Hockey are probably giving a bit of thought to this right now.

With GDP growth below the rate required to prevent unemployment rising, there is no economic case over the next several years to cut the deficit more rapidly than the IGR projects on current policy. While it won’t be in the forward estimates, the deterioration of the deficit beyond 2020–21 will be apparent in the medium-term fiscal path that is now published in the budget. Both the opposition and the government will need some sort of narrative to meet this emerging deficit, even though these measures need not begin to take effect for six or seven years.

The long-term fiscal problem

The projected recovery of tax revenue solves the deficit problem over the next five or six years but it then re-emerges. The deficit stabilises around 2020–21 and then deteriorates from 2023–24. This is not because program costs suddenly explode. As mentioned, it is because the IGR projection holds tax to 23.9 per cent of GDP and total revenue to 25.4 per cent of GDP from 2020–21, while spending grows a little faster than GDP. The pattern is probably influenced by the diminishing importance of cuts to foreign aid.

The size of the longer-term problem is evident in the trajectory of the “currently legislated” spending projection, excluding debt interest. The deficit of 2.4 per cent of GDP in 2054–55 is the long-term gap between revenue and spending that has to be bridged plausibly with some combination of spending cuts and revenue enhancements.

Though that gap is a long way away, the emerging gap needs to be plugged quite soon to prevent interest costs on accumulating deficits claiming a higher and higher share of spending.

In figuring out the size of the problem presented by the 2.4 per cent gap in 2054–55 we need to know what Treasury has included in or excluded from the path of “currently legislated” spending. We especially need to know how many of the big spending cuts sought by the government in the 2014–15 budget have been included. The IGR is not as helpful as it might be on this point, but it does tell us a lot of what we need to know.

Treasury has included all current and proposed spending plans except those requiring legislative change that has either been denied or not yet sought. Following this rule, it has included the cuts in proposed hospital funding, but not the Medicare co-payment, in “currently legislated” policy. The change in hospital funding planned from 2017 onwards doesn’t need legislation; the Medicare co-payment does. (For all the difficulty it caused the government, the Medicare co-payment makes very little difference to the trajectory of healthcare costs.)

The hospital funding cuts seem to be the only real nasty left in the “currently legislated” projection. The cuts to foreign aid are included, but they are not politically fraught. Specifically excluded are the freezing of the real value of the age pension from 2017, and the proposed increase in the pension age to seventy. (Treasury imposed the assumption that the pension freeze starts in 2017 and ends about a decade later.)

The biggest single exclusion from “currently legislated” policy is in education and training. The proposal to hold school funding to CPI plus population from 2017 seems to be worth 0.6 per cent of GDP by 2054–55.

It may be that the major parties can avoid having to explicitly deal with the long-term deficit in the run-up to the 2016 election. It is far enough down the track for both sides to promise to examine the problem and present to the electorate a package of measures at the election after next. It is not entirely satisfactory, but it may well be what happens and there are worse possible outcomes. After all, we are talking about a problem that doesn’t begin to arise for the best part of another decade. Given the calamity of the 2014–15 budget, evading the issue may be the only way through.

It would be very much better, however, if both major parties presented to the electorate packages to close the deficit that re-emerges after 2020–21. They could then move on to a contest over the merits of different spending and taxing options, instead of a tedious contest of rival claims over debt and deficits. Nor should it be too hard for both sides to find an electorally tolerable set of measures that would produce a budget balance beyond 2023–24. On the IGR’s “current policy” scenario the deficit reaches 2.4 per cent of GDP only in forty years’ time, and only very gradually. In twenty years’ time it is still only half a per cent of GDP. The minimum task then is to put together a package that would amount to half a per cent of deficit reduction in twenty years’ time, so long as the measures start sometime in the next five or six years and are worth 2.4 per cent of GDP in forty years time.

Despite all the blather and hype, that is it. Addressing Australia’s fiscal problem does not require a fiscal or tax revolution, it is very far from a crisis, and it is not beyond the capability of our political system. The IGR makes that clear. Any half dozen fair-minded and well-informed people could produce a set of reasonable options, broadly acceptable to a majority of Australians, as long as they had an official from Treasury or the Parliamentary Budget Office sitting by with the relevant spreadsheets.

Through to the next election

In the 2016 budget, the one prior to the next election, the prime minister will be able to show a path of declining deficits in the forward estimates through to 2019–20. But unless he is vastly more popular than he is now, which seems unlikely, he can’t go to the next election with a plan to freeze the real growth of age pensions for a decade. He can’t promise to bring in a Medicare co-payment. In fact, he will have to deny and forswear these cuts, explicitly and repeatedly, because Bill Shorten will certainly accuse him of planning them. Given that they are already in the forward estimates and treated as currently legislated policy in the IGR, he may have no choice but to stick with the proposed cuts to hospital funding. He could probably argue that he will make it up to the states in some other, yet-to-be-determined way. Since the school funding cuts are not yet counted they are more easily repudiated, though he will be very reluctant to let them go.

Regardless, Shorten’s attack lines are already pretty clear. He will say the prime minister plans to cut funding for hospitals and schools, and freeze the real value of old age pensions. This line is now an inescapable given. Nor will it be seen as baseless rhetoric. After all, Abbott ruled out cuts in the last election campaign, and then in office proposed them. These are all policies he approved, proposed and supported, and will recant only reluctantly. In opposing cuts to hospital and school funding and a freeze on the real value of pensions Shorten will not have to offer compensatory cuts elsewhere, because the government will probably have already dropped them from the forward estimates.

For his part, Abbott will say that the budget mess is Labor’s fault, and he has now resolved it – witness the small deficit predicted for the end of the forward estimates period.

In terms of actual programs and spending outcomes over the next three or four years the difference between the parties may well be decidedly thin. It is already apparent that the Abbott government is moving along the lines dictated by the IGR. He has dropped the Medicare co-payments, and is looking for a way to drop the pension freeze without losing all the savings it promised. The likely way forward for both government and opposition is to toughen the means test for both full and part pensions while keeping the current indexation arrangements intact. Similarly with family assistance and other transfers. On school funding Labor could make savings from the IGR’s “current legislation” path by retaining increased funding for disadvantaged schools partly or wholly at the expense of other schools. (The Gonski review’s hands were tied by the Labor government’s instruction that no school could be worse off.) On hospitals, either or both of the major parties will need to restore a higher level of funding to the “current legislation” path of the IGR, perhaps minimising the increase by claiming they would require greater efficiency from hospital administrations.

If all these and other possible economies are not enough to eliminate the prospective deficit then there is the option of a tax increase to balance the books. Since we are looking for a package that amounts to only 0.5 per cent of GDP in twenty years, the tax increase would be hardly noticeable. But I think the option of a net tax increase is unlikely to be chosen by either side. The government will certainly not propose an increase in the tax take beyond 23.9 per cent of GDP. Labor would be suicidal to propose a net increase, especially since the IGR makes it fairly plain that a quite acceptable spending path can be mapped without one. And a tax increase would only temporarily narrow the deficit. Unless the proportion of tax to GDP is allowed to rise indefinitely, deficits will arise so long as spending growth outruns GDP growth.

The prime minister’s apparent tolerance of debt at 60 per cent of GDP is unlikely to be reiterated. This is the outcome produced by the “currently legislated” scenario, which specifies that in 2054–55 government spending including debt servicing reaches 31.2 per cent of GDP, compared to 25.9 per cent today. That is not a usual Liberal position. Social security minister Scott Morrison also recently wandered off script in floating the suggestion of increased taxes on superannuation to pay for higher pension indexation. In the Abbott government script, tax increases in one area can only be permitted if they pay for tax cuts in another.

If Abbott is replaced by Turnbull nothing much changes except perhaps the timing of the next election. The fiscal and economic circumstances are just as constraining for Turnbull as for Abbott, though he would not have quite the baggage of the broken promises. His best bet might well be to go for double dissolution as soon as he can. It is unlikely that a double dissolution would improve the government position in the Senate and it would certainly see its majority in the House reduced, but that would be a price Turnbull would be happy to pay to restart the fiscal debate on his own terms in a new parliament. The implacable logic of the IGR arithmetic would remain.

Changing Taxes

As the Financial Review’s Laura Tingle has pointed out, the response of the government and the opposition to Treasury’s recent tax information paper was surprising and telling. Both sides have effectively ruled out an increase in the GST, or its extension to fresh food, education and health. Both sides have shown a willingness to discuss increased taxes (or less concessionality, which is the same thing) on superannuation and capital gains.

Both sides have a long history of constraining the growth of taxation revenue as a share of GDP. This was part of the Hawke and Keating governments’ “troika” commitment and part of Peter Costello’s “fiscal framework,” and was adopted by Wayne Swan as treasurer. The vast share of the continuing fiscal problem while Swan was treasurer was that tax revenue fell well below the ceiling. The relatively easy path for the next three or four budgets is almost entirely due to the projected recovery of tax revenue to a ceiling long accepted by the two major parties.

If both sides also accept a maximum tax take of 23.9 per cent of GDP, then what they are talking about is using additional revenue from sources such as capital gains and superannuation tax reforms to fund cuts in other taxes, most likely personal income tax. On the revenue side as on the spending side there is far less difference between the major parties than the stridency of the public debate suggests.

As John Quiggin has rightly remarked, there hasn’t been much new in the tax debate since the Asprey report forty years ago. It urged a form of the GST and a capital gains tax, and made a case for a fringe benefits tax. In the preliminary report recommending a value-added or goods and services tax Asprey and his colleagues said that once introduced, it would be easy enough to increase. This remains Treasury’s central goal, along with a reduction in company tax and a shift in health and education spending to the states.

While there is certainly no room for net tax cuts for many years to come, it is quite possible to change the mix in various ways.

In this respect Labor probably has more options than the government. Paradoxically, Labor’s policy problems in tax have been eased by falling demand for (coal-fired) electricity, and the continuing decline in commodity prices. These trends mean that a both a carbon tax and a mining super profits tax are off the table. Business and household electricity demand is already doing the work of a carbon tax, and the super profits in mining won’t be there.

I think it is fanciful to imagine either side will look at a serious extension of the goods and services tax, though both sides could if necessary look to picking up a bit more revenue (for the states) by extending the GST to financial services.

Treasury is again pressing for the elimination or reduction of dividend imputation, with the revenue gain used to reduce the company tax rate. Labor might be able to look at this. My guess is that there is no chance whatsoever that the Liberal Party would accept it. There are hundreds of thousands of Liberal-voting self-managed super fund trustees who like the combination of big dividends and imputation credits. There are hundreds of thousands of small businesses benefiting from imputation. They are both core Liberal constituencies. The main beneficiaries of reducing company tax by reducing imputation credits are foreign shareholders in businesses paying Australian company tax. If it is tax neutral in the medium term, the foreign shareholders must be benefitting at the expense of Australian shareholders.

The concessional taxation of capital gains is a standout distortion. Its reform could fund some reduction in personal income tax rates. Either side could look at this, but Labor would find it easier. It was Labor, after all, that introduced capital gains tax at the taxpayer’s marginal rate, and a Liberal government that later halved it.

Finally, there is the biggie – super tax concessionality. Both sides could fund some personal income tax cuts by more heavily taxing superannuation, and may well do so. As Malcolm Turnbull has remarked, it is odd to have a tax system that imposes tax disincentives on additional work in the most active period of people’s working lives and then removes them when their working lives are over.

As the IGR makes plain, the Australian government does have a fiscal problem. Over the next five or six years, though, the immediate problem will solve itself through the increases in tax revenue that come with increasing income. Beyond 2020–21, deficits will increase so long as tax revenue is constrained to its average share of GDP in recent decades. That longer-term problem can be met with modest changes to spending programs, amounting to 0.5 per cent of GDP in twenty years’ time and 2.4 per cent of GDP in forty years’ time. There are vastly more important issues in Australian politics than this fiscal arithmetic, and the sooner it is addressed the sooner we can move on to debate them. •

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One problem is that, as he acknowledges, money and debt are not the same thing. The existence of debt long preceded the existence of money. Debts can be contracted equally well using cows or camels, a commodity money like gold coins or a state-mandated money like Australian dollars. Banks facilitate the creation of debt by lending and borrowing, but they could do and have done so using either form of money. The history of money accordingly does not tell us a lot about contemporary financial crises.

Another problem is Coggan’s focus on debt among the set of financial claims. Every debt is an asset to the lender, so one might say that in creating debts we create an exactly equivalent amount of financial assets. Except in the case of governments, debt is mostly (though certainly not always) secured directly or indirectly against some physical asset – a home, a factory, the assets of a corporation – or against an income stream that arises from an asset. Accordingly, we would expect the volume of debt to increase with the value of underlying assets. Over time the value of these assets will likely rise faster than output, in line with increase in capital to output (or the decline in capital productivity). As a result we might well see debt rising faster than GDP, even without the influence of financial intermediation. A banking system can increase the amount of debt compared to the size of the economy by more efficiently matching savers and lenders. So, too, the more complicated a financial system becomes, the greater the range of debt products it will create and sell.

For all these reasons we would expect to see debt (and for that matter financial claims that take the form of equity, such as shares) expanding faster than GDP for prolonged periods. An increase in the share of GDP taken by financial assets in the form of debt claims is not of itself evidence of a problem – though Coggan seems to suggest it is.

Coggan argues that not all of the debt accumulated in the last twenty years is likely to be repaid. This is incontestably true. It was evident in the global financial crisis when lots of businesses – big and small, financial and non-financial – went bust. It extends to governments. Iceland refused to accept full liability for the debts of its banks; Greece has in practice defaulted on a large share of its debt; Italy and Spain may have to restructure their sovereign debt at some point. For years to come, the politics of Europe, the United States and Japan will be complicated and soured by the need to service very high government debt. But it is hardly a new development.

If we are seeking explanations of the global financial crisis, however, it does not get us very far merely to say debt was too high. In the United States, the debt of financial businesses was high compared to their assets. But this was not true of non-financial businesses. Household debt was high, though most of the increase was related to the acquisition of homes, a long-lived asset that is appropriately funded by debt. The problem in the United States was not the existence of debt but the existence of particular financial instruments that became impossible to value – and therefore impossible to sell – when confidence in them eroded. The problem was compounded by the practices of major investment banks, which funded themselves in overnight markets and used some of the money to buy the very bundles of home mortgages (or derivatives based on them) that became untradeable. The financial crisis in a few large investment banks was then propagated in the usual way as banks became wary of dealing with other banks.

The real and paper losses resulting from the global financial crisis were and are immense, but recovery is evident. US household debt has steadied compared to GDP and, with lower interest rates, household debt service ratios have declined. The US government is stuck with net debt that will reach 100 per cent of GDP this year, but there is a pretty good chance that with continuing low interest rates, nominal GDP growth of 3 to 4 per cent and a continuing decline in deficits, the ratio of US debt to GDP will stabilise in two or three years. Meanwhile, the private US economy continues to slowly deleverage. Remarkably, much of the money the US government was compelled to spend to buy distressed financial assets and prevent wider calamities has already been repaid.

It would have been vastly better to have decent regulation and continuous oversight in the first place so that the frequency and size of financial crises were mitigated, but modern economies have a surprising capacity to deal with financial catastrophe. All of which means that I’m not convinced of Coggan’s conclusion that the collision of interests between lenders and borrowers will be the driving force in the global economy for decades to come. •

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There is no argument with Shiller’s proposition that the financial tidal wave still coursing through the global economy started with the downturn in the US housing market, though the manner in which it started there is worth pondering. According to Shiller (and most other commentators) US house prices were in a bubble, which had been inflated partly by lower credit standards and the extension of lending to “sub-prime” borrowers. These are borrowers who had a history of difficulty in servicing their debts. Through 2004, 2005 and 2006 they accounted for a rising share of all new mortgages.

An important characteristic of sub-prime mortgages is that by definition they could not be bought or guaranteed by the government-supported institutions which guaranteed most US home loans, Fannie Mae and Freddie Mac. Another important and relevant characteristic of the US market is that many states limit the borrower’s obligation on the mortgaged property to that property alone. Once the value of the home falls below the value of the mortgage, the owner has an incentive to send the keys to the lender and move out. Sub-prime loans had very high loan to valuation ratios, so they were at risk from any sharp decline in house prices.

Finally, and this is also relevant to understanding what happened, more often than not sub-prime loans had an affordable introductory interest rate, which after a period of a year or two would convert to what was usually a penalty rate – unless the loan was renegotiated before the reset date. The incentive, intent and practice were that sub-prime loans would be renegotiated to a long term rate, with a lower loan-to-valuation ratio. So long as house prices rose, it was good business. But it all depended on house prices continuing to rise. Once they started to fall, which was inevitable sooner or later given the size and rapidity of the increase, there had to be a sharp increase in sub-prime mortgage delinquency. This became apparent through 2006 and into 2007.

But if a decline in US house prices and a rise in mortgage delinquency in a relatively small part of the market were the extent of the problem, the global financial crisis would not be anything like as serious as it now is. After all, sub-prime mortgages are only 15 per cent of all US mortgages, and even if we say 25 per cent are delinquent – around the agreed estimate today – that is only 4 per cent or so of US mortgages. Furthermore, some of the losses are recoverable when the repossessed property is sold. It is true that there is another class of mortgages – we call them low-doc and they are called “Alt A” in the United States – which are also not guaranteed and which have seen rising default rates. There is yet another class of unguaranteed loans called “jumbos,” which are too big to guarantee, though the default rate there is not particularly high. Even taking the estimated defaults in all unguaranteed loans, the total provisioning (which is higher than the actual loss, when recoveries are made) is roughly $600 billion. The Bank of England has estimated the likely actual loss after recovery at much less. The $600 billion estimate is a big number, but financial institutions have already written that amount off. More importantly, they have acquired a matching amount of additional capital.

If that was all there was to it, we would have moved on sometime around the end of 2007. It’s true that the decline in house prices in the United States would have continued and racked up further losses. In Australia or Britain that would mean banks and mortgage funds sustaining large and continuing losses. In the United States, however, most mortgages are guaranteed by the government-supported housing agencies. The losses in prime mortgages would have been almost entirely borne by Fannie Mae and Freddie Mac as the guaranteeing institutions for these loans. They would have been bailed out and taken over at enormous taxpayer expense (as they have been) but the world would have moved on.

The important point here is that the US home price bubble does not, as Shiller suggests, explain the seriousness of the global financial crisis. It only explains how it began, and not all of that. It was not so much the bubble itself as the innovation of providing an increasing proportion of unguaranteed mortgage loans to people who had a history of difficulty in meeting loan payments. (Incidentally, there was no legislated inducement or incentive to extend lending to sub-prime borrowers, as is now frequently alleged. It was not the outcome of warm-hearted but muddle-headed intervention by US liberals. This is startlingly apparent from the fact that the loans were not guaranteed. Hence the problem. The boom in sub-prime lending was a business calculation, which went very wrong.)

Shiller repeats the widespread claim that lending standards fell in 2005 and 2006. This has been contested, with other analysts suggesting there was no decline – though of course the standards were not severe in the first place. But you don’t need declining credit standards to explain what happened. All you need is high loan-to-value ratios in a particular part of the market (and they had to be high to be accessible to sub-prime borrowers), the option in many states of turning the property over to the lender with no further obligation – and declining house prices.

That is all you needed to start it, and all you need for a nasty shock to financial institutions. But it does not necessarily create a global financial catastrophe of the kind we now have. That is not a story about a bubble or house prices. It is about the way in which parts of the finance business worked, and Shiller does not come to grips with this. One reason he doesn’t is perhaps that he admires the technology of finance and is reluctant to hold it at fault. Indeed, his solutions typically involve yet more complicated financial instruments to insure against risk.

The transmission from mortgage delinquencies among poor US home owners to a global financial crisis was through a lethal gap in financial markets. Sub-prime loans were bundled together in their thousands into financial securities which could then be sliced up into different risk buckets and sold into the market. These are known as collateralised debt obligations or CDOs. They were (and in many cases still are, since they are not trading) held by financial institutions mainly in the United States and Europe, either directly on their balance sheets or indirectly in related entities funded by short term loans. By July of last year financial markets were well aware that the rate of delinquency in sub-prime lending was rising much faster than expected by the ratings agencies that assigned risk weightings to the various tranches of sub-prime debt. Often sub-prime debt was mingled with other debt, and it was impossible to separate it out. Buyers found it hard to value the CDOs, and were aware that the sellers, who often originated the security, knew more about it than they did. The buyers became reluctant to buy and over the whole globe the market in CDOs just stopped functioning.

It might be said that an ordinary share is also hard to value. It is no easier to forecast the stream of earnings for Qantas or BHP Billiton ten years into the future than to forecast the stream of earnings for a CDO. It ought in most circumstances be a lot easier. But share markets are deep, liquid and open. At any time of the day you can find out what the market thinks a Qantas share is worth. The market for CDOs is known in the trade as “over-the-counter”: they are traded transaction by transaction between institutions, and very often the characteristics of the instrument may be designed for a particular buyer. It is difficult to discover the price the market as a whole sets on CDOs at any one time. If the price is uncertain, the instrument becomes illiquid – it cannot be traded.

So CDOs stopped trading, and with them many forms of asset backed securities. Australian triple A mortgages for example, which then and now have very low default rates, could not be traded. Confronted with the need to take their structured investment vehicles, or SIVs, back on their own balance sheets and pay out the debt owing on them, major banks and other financial institutions became reluctant to lend to each other. Businesses found it difficult to issue debt, and instead turned to banks. This increased the lending requirements on banks at the same time that banks needed to pay out debt on their SIVs, and write off the diminished value of CDOs they held. Banks stopped lending to each other, conserving cash for their own needs. Lending growth slowed as bank capital declined. Central banks stepped in to lend cash to banks, and the banks were also able to raise capital by selling shares – often to government owned funds in Asia and the Middle East.

THIS TAKES THE story to the beginning of this year. It was calamitous enough then, but still within the realm of experience and policy. Then there were two further waves. The first was the serial collapse of New York investment banks. Investment banking used to be about advising businesses on mergers and acquisitions, arranging debt and equity issues, and broking in equities and debt securities. It was not a heavy balance sheet business. But for well over a decade major investment banks in London and New York have been making a bigger and bigger share of their profits from trading on their own account. They borrow from and lend to hedge funds, they buy debt, equities and other financial instruments, and they fund these investments by issuing debt themselves.

There are two generic trades at the bottom of all this. One is to lend a less risky asset in exchange for cash to a buy a more risky (but better paying) asset. Another is to borrow in highly liquid short term markets to buy assets which are less liquid and longer term (but better paying). Once lenders detected that US investment banks had suffered big losses in CDOs, they became reluctant to buy their debt. The investment banks could no longer fund their asset books, and the unwinding of their assets (now including not just the troubled CDOs but many other securities) caused further declines in financial asset prices and further losses, which accelerated the whole process.

The world was now in a thorough-going asset price deflation, in which hedge funds and other holders of speculative positions had to liquidate their holdings as quickly as they could to meet debt repayments. One result was that equity prices collapsed, though it was not in the first place an equity market problem and the price decline is much more than could be rationalised by a forthcoming global recession. The most recent stage of this unwinding came with the collapse of Lehman Brothers, which one way or another turned what was a panic among financial market traders into a panic in households, requiring government guarantees of bank liabilities to prevent complete destruction of the global financial system.

So there we are. The agreement among the rich economies that no major financial institution will now be permitted to fail has checked the subsidence of global finance. As I write share prices have steadied, and inter-bank lending rates have begun to decline. But we are in a very peculiar world – one where the US central bank lends money directly to US non-bank businesses by buying their debt, where the United States, Britain and some European governments are now direct shareholders in banks, where bank liabilities are for the most part guaranteed, where the US taxpayer is about to shoulder the burden of buying hundreds of billions of dollars in financial assets which are otherwise untradable, where those big stand-alone US investment banks no longer exist, and where the US government has had to fund a major debt insurer (AIG) and the two major mortgage guarantee businesses. We are looking at recession in the United States, Britain and Europe. I don’t now expect it, but it is entirely possible that some new episode of deleveraging, of the liquidation and deflation of financial assets, could be just around the corner. Third world debt perhaps, or commercial property. We have not yet seen what feedback impact unemployment and business bankruptcy will have back on to financial markets and businesses. I think we are getting towards the end of the worst of it, but I have thought so at various times before and been wrong.

Robert Shiller may well claim to have predicted this, but his remedies are quite insufficient for the immensity of the current problem or to prevent a recurrence. He suggests, for example, that people need better financial advice, and governments should subsidise this advice. But the biggest errors in this catastrophe were not made by the poor Americans who brought houses. They were made by the finance industry experts who provided the loans, by clever and well remunerated people in ratings agencies and banks, experienced regulators, hot shot fund managers. He suggests the encouragement of more insurance contracts, for household risks, national risks and so forth, notwithstanding the discovery during this current episode that private risk insurance is quite unreliable once we move beyond our normal experience of risk.

Shiller does advocate more disclosure about instruments like CDOs but has remarkably little to say about the need to replace over-the-counter markets for very big financial securities with exchanges, so that the market has continuous knowledge of prices and transactions. He does not have much to say about the need to improve regulation in the United States to mandate good rules on loan-to-valuation ratios, on transparency, and on permissible gearing. He does not have much to say about the need to change the Basle banking rules to make bank capital requirements counter-cyclical instead of pro-cyclical. Shiller may have foretold the housing downturn but this book is not (as it claims) either an account of how the global financial happened or what to do about it. •

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