Talk to Economic Society, Victorian branch, Wednesday, September 9, 2015
I want to draw on a few themes from my new book, Gittins: A life among budgets, bulldust and bastardry, particularly some observations about macro management, recessions and, what I consider to be my special subject, the politics of economics.
Don Stammer, the veteran business economist, says you need to have seen four recessions before you’re fully qualified. I thought the global financial crisis of 2008-09 would bring my fourth, but if you don’t count that---l count it as a potentially severe recession turned into a mild one by remarkably skilful management---I’ve seen three big ones. The recession of 1974-75 would by itself have caused the Whitlam government’s defeat had there not been more than enough other reasons. The severe recession of the early 1980s brought the Fraser government’s reign to an end after just seven years and the severe recession we didn’t have to have in the early 1990s---in the sense that all recessions happen by accident rather than design---finally did for the perpetrator of that bravado in 1996, although his execution was delayed three years by the political inexperience of a former economics professor, John Hewson.
I soon formed the view that recessions occurred roughly every seven years. I know from the three recessions that have occurred so far ‘on my watch’---each of them accurately branded ‘the worst recession since the Great Depression’---how terrible recessions are: the fear and pain they cause to small business people, workers who lose their jobs and young people who have the misfortune to be leaving school or university at the time. Whitlam’s recession saw the rate of unemployment shoot up from 2 per cent to 6 per cent, Fraser’s recession saw it peak at 10 per cent and Keating’s at 11 per cent. I know how thoroughly depressed people get for years on end, convinced things will never pick up again. I also know how bitter are the public’s recriminations against economists. Recessions may be a ‘good story’---in the sense they give people like me plenty to write about---but I hate them.
My notion that recessions occur about every seven years remains pretty true for all the developed economies bar Australia. Even if you count the mild recession of the GFC---which I do---it remains true we haven’t had a recession bad enough for ordinary people to notice for 24 years. There are two things to say about this.
First, in one sense only it’s a pity you have to be so old to know how terrible a severe recession is and hence to be hugely relieved, even grateful, we managed to avoid one in the aftermath of the GFC. About seven years later the North Atlantic economies are still embroiled in the Great Recession we escaped.
Second, that we’ve avoided severe recession for an unprecedented period is thanks more to good management than good luck. Even if you’re so ill-informed as to imagine our escape from the Great Recession is due purely to China and the resources boom, you still have to explain 17 years of uninterrupted growth since the recession of the early 90s, including our exemption from the world recession of the early noughties. We should have been brought low by the Asian crisis of 1997-98, but weren’t.
I decided very early in that 17-year period that the ultimate test of good economic management was to keep the recessions as far apart as possible, mainly because recessions put a lot of people out of work for long periods, and the longer you’re jobless the harder it gets for you to regain a berth. I could have decided the ultimate test was to keep the inevitable recessions as mild as possible. Either way, our economic managers pass with flying colours. I know Australians find it hard to believe Aussies could be world-class at anything but sport, but it happens to be true of our econocrats.
I know because I watched at close quarters as it happened and I know how they did it. It’s certainly true that our economic management was pretty bad for at least the first decade of my time as an observer. But between the late 80s and the early 90s the econocrats started getting their act together. Although most of the seeds were sown under the Hawke-Keating government, the Howard government was the first to enjoy the fruits. The Rudd-Gillard government also enjoyed them---as witness, its avoidance of the Great Recession---though it lacked the whit and internal cohesion to reap the harvest.
The econocrats did it by persuading their successive political masters to subject the conduct of day-to-day economic management to ‘frameworks’ of rules and targets intended to limit the scope for politically motivated short-termism. The obvious example is the decision---formalised by Peter Costello---to use an inflation target to guide decisions about changes in the official interest rate and to hand control over interest rates to an independent central bank.
The many acts of ‘micro-economic reform’---including floating the dollar, deregulating the banks and various other industries, phasing out protection against imports and shifting the locus of wage-fixing to the level of the individual enterprise---also helped. Micro reform failed in its stated objective of permanently lifting the rate at which the economy could grow, but it had an unexpected benefit: by intensifying the competition within industries it made the economy far less inflation-prone and unemployment-prone, thus greatly simplifying the macro-managers’ task in keeping the economy on an even keel.
What they do in Canberra
The theory of public choice holds, among other things, that politicians and bureaucrats always act in their own interest rather than the public’s interest, and that, whatever its original motivations, all government regulation of industry ends up being ‘captured’ by the industry and turned to the industry’s advantage in, say, reducing competition within the industry (to the incumbents’ advantage), increasing protection or in persuading the government to subsidise industry costs. The regulated have a huge incentive to get to the regulators so as to modify the regulation in ways the industry finds more congenial, or to advantage the existing players against new entrants or rival industries.
I don’t accept for a moment the accusation that all regulation of industry is subverted. But I do believe there’s more than a grain of truth to the accusation: there is considerable scope for regulatory capture. And I’ve long suspected that the way our bureaucracy is organised---where the department of agriculture looks after the farmers, the industry department looks after the manufacturers, the environment department looks after the greenies, the resources and energy department looks after the miners and the tourism department looks after the tourist industry---could have been purpose-built for regulatory capture.
In the various industries’ battle for their share of industry assistance, in the inter-departmental battle for influence and resources, each industry has its own special champion, those whose true role is supposed to be to keep the industry acting within the bounds of the wider public interest. Is the bureaucracy divided up this way just to gain the benefits of specialisation, or is each department’s real role to keep their particular industry happy and not making trouble for the elected government?
Of course, the two government agencies whose motivations and behaviour I’ve watched most closely are Treasury and the Reserve Bank. Being---like Prime Minister & Cabinet and the Finance department---‘co-ordinating departments’---Treasury and the Reserve have no particular industries they regard as ‘clients’. For instance, though the Reserve has daily dealings with the banks and the financial markets, I’ve never suspected its decisions about the level of interest rates were influenced by anything other than what it believed to be in the best interests of the wider economy over the medium term.
In other words, Treasury and the Reserve are on about macro management or ‘stabilisation policy’. But since they each wield different macro instruments, there is some specialisation between them. The question I ask is: what would they die in a ditch over? They care about lots of things, but what do they care about most?
In the Reserve’s case, the answer is inflation. Its attitude is, if we don’t accept ultimate responsibility for keeping inflation under control, who will? It also regards its instrument---monetary policy, or the manipulation of interest rates---as the best one to use to keep inflation in check. All this is implicit in its single target of keeping the rate of inflation between 2 and 3 per cent on average over the medium term. When it first adopted that solitary target 20 years ago, some took this to mean achieving low unemployment was not something it cared much about. Fortunately, our experience since then has dispelled such fears. The best way to think of its objective is ‘non-inflationary growth’. Even so, it does mean that, when forced to choose, fighting inflation will always come first.
So what does Treasury care most deeply about? What does it see as its ultimate responsibility, the responsibility others are less likely to care so much about? This took me longer to realise, but treasuries---state as much as federal---care most about the budget and getting it back to surplus just as soon as the state of the business cycle permits. As the recent troubles of governments in America and Europe attest, left to their own devices politicians are capable of running budget deficits year after year, in bad times and good, for decades until finally their lack of self control gets them into serious difficulties, invariably at the most inopportune times.
That our governments’ records have been so much more disciplined is testimony to our treasuries’ obsession with keeping budgets in balance ‘over the cycle’ and thereby avoiding the build-up of excessive levels of public debt. It’s testimony also to our treasuries’ greater success in persuading their political masters to curb their natural instinct to spend more than they raise in taxes.
Bearing in mind the wide discrepancy between the politicians’ willingness to increase taxes to cover their increased spending, much of Treasury’s effort goes into urging politicians to restrain their spending and into developing devices to help the co-ordinating, ‘purse-string’ ministers keep the other, ‘spending ministers’ in line. In this, Fraser’s attempt in the mid-1970s to punish Treasury by splitting a Finance department off from it---with Treasury responsible for revenue and Finance responsible for spending---had the unexpected effect of doubling Treasury’s influence at the cabinet table. It could have meant Treasury lost interest in the spending side of the budget, but it certainly hasn’t.
When Costello introduced the reforming Charter of Budget Honesty early in the Howard government’s term, he included---no doubt at Treasury’s suggestion---a requirement for Treasury to produce an ‘intergenerational report’ every five years to assess the fiscal sustainability of present government policies over the next 40 years. The first of these reports in 2002 found that (given a quite restrictive assumption about the growth in tax revenue) the present comfortable budget surpluses would soon give way to ever-growing budget deficits thanks to the ageing of the population and, more particularly, the public’s ever-growing demand for access to medical science’s ever-more-expensive advances in health care.
The following three reports have used the same assumptions to tell essentially the same story. From the first report it became clear to this (not unsympathetic) Treasury watcher that the report was being used by the treasurer as a kind of waddy to wave over the heads of the spending ministers. See the problems we face down the track? See how much worse it would be if I were to stop beating off your grandiose schemes? It was such a handy implement the state treasuries lost little time in producing their own intergenerational reports, each telling a story remarkably similar to federal Treasury’s.
But the state treasuries’ favourite disciplinary device is the state governments’ triple-A credit rating, ratings that emerged early in the Hawke-Keating government’s budgetary reforms when it ceased the practice of borrowing on the states’ behalf. No innovation could have been more effective in disciplining the states’ propensity to borrow, probably to the extent that it helps explain those governments’ inadequate spending on infrastructure.
State governments of both colours live in fear of the political censure that might follow a downgrading of their credit rating, not the modest increase in their borrowing costs it would also bring. And state treasurers exploit this fear indefatigably. When occasionally state governments do suffer a downgrading, they work untiringly to get their top rating restored.
I half agree with the academic economists who think too much attention is paid to credit ratings and that state governments could borrow for infrastructure investment a lot more heavily than they do without this creating an economic (as opposed to political) problem. I also suspect the rating agencies draw their lines in the sand more conservatively for governments than they do for businesses.
When you remember the big American rating agencies’ disgraceful contribution to the sub-prime debt debacle---where they sold paying customers triple-A ratings for the mortgage-backed securities they were issuing, only to have those securities ultimately revealed as ‘toxic assets’---you wonder why they give governments such a hard time. I finally decided they do it because they viewed the state treasuries as their clients, and know full well the treasuries want them to take a hard line.
But having conceded all that, I don’t criticise treasuries and their treasurers for the way they use credit ratings to beat back spending ministers’ insatiable demands for more spending on this worthy cause and that. What the academic critics forget is that their theories provide no clear dividing line between what level of borrowing is safe and what isn’t. In the real world of government, treasurers have to draw an unavoidably arbitrary line and then enforce it. If they use the bogeyman of credit ratings to keep their governments out of trouble, I’ve been loath to criticise.
