RICHARD WOOD responds to a series of articles in The Age that criticised economic rationalism.
THE recession has produced a troop of critics of economic rationalism.
The latest outpourings are contained in Shutdown: The failure of economic rationalism and how to rescue Australia, edited by John Carroll and Robert Manne ($16.95, RRP), excerpts from which were published in The Age yesterday and on Saturday. These dirigiste critics are attacking policies that are sometimes described as levelling the playing field -- but leaving nobody capable of playing the game. They believe exposure to market forces does not strengthen industries but leads to their destruction and high unemployment. The manufacturing industry is seen as particularly susceptible to the devil of foreign competition of protection is removed.
Economic rationalists are portrayed as ruthless pursuers of economic efficiency, prepared to sacrifice anything that stands in the way regardless of its effects on particular industries or individuals; equally, they allegedly have no cultural or social values, always putting economic efficiency and material outcomes first.
It is difficult to avoid the conclusion that such portrayals are painting a deliberately distorted picture in order to set up a straw man. Although economic rationalist want to see decisions being determined much more by the interplay of market forces, with a few exceptions they accept that government has a significant role to play.
However, they argue that we would have a better economy and a better society if there was much less intervention than at present. Why has this view emerged so strongly in recent years?
The main reason is disillusionment with the results of the enormous expansion in government in most OECD economies in the '60s and '70s.
That led to a deterioration in economic performance and a worsening of social problems. It seems that, unlike the majority of political scientists and sociologists, most economists came to realise that the possibility of market failure has to be balanced against the serious risk of government failure.
An American survey of economists' views -- by a political scientist, Steven Rhoads -- has summed it up as follows: "Two decades ago many economists optimistically imagined a federal government that would selectively intervene in the economy to correct for market imperfections once the principles of public finance were better developed and disseminated. Few today have such a vision." Evidence of government failure is now easier to find and much more extreme than market failure. The most striking examples are to be seen in the former Soviet Union and Eastern Europe.
Close to home we have had the fiascos of the state banks in Victoria and South Australia. More generally, there is convincing evidence of an increase in welfare dependency and family breakdown following the increase in government intervention in Western countries to try to eliminate poverty.
Notwithstanding the gross failure of government intervention, the majority of economists still agree it can still be justified in certain circumstances: on social grounds (for example, to provide assistance to genuinely disadvantaged and needy groups), on economic grounds (import parity pricing for oil) and on both economic and social grounds (the subsidisation of primary, secondary and, to some extent, tertiary education).
The challenge now thrown out, however, is that those who argue for a continuation (or intensification) of the present extent of government intervention need clearly to demonstrate, rather than merely assert, the benefits that allegedly flow from it.
What, for example, are the benefits -- economic, social or cultural -- from continuing to employ capital and labor in producing say, motor vehicles, when we could import most of our needs at a lower price? Given that the tariff is a tax on consumers, what "external" factors justify such a tax to maintain such industries.
The interventionists' argument is based on the false premise that, if protection is eliminated, or even reduced, there will be continued high unemployment because manufacturing will cease to provide jobs. However, manufacturing industries long ago ceased to be a source of jobs growth.
In the past 20 years, employment in Australian manufacturing dropped progressively from 1.4 million to less than 1.1 million. Yet over the same period employment in non-manufacturing industries increased by 2.5 million. The service industries have provided the jobs growth, and that is likely to continue.
This change in the employment role of Australian manufacturing has perfectly straightforward explanations. As incomes increase, people tend to spend smaller proportions of their (higher) incomes on manufactured products. Technological advances also reduce the need for labor employed in manufacturing. Thus every OECD country except Turkey has had a relative decline in manufacturing since the early 1970s. Certainly, Australia needs a viable, strong and competitive manufacturing industry -- but that will not provide jobs growth.
The disappearance of manufacturing as a source of employment growth in itself provides a powerful counter to suggestions that we should now copy Japan and the Asian "tigers" by pursuing policies to "encourage" particular industries. But the basis of such suggestions was, in any event, always flawed. In particular:
- Many studies have concluded that government assistance had little net positive effect on the performance of the targeted industries in these countries;
- The most important factors explaining their strong growth were the initial "catching-up" with Western technology;
- flexibility and competitive labor markets;
- a strongly unified culture supportive of the "work ethic";
- and the establishment of international competitiveness through vigorous competition at home or internationally.
The intervention occurred in a period when there was maximum concern in those countries with improving material welfare and only limited concern with democracy and individual rights. That period is now passing, and has long since passed in Australia, if it ever existed.
The experience of Japan and the five Asian "tigers" with government intervention has no substantive relevance for Australia.
Interventionists also argue that, as Australian producers face a wide range of subsidies, tariffs, non-tariff barriers and tax concessions when they attempt to compete internationally, it is appropriate for Australia to tilt its own playing field.
However, contrary to popular conception, the level playing field concept has nothing whatsoever to do with international level playing fields but is about having a level playing field within Australia.
The whole basis of the concept is that, as government assistance to some industries involves taxes on other industries or consumers within the same economy, it should be removed and the exchange rate should be left to play its role as "natural" protector. The vital role played by the exchange rate in adjusting to foreign competition is almost invariably completely overlooked (or perhaps not understood) by interventionists.
Contrary to the assertions of interventionists, Australia is a long way from having policies that could be described as economically rational.
We still have high protection. More importantly, that policy is of relatively minor significance in the total policy scheme of things.
We still have one of the most regulated industrial relations systems in the world and the accord between the Government and the ACTU is a classic example of how not to leave it to the market. We also still have an extended social welfare system and a high degree of government intervention in the operation and financing of electricity, transport, water supply, airlines, telecommunications, shipping and wool marketing, to name just a few areas. While some of these areas are now being given greater exposure to market forces, in most cases government still retains a significant role.
As the Economic and Planning Advisory Council recently pointed out, "Privatisation is yet to have any marked impact on the size of the Government business enterprise sector in Australia", which "actually grew slightly in importance in the mid-1980s in contrast to a number of other OECD countries".
NOW, it is true that there has been a substantial amount of deregulation in two area -- the protection of the manufacturing industry against import competition and the protection of the banking industry against competition, whether overseas or domestic. But can the increased operation of market forces in each of these areas be blamed for the present recession?
Greater competition in the area of financial deregulation provided the opportunity for both increased borrowing and increased lending. Equally, it is clear that the 1980s witnessed "excessive" borrowing and lending in the private sector -- "excessive" in the sense of being unsustainable. However, that does not mean that financial deregulation was the cause of that excessive borrowing and lending.
The main cause of the present high levels of unemployment is the expansionary interventionist policies pursued by the Government in its first five years in office. These policies sought to allow demand and employment to grow continuously at a faster rate than before -- and faster than in our major trading partners.
Pursuit of this expansionist macro-economic strategy -- ironically, under the slogan of "jobs first" -- led to a rate of spending and borrowing that could only have been sustained with a marked improvement in productivity.
That improvement did not occur, and could not have occurred without a marked reduction in government intervention in labor markets and in protection.
In the case of the reduction in protection, there is an even stronger case to say that no connection exists between the present recessed state of the manufacturing industry and the lowering of tariffs and elimination of quotas. The reduction during the 1980s in the average effective level of assistance to manufacturing -- from about 24 to a still high 16 per cent -- has been more than offset by the depreciation in the real exchange rate.
In fact, it has been estimated that manufacturing's overall capacity to compete has actually increased by about 20 per cent since the early 1980s.
The advocacy of interventionism as an alternative to more market-oriented policies is based on a lack of understanding of the causes of present problems and of the capacity of the economy to adjust to changing circumstances.
Free trade could even lead to a relative expansion in manufacturing, as suggested in one recent report to the Australian Manufacturing Council.
A FINAL word about social and cultural values. While the interventionists frequently fail to identify their "cultural values", they imply that "full employment" is one of them. If that is the case, they are at one with economic rationalists. Any difference thus boils down to how that is going to be achieved.
The bottom line is that interventionists are not facing the reality that the experiment with increased government intervention, especially in the past 25 years or so, has failed.
Like it or not, big government and the corporatist approach to governing are on the retreat. They are on the retreat because there is a growing understanding that all countries must compete internationally and that the standard of living of their people depends on them doing so.
Australia is no exception.
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