Vol. 7, No. 4
SUMMARY
Increased globalisation has led to claims that governments now have a more limited capacity to pursue "independent" macroeconomic policies. However, before financial deregulation, financial markets also imposed constraints on such policies. Concerns about financial deregulation derive importantly from the experience of the 1980s and largely overlook the poor policy performance of governments, including Australia's.
While globalisation is putting competitive pressure on Australian governments to perform more efficiently in the delivery of services, it does not provide any significant inhibition on "big" government where financing is not by borrowing.
Financial deregulation has resulted in a deepening of international capital markets and increased the scope for governments to pursue "flexible" macroeconomic policies. It imposes less "discipline" on such policies than the pegged exchange rate regime. Indeed, governments are now allowing the exchange rate to be used more as the adjustment mechanism and are pushing against prudent limits on debt, whether internal or external.
To reduce significantly the risk of major instability from volatile actions of international financial markets, and markedly improve the medium-term performance of the Australian economy, the following approaches should be adopted:
- The Commonwealth Government should state as a policy objective the achievement of an external situation with a much reduced risk exposure.
- The Commonwealth Government should become a significant net saver -- not by raising taxation but by reducing spending.
- Over time, social security and associated assistance should be reduced by concentrating them more on low-income and other genuinely disadvantaged groups.
- Price stability should be established as the sole objective of monetary policy by adopting a monetary policy framework similar to that in New Zealand.
- The Commonwealth Government should indicate that the savings and price stability objectives would not be varied when fluctuations occur in the domestic economy, except where there is a large exogenous "shock".
- A public programme of "education" should be implemented showing why governments do not have the capacity to prevent short-term fluctuations in the economy.
- Legislation should be introduced to make budgetary and monetary policy processes more transparent and accountable, and to constrain the power of executive government, along similar lines to New Zealand's fiscal/monetary legislation.
INTRODUCTION
According to the Bureau of Industry Economics, "the essential feature of globalisation is that firms pursue global strategies in which their international activities are linked and coordinated on a world wide basis". (1) But the phenomenon of globalisation extends also to capital markets and has been an influence since at least the establishment of the euro-dollar market in the 1960s. In those markets, financial institutions of various kinds, together with individual investors, are also pursuing global strategies in the investment of funds under their control. Such globalisation may be viewed as both a cause and an effect of the increased interdependence of countries -- a cause in the sense that the natural tendency, in a world of vastly improved communications and transport, for entrepreneurs to extend their activities beyond national borders opened the eyes of governments to the potential advantages from allowing and encouraging such activities; and an effect in the sense that the removal of restrictions on trade and capital flows encouraged further globalisation of national economies.
This growing interdependence is reflected in the increased ratios of international trade to GDP and of foreign private direct investment to total domestic business investment, as well as in the increased number and size of multi-national enterprises. It is also reflected in the increased international capital flows of a shorter term nature. Thus, between 1980 and 1992, world merchandise trade increased by an average of 3.9 per cent per annum in real terms, and world output by an average of 2.1 per cent per annum (Australia's foreign trade also increased significantly relative to GDP in the 1980s, as did its outwards and inwards foreign equity investment). Between 1983 and 1992, total direct investment abroad grew at an average rate of 25 per cent per annum and, by the early 1990s, there were some 37,000 parent multi-nationals (of which BHP and News Ltd were among the 100 largest) which had over 170,000 affiliates. (2)
Increased interdependence has naturally tended to increase the exposure of domestic economies to developments in other economies and to attitudes of investors from those economies. In Australia's case, one recent study indicates an increasing correlation between Australian and foreign output growth since the early 1980s, although the author acknowledged that it is not clear how this has occurred. (3)
These globalisation effects have, in turn, led to claims that national sovereignty has been reduced and that governments now have a more limited capacity to pursue "independent" policies. Such claims relate to a wide range of policies. In their more extreme form they even postulate that multinational enterprises and "financial markets" are now the controlling influence on domestic economies.
In the case of macroeconomic policies, financial deregulation may be regarded as the facet of globalisation which impinges most heavily. The concern most frequently expressed is that governments have become excessively subject to either the "discipline of financial markets", resulting in excessive focus on economic efficiency at the expense of social equity; or to the vagaries of such markets, resulting in disruption to domestic economies or forcing governments to implement unnecessary changes in policies. For example, in a recent article, Mr Fred Argy, who was secretary of the Campbell Committee inquiry which recommended deregulation of the financial system, argued that the effect of financial deregulation has been to impose "a major constraint on the ability of governments to implement (through tax and transfer policies) the community's preferred set of social priorities", and that it has created "a strong policy bias in favour of low inflation and 'small government' ". (4) Reflecting concern at the potential for destabilisation from speculative capital movements, Argy went on to suggest that "The time has surely come for co-ordinated international action to better manage destabilising short-term portfolio capital flows across national borders".
GENERAL OBSERVATIONS
Changes in technology and improved communications have undoubtedly played an important role in the globalisation process, in the sense that they have both allowed and encouraged the process -- some would say, made it almost irresistible. However, the increased exposure of most countries to international trade and capital flows also reflects decisions by governments to reduce the barriers to such flows: indeed, without decisions to allow foreign direct investment, and to provide an environment conducive to it, multi-national enterprises would not exist. Such decisions were made on the perception that net benefits would flow from them. The great majority of economic and other informed analysts continue to perceive such net benefits. Indeed, the liberalisation of capital flows has recently been portrayed as offering potential benefits not previously identified, at least by economic theorists. (5)
It should also be noted, nonetheless, that many governments still retain extensive barriers to trade and capital flows. (6) Many also still have exchange rates which are either fixed or set via managed floats. These governments have presumably decided that the potential benefits from more liberal regimes are more than outweighed by the costs. Restrictions on trade and investment are often retained where greater exposure to foreign influence is judged as being likely to have detrimental effects on national "culture".
In Australia's case any move to return to a more "isolationist" regime, even as regards capital flows, would be most unlikely to find significant support. Argy, for example, did not advocate financial re-regulation in his recent analysis and it is now widely accepted that such re-regulation would be impractical for a government that wants to ensure that the country's businesses and citizens play a significant role in the international marketplace.
The main issue, therefore, is whether anything can (or should) be done to reduce the perceived potential for adverse effects arising from globalisation. This issue extends across a range of policies but, for present purposes, consideration is limited mainly to macroeconomic policy and financial deregulation issues. As such, it also serves to raise the question of the role of macroeconomic policy itself.
IMPLICATIONS OF GLOBALISATION
FOR MACROECONOMIC POLICIES
Argy suggests that financial deregulation imposes a bias in favour of "small government". However, international investors are much more concerned with whether social policies are soundly financed than with their extent. There are already wide differences in sizes of government and extents of taxes and social transfers. "Big" governments in this sense may be somewhat more susceptible to destabilising capital flows than are "small" governments. But financial markets provide no serious inhibition to a country moving to a bigger government provided it does so in a financially responsible way.
Of course, if a country's government moved to extend income redistribution and, in consequence, reduced national productivity growth and the national propensity to save, that would, over time, necessarily be reflected in a lower real exchange rate and reduced relative living standards. Such a process would also occur, however, if the country was less internationally oriented. And, provided the extension of income redistribution was not financed by borrowings, there is no reason to expect that it would unleash forces that would destabilise the domestic economy.
Nor should such forces be unleashed solely because a country opts to provide a significantly greater proportion of services through the government sector. While there is little doubt that globalisation is causing greater emphasis to be placed on improving the efficiency of the government sector, such action was (and is) needed in any event.
For macroeconomic policies, the main issue is whether financial deregulation has reduced the capacity to employ fiscal and/or monetary policies to "manage" the domestic economy and, if so, whether anything can or should be done about that.
In considering this, it might first be noted that there were many occasions prior to the 1980s when the excessive pursuit of interventionist macroeconomic policies, designed to achieve benefits in terms of economic activity and employment, produced adverse reactions from financial markets. Indeed, the post-World War II era of pegged exchange rates, and highly regulated international capital flows, witnessed periods of balance-of-payments "crisis" and remedial demand-restraining action for many countries. An OECD study of eleven major crises among OECD countries (7) -- of which the most notorious is perhaps the U.K. sterling crisis of 1976 which ended with the government signing a letter of intent with the IMF setting out fiscal and monetary targets -- clearly shows that such crises were serious and not infrequent prior to the 1980s. The study shows that the underlying causes were bad domestic macroeconomic policies. As noted, the globalisation of financial markets started well before the 1980s.
In Australia's case it was consistently argued by some analysts in the 1950s and 1960s that a chronic balance-of-payments problem existed, requiring more centralised economic planning. Fortunately, the Menzies Government rejected this approach as recommended by the Vernon Committee in 1964. Moreover, notwithstanding the existence of stringent exchange controls on capital movements, the period was far from being free from "speculation", which was always available through "leads and lags" in Australia's external payments.
It might also be noted that most Latin American countries experienced a massive debt crisis in 1982 when they allowed re-cycled petro-dollars to be injected into their economies without taking adequate countervailing action on fiscal or monetary policies. Governments of these countries were subsequently forced to curtail domestic demand because foreign capital ceased to be available to finance large current account deficits. The result was, as one observer has put it, "The 1980s was a lost decade for Latin America and not only in terms of capital inflows. Growth was low or negative and, in several countries, annual inflation rose to three or four digit rate". (8)
In short, prior to financial deregulation the capacity to use fiscal and/or monetary policies to "manage" domestic economies was constrained -- and was also subject to the "discipline of financial markets". Arguably, the widening and deepening of international capital markets since financial deregulation now provides greater scope for countries to pursue policies which "stimulate" economic activity or which seek to maintain it in the face of, say, reduced export income.
Indeed, international investors appear to have a surprisingly wide range of tolerance. This is reflected in the considerable spread of ratings which the credit rating agencies apply even to national governments. (9) What this says, in effect, is that international investors are prepared to lend to national governments even when those governments allow relatively high rates of inflation and borrowing, provided those governments are prepared to pay an additional risk premium. Thus, governments do still have scope to pursue macroeconomic policies which differ quite substantially: but, as one would expect, there is a cost of doing so which will be reflected in higher real (and nominal) domestic interest rates and lower private investment. I believe that the credit rating agencies and international investment institutions are too tolerant of lax macro-policies, allowing governments to pursue those policies to the point of financial crisis.
The main concern about the implications of financial deregulation derives to a large extent from the experience of the 1980s, which ended in a quite severe recession and increased unemployment. Those expressing concern about that period and its aftermath point to the apparent growing tendency for "financial markets" to react adversely -- and in some cases, extremely -- to economic developments which, while capable of being interpreted as sending a signal that a government is pursing macroeconomic policies that are too "lax", may also be open to the interpretation that they are a normal part of the business cycle. (Australia's present current account situation might, arguably, be said to be open to such different interpretations.) When such financial markets' reactions occur, a government may be "forced" to take action to curtail domestic demand when, it is argued, no such action is required if a longer-term perspective were taken by international investors.
The problem with those putting this position -- and arguing that "something" needs to be done about it other than to pursue better macroeconomic policies -- is that they fail to acknowledge the poor record of macroeconomic performance of governments not only in the 1980s but also in the decade or so leading up to that time and, in many cases, their continued relatively poor performance, particularly as regards fiscal policy. In Australia's case, the macroeconomic policies pursued by the Labor Government in the first part of the 1980s were undoubtedly the most interventionist ever pursued by an Australian Government. Thus, under an Accord with the trade union movement which provided for wage restraint, the Government sought, through a combination of fiscal stimulus and relatively "benign" monetary policies, to achieve a higher rate of economic growth than would otherwise have been the case. The notion was that the Accord would prevent the wages upsurge which would normally be expected to occur as the economy approaches "full employment", and that the (newly floated) exchange rate would "absorb" any strain on the balance of payments. However, the fact that productivity growth remained stagnant meant that the (stimulated) increase in national spending was not matched by an equivalent increase in national output. This resulted in a "blow-out" in external debt and other foreign liabilities and, to retain the confidence of foreign investors, necessitated the severe tightening of monetary policy which produced the recession of the early 1990s and the associated steep rise in unemployment. (10)
Against this background, and having regard both to the large foreign liabilities accumulated by the public and private sectors as a result of the 1980s experience, as well as to indications that Prime Minister Keating has been prepared to adopt a high risk strategy with regard to the operation of macroeconomic policies, (11) it is scarcely surprising that international investors are "twitchy". There is little doubt that pursuit of similar macroeconomic policies before financial deregulation would have resulted in a(nother) balance-of-payments "crisis" well before now and, importantly, a hauling back in the stance of macroeconomic policies. In assessing the implications of financial deregulation, it is important that this increase in flexibility be recognised.
In short, contrary to the thesis that financial deregulation reduced the scope for adopting "flexible" macroeconomic policies, I argue that it increased it. In particular, under the "fixed" exchange rate system, the need to change the rate was widely acknowledged as also requiring adjustments to other domestic policies at the same time. By contrast, the move to floating rates gave governments greater scope to pursue "flexible" macroeconomic policies which, through the operation of relatively large budget deficits and/or relatively high rates of growth of monetary aggregates, have resulted in high and (in many cases) increasing ratios of public debt to GDP and/or of external debt to GDP. In effect, governments have increasingly taken the easy way out and allowed the exchange rate, coupled with external debt accumulation, to be used as the adjustment mechanism when it is politically "too hard" to use macroeconomic policies.
Of course, increases in debt are not necessarily to be regarded as a "bad thing", if borrowing proceeds are used productively. There is evidence to suggest, however, that, in Australia's case particularly, they have largely financed increases in consumption rather than investment. In consequence, international investors are now making investment decisions against a background where governments and/or countries appear to be constantly pressing against prudent debt limits. (12) It is scarcely surprising, in these circumstances, that financial markets are volatile or that they are prone to take a set against particular countries and their currencies.
Economic theory in fact supports the view that financial deregulation has given to governments more flexibility in operating macroeconomic policies. In principle, the move to a floating exchange rate allows a country to pursue an "independent" monetary policy because the supply of money is no longer affected by changes in the external situation. Such changes are, instead, reflected in variations in the exchange rate needed to balance any change in the underlying demand/supply situation for a country's economy. (13)
Thus, so the theory goes, a government that wishes to use its monetary policy to, say, effect a short-term stimulus to economic activity, or to maintain it in the face of, say, reduced export income, is able to do so without fear of losing external reserves, provided it is prepared (and able) to live with the consequential exchange rate and price adjustments, as well as the consequential deterioration in the current account deficit. Equally, a similar use of fiscal policy will tend to have similar consequences. What happens in these situations, in effect, is that there is an increased draw on overseas savings in order to finance an expansion or maintenance of domestic economic activity.
Under a "fixed" exchange rate regime, the pursuit of similar macroeconomic policies would also have increased Australia's current account deficit and draw on overseas savings. Moreover, while that process would tend to have been reflected to a greater extent in drawing down overseas reserves (with consequential effects on the money supply), that did not necessarily prevent the exercise of flexibility in macroeconomic policies. For one thing an expansion in domestic activity would tend to have attracted additional private capital inflow, thus offsetting the downward trend in reserves. For another, it was open to the government to offset reductions in reserves by overseas borrowing. In short, there was scope under a fixed exchange rate regime to exercise flexibility in macroeconomic policies. But, as noted, that regime actually tended to impose a more disciplined approach to macroeconomic policy.
Comparisons between what happened or would have happened under a pegged exchange rate and exchange controls on capital movements, on the one hand, and what happens under the present floating regime to-day, on the other hand, are largely of academic interest only. For those who wish the Australian Government to have macroeconomic flexibility, the main issue now is the price at which international capital markets are prepared to finance an increased current account deficit, whether that be from "expansionary" macroeconomic policies or reductions in exports due to an overseas recession. If "financial markets" judge the external situation to be unsustainable, the result will be downwards pressure on the exchange rate and upwards pressure on domestic interest rates, with potential adverse consequences for domestic economic activity.
The reality is that, whatever the theoretical validity of the argument that there is now a greater capacity to pursue an "independent" monetary policy, limits still exist on the extent to which international investors are prepared to finance current account deficits even in a world which perceives (for the present) inflationary risks to be relatively small, particularly where such deficits appear to be driven to an imprudent extent by consumption expenditure. Nobody knows what those limits are, and economic theory tells us that the current account deficit should not be a policy target. (14) Yet the sensitivity of financial markets to changes in Australian Government policies, and to various economic indicators, probably reflects the using up of a good deal of credibility in the 1980s and the apparent preparedness of the Government to continue to run high-risk policies in the 1990s.
CAN INTERNATIONAL CO-OPERATION HELP?
Whether or not globalisation has made it more difficult to "manage" the economy, the question thus arises as to whether anything can (or should) be done.
As noted, even quite strong critics of financial deregulation accept that the benefits outweigh the costs and do not wish to re-regulate. Such critics do, however, point out (correctly) that assessments made by international investors of a country's economic position and policies are not only sometimes incorrect but also tend to be somewhat volatile. The net result may be to add to the uncertainty of domestic economic decision-makers, or to cause exchange rates and longer-term interest rates to move out of line with economic fundamentals, with adverse effects on national economic performance.
One possible response to this situation is to strengthen international "co-operation" in one form or another. Possible suggested areas of co-operation include greater co-ordination of macroeconomic policies and/or action to maintain exchange rates within a given range. The International Monetary Fund is, for example, seeking to strengthen its surveillance of countries' economic positions and policies "in order to improve (the IMF's) capacity to work as an early warning system"; to obtain increased resources to avert crises similar to the recent Mexican one by strengthening its capital base "through a quota increase"; to "work on the role the SDR could play in putting in place a last-resort financial safety net for the world"; and "to make our most effective instrument -- the enhanced structural adjustment facility -- better suited to addressing the problems of poorer countries." (15) Another example is the agreement by the countries that are to form the European Union to standards of performance in regard to budget deficits and inflation rates as a pre-condition for the foreshadowed move to a common currency. However, there has been little, if any, progress towards achieving the performance standards and those standards appear, in any event, to be minimal. They are certainly of limited relevance to Australia, which has some different structural problems from those of European countries.
To reduce the potential for destabilising short-term capital flows through international co-operation, the minimum action that would be necessary would be for there to be agreement on a convergence in macroeconomic policies of at least the major countries and an implementation of the policies needed to achieve such convergence. The domestic political difficulties of achieving that appear to be almost insuperable. Yet measures which attempted to keep exchange rates within prescribed limits would be doomed to failure in the absence of such policy convergence, as European experience in 1992 and 1993 demonstrates. Moreover, even with macro-policy convergence it is by no means clear that destabilising capital flows would not occur from time to time. (16)
To be effective in a sustained way, international policy co-ordination would also need to be directed to medium-term objectives, such as price stability, public sector saving, and improved efficiency of the government sector. Attempts by OECD governments in the 1970s to lift growth rates through co-ordinated stimulatory macroeconomic policies do not appear to have had any sustained effect on growth rates, and the higher inflation rates which resulted may have had counter-productive effects over the medium term. At all events, such attempts have largely been abandoned, and OECD (and IMF) analyses and reports increasingly emphasise the need to (for example) reduce structural budget deficits.
Particularly having regard to the rather different structure of the Australian economy, it seems most unlikely that Australian governments would be able to obtain relief in the economic management task from increased international co-operation and policy coordination, at least for the foreseeable future. As its representatives did in the OECD debates of the 1970s, the Australian Government should itself concentrate on encouraging international institutions to promote sound domestic economic policies among their members and to avoid international schemes, such as the IMF's pipedream for the Special Drawing Rights (SDR), that are more likely to induce a false sense of security and give international institutions undue and unnecessary power and influence, than to improve economic performance. International economic and financial institutions do have some potential to assist in bringing greater stability to international financial and product markets and, hence, to domestic economies. But that role is more of an information one -- of keeping markets informed and of sounding warnings -- than of a policy co-ordinator or a supplier of temporary financial support. The recent public statement by IMF Managing Director Camdessus, made in the context of the sharp depreciation of the $US against the yen, that the US should tighten credit, is of particular interest in the context of his espousal of the IMF's role as an "early warner". It appears that the G7 meeting at the end of April 1995 actually endorsed an enhanced role for the IMF in acting as an early warner.
WHAT ROLE SHOULD MACROECONOMIC POLICIES PLAY?
Given that international policy co-ordination/co-operation are most unlikely to alleviate problems perceived to be faced by Australian governments in managing the domestic economy in the context of increasing globalisation, what, if anything, should be done to reduce the risk of the Australian economy being adversely affected by international developments of one sort or another? The posing of such a question raises the further, in some ways more fundamental, question of whether macroeconomic policy should seek to "smooth" fluctuations in the domestic economy.
One thing seems plain. While it would not be appropriate to set a target or targets for the current account deficit, the Government needs to pursue policies that move the external accounts to a situation with a much-reduced risk exposure. It is little short of astonishing that, after the disastrous experience of the 1980s of allowing the current deficit to "blow-out", deficits are again running at levels which expose us unduly to the vicissitudes of international capital markets. We are, in effect, riding the high wire and, if something goes wrong, we have no idea how far below us the safety net may be.
While some argue that we are unlikely to indulge again in a splurge of overseas borrowings so soon after the experience of the 1980s, such abstention would not necessarily guarantee that we will avoid an externally-induced recession. Running a persistently large current account deficit creates the constant risk of a loss of confidence in the sustainability of that excess-spending situation, and of a sudden difficulty in attracting the foreign capital needed to finance the deficit, not to mention the possibility of outflows of capital. (17) For Australia, a repetition of the 1980s experience of many Latin American countries is unlikely: but we should nonetheless take careful note of the lessons from it.
One of two primary requirements is a higher rate of domestic saving. Fitzgerald and others have suggested that the aim should be to increase domestic saving by about 5 percentage points of GDP, equivalent to over $22 billion in current prices. That would take domestic saving back to around the average levels achieved in the 1960s and would allow, possibly even ensure, (18) the lift in investment which is needed to secure a sustainable increase in Australia's rate of economic growth.
This is not the place to examine all the various possibilities for increasing domestic saving. It is sufficient for present purposes to make the point that a major contribution needs to come from the public sector. There is, in fact, justification for the public sector becoming a net saver quite apart from the need to lift total domestic saving to reduce our call on overseas saving and increase domestic investment. That justification derives from the large expansion in public spending on social security and associated forms of government assistance (such as health, education and housing) over the past 20-25 years in particular. That additional public spending has had an anti-saving and anti-employment bias. It has eroded the incentive to save and to work and has undoubtedly contributed both to the decline in private sector savings rates and to the increase in unemployment rates. It has encouraged the attitude -- why save, and why try for a job, when the State will look after you?
What has happened, in essence, is that there has been an expansion in government social security and associated forms of assistance which has reduced the private sector's propensity to save. Yet nothing has replaced that source of saving. In fact, over the past 20-25 years during which this assistance has exploded there has been an increase in public sector deficits. Thus, national savings have been hit by a double whammy -- reduced private and public sector saving.
The ideal response would be to cut back sharply on government social security and associated assistance, by concentrating such assistance to a greater extent on low income and other genuinely disadvantaged groups. (19) Large reductions in such spending may, however, require a good deal of public education and can probably only be achieved politically over a period. In the meantime, the Commonwealth Government needs to move, as quickly as possible, to establish a Budget surplus of the order of 2-3 per cent of GDP as the public sector's contribution to raising the rate of national saving.
That should be attained not by raising taxes but by reducing Commonwealth spending, including social security and associated assistance. Indeed, it should be a major policy objective to reduce spending sufficiently to both achieve a surplus of 2-3 per cent of GDP and to reduce taxation. All too often the high costs of taxation -- the so-called deadweight losses -- are overlooked. A recent study estimated that, in New Zealand, for every additional dollar raised from labour (or income) taxation the deadweight loss increases by 18 cents; in other words, national income is reduced by 18 cents. Such high deadweight losses from taxation at existing rates confirm the commonsense view that there would be considerable benefits in reducing the overall burden of taxation by, in particular, reducing the "churning" which leads to a net reduction in living standards.
The other main macroeconomic policy requirement is to operate monetary policy so as to try to maintain price stability. Requiring the Reserve Bank to aim for an inflation range of 0-2 per cent per annum, as in New Zealand, would seem appropriate. The attainment of such price stability could be expected to have a number of spin-offs, including increased saving and investment.
The two primary requirements proposed for macroeconomic policy imply that there would be a major shift in the objectives of such policy. In particular, the policy targets of a significant positive public sector contribution to national savings and of price stability would be objectives to be maintained over the medium term, to the extent possible. There would be no attempt to vary the stance of macro-policies to offset short-term fluctuations in the economy, either down or up, except where there was a large exogenous "shock", such as from a major change in the terms of trade. In that event some attempt to smooth out the effects (but not to permanently offset them) could be appropriate.
Experience and economic analysis indicate the undesirability of governments varying macroeconomic policy settings in an attempt to induce changes in economic activity. Particularly after the severe recession in many countries at the end of the 1980s and the long-term upward trend in unemployment, there is now a fairly widespread realisation that persistent attempts by governments to "smooth" the business cycle are likely not only to be ineffective but may also be counterproductive. (20) In this regard, the analysis by David Gruen, referred to in footnote 3, suggesting that there is a strong causal link between changes in Australian output and in overseas output, is of some interest. This seems to imply that attempts by Australian policy makers to smooth fluctuations in the domestic economy have been unsuccessful. It also implies that, having regard to the lags between policy action and response, our policy makers would need to accurately predict the course of fluctuations in overseas economies if they were to succeed in smoothing fluctuations in Australia. Moreover, there is little doubt that a definitive move to medium-term objectives of the kind proposed would have a major beneficial effect on the attitudes of international investors which would, in turn, reduce the risk premium on Australian interest rates and encourage additional private investment.
However, notwithstanding the potential for considerable benefits from establishing firm medium-term fiscal and monetary objectives, there is also little doubt that governments would be tempted to depart from such objectives from time to time, particularly as election time approached. To counter such tendencies it would be desirable to make the process of budgetary and monetary policy-making much more transparent, and much more accountable, along lines similar to those adopted in New Zealand.
There, the Fiscal Responsibility Act 1994 legislates for Governments to report to Parliament on their longer-term fiscal objectives and requires regular fiscal disclosure by the Government. The Act contains four main elements:
- a requirement for regular and explicit fiscal reporting (including immediately prior to an election);
- a set of benchmarks against which fiscal policies can be assessed (five principles of responsible fiscal management are set out);
- a move to a more open and transparent Budget process; and
- a requirement for select committee review and Parliamentary debate of fiscal reports.
It might be noted that current New Zealand fiscal objectives include the use of budget surpluses (which are forecast to reach 7.5 per cent of GDP by 1997-98) to pay off government overseas debt before any consideration is given to reducing taxation. Current fiscal projections provide for a reduction in the size of government to around 31 per cent of GDP over the next 3 years, from a peak of about 42 per cent in 1990-91.
New Zealand has also legislated to make the monetary policy process more transparent and accountable. This legislation provides, in particular, for monetary policy to be directed towards the single objective of achieving and maintaining price stability. It requires a written agreement between the Minister of Finance and the Governor of the Reserve Bank of New Zealand on the specifics of the price stability objective, and for that agreement to be made public. The current agreement requires the Governor to maintain underlying inflation within the 0-2 per cent range, excluding the effects of certain exogenous shocks, and to publish at least every six months a comprehensive statement on the monetary situation.
Legislation along the New Zealand lines in respect of both fiscal and monetary policy should be an important objective for the Australian Government. It would significantly reduce the risk of major instability from irrational or volatile action of international financial markets.
CONCLUSION AND SUMMARY
In considering concerns about the implications of globalisation, it is necessary to have regard to a number of points:
- As it has with the private sector, globalisation is putting pressure on Australian governments to perform efficiently in the delivery of services as part of the process of improving competitiveness. This was (and is) needed regardless of globalisation;
- Globalisation does not provide any significant inhibition on "big" government or on expanding the size of government for income redistribution or other purposes. Provided the financing is not undertaken by borrowing, the main adverse economic effects of "big" government (high taxation and less efficient services) will be reflected over time in lower real exchange rates and lower relative living standards;
- Before financial deregulation there are numerous examples of the constraints imposed on macroeconomic policies (and adverse effects from ignoring those constraints) by financial markets, notwithstanding the existence of (often stringent) exchange controls on capital flows;
- The concerns expressed about the effects of globalisation and, more specifically, financial deregulation, derive to a considerable extent from the experience of the 1980s. However, those expressing such concerns appear largely to overlook governments' poor performance in the operation of macroeconomic policies and, in particular, the unrealistic and naive attempts to use those policies to maintain economic activity and employment at unsustainable levels. In Australia's case the first four or five years of the Labor Government's period in office in the 1980s saw the adoption of the most interventionist macroeconomic strategy that has ever been pursued in Australia. Given the outcomes (including particularly the large accumulated overseas debt), it is scarcely surprising that the credibility of macroeconomic polices with financial markets has been diminished, all the more so in Australia's case as (at least up until very recently) Prime Minister Keating has given the impression that there are no lessons to be learned from the 1980s; and
- Globalisation and financial deregulation have resulted in a widening and deepening of international capital markets and, consistent with economic theory, floating exchange rates allow countries to operate more "independent" monetary policies. This has increased the scope for governments to pursue "flexible" macroeconomic policies and it imposes less "discipline" on such policies than the pegged exchange rate regime did. Certainly, the wide range of international credit ratings indicates that (subject to paying a price for less disciplined policies) international investors have a considerable tolerance of differences in macroeconomic policies. As a result, governments are now to a much greater extent allowing the exchange rate to be used as the adjustment mechanism and appear constantly to be pushing against prudent limits on debt, whether internal or external.
Whether or not financial deregulation has had this effect, however, the main issue now is what should (or can) be done to reduce Australia's exposure to (in particular) changes in attitudes of international investors. While economic theory suggests that the current account deficit should not be a policy target, the reality is that the size of and/or trend in that deficit can operate as an important constraint on macroeconomic policies, and can lead to a recession if the appropriate policy response is not forthcoming.
To reduce the risk of the Australian economy being adversely affected by international developments (whether arising from globalisation or otherwise), the following approach should be adopted in regard to macroeconomic policies:
- The Commonwealth Government should state as a policy objective the need to move to an external situation with a much-reduced risk exposure. The idea that the 1980s experience of over-borrowing will not be repeated is misleading. There is still a potentially serious external financing problem;
- The Commonwealth Government should move as soon as possible to a budget surplus of 2-3 per cent of GDP, not by raising taxation but by reducing spending. This is justified both as a contribution to the need for increased national saving as part of (i) and to increase domestic investment; and, in its own right, as an offset to the adverse effects on private sector saving from the enormous increase in spending on social security and associated forms of assistance;
- Over time there should be a major reduction in such assistance by concentrating it more on low income and other genuinely disadvantaged groups. This would help reduce social welfare dependency (with consequent economic and social benefits) and would also allow a reduction in the significant adverse effects from existing levels of taxation;
- Price stability should be established as the sole objective of monetary policy by adopting a monetary policy framework similar to that in New Zealand;
- The Commonwealth Government should indicate that the budget surplus and price stability objectives would not be varied when fluctuations occur in the domestic economy, except where there is a large exogenous "shock". (However, the budget surplus objective would be allowed to "absorb" cyclical fluctuations);
- As part of a new policy approach that focuses on medium term objectives (for both macro- and micro-policies), a public programme of "education" should be implemented to the effect that governments do not have the capacity to prevent short-term fluctuations in the economy, that such fluctuations appear largely to be externally-induced (where they are not caused or aggravated by policy mistakes), and that fluctuations are a normal (and healthy) part of the operation of the market-oriented system in which we live. Such a programme might include the publication of a Green Paper by the Treasury analysing the post-World War II fluctuations in the Australian economy, their possible causes, and the effects of policy interventions; and
- Legislation to make budgetary and monetary policy processes much more transparent, and much more accountable, along similar lines to New Zealand's Fiscal Responsibility Act 1994 and Reserve Bank of New Zealand Act 1989. This would require, inter alia, specific statements of fiscal and monetary objectives and more comprehensive and regular reporting in regard to those objectives and the economic and financial situation generally.
An approach along these lines should significantly reduce the risk of major instability from irrational or volatile actions of international financial markets. It should also result in a marked improvement in the performance of the Australian economy over the medium term.
ENDNOTES
1. Bureau of Industry Economics, Globalisation: Implications For Australian Information Technology Industry, AGPS, Canberra, 1989.
2. Data from Professor Peter Lloyd's "The Nature of Globalisation" in Globalisation: Issues For Australia, Papers and Proceedings from an EPAC Seminar, September 1994.
3. "Globalisation and the Macro-Economy" by David Gruen, Reserve Bank of Australia, in Globalisation: Issues For Australia, Papers and Proceedings from an EPAC Seminar, September 1994, concluded that international asset market links may have been the main way in which changes in foreign output in the 1980s were reflected in changes in Australian output, but could not establish this statistically.
4. "Deregulation Expresses Conflict between Efficiency, Social Equity" by Fred Argy, AFR, 11 April. The author's views are spelt out at greater length in Financial Deregulation: Post Promise – Future Realities, CEDA Research Study, P42, April 1995.
5. According to Professor Peter Lloyd, "There is a gain from freeing trade in primary factors over and above the gain from freeing commodity trade, assuming the latter does not equalise factor prices. The result derives from differences in the countries in terms of the productivities of factors". (From "Globalisation, Regionalisation and International Trade", paper to Economic Society, Victorian Branch, 29 March 1995.)
6. There are wide differences between countries in the size of external sectors relative to domestic economies, and in many cases these differences reflect restrictions on trade and/or capital flows.
7. Why Economic Policies Change Course: Eleven Case Studies, OECD, Paris, 1988.
8. "Globalisation and Financial Integration" by P.S. Anderson, Reserve Bank, in Globalisation: Issues For Australia, Papers and Proceedings from EPAC Seminar, September 1994.
9. For sovereign governments, the ratings agency Moody s has 19 international ratings, ranging from Aaa to C. Ratings below Baa3 are categorised as "speculative". Standard and Poors also has 19 international ratings, of which 10 are classified as "investment grade".
10. For a more extensive account of the policies pursued in the 1980s and their effects, see "Can Monetary Policy Be Made to Work?" by Richard J. Wood in the publication of that name.
11. While Mr Keating's public rhetoric has recently changed to acknowledgment of the potential for high current account deficits to create problems, it is apparent that his Government will do the minimum judged to be necessary to avoid a "crisis".
12. For further discussion of debts limits and associated issues, and their implications, see Debt: What Should Be Done, Richard J. Wood, October 1989.
13. Of course, monetary authorities rarely disregard the exchange rate in deciding monetary policy and changes in the external situation do not only affect the money supply. There may also be income effect6 (such as from terms of trade changes) and price effects (from changes in the exchange rate itself). Note also that changes in the exchange rate in response to changes in the current account situation will, over time, tend to produce responses which return that situation to "normal".
14. Interestingly, however, the Governor of the Reserve Rank has suggested that a current account deficit equivalent to about 3.5 per cent of GDP would be "sustainable". This implies that Australia's net foreign liabilities would increase at about the same rate as the economy grows (so that the relative net foreign liability burden would stabilise), which has not been the case for same time.
15. From an address by IMF Managing Director Michael Camdessus on March 7 at the United Nations World Summit on Social Development in Copenhagen, reproduced in IMF Survey, 20 March 1995. It might be noted that the IMF has also been giving consideration to possible schemes for stabilising exchange rates to a greater extent by keeping exchange rate changes within bands. It is somewhat ironical that Mr Camdessus expressed concern at the rapid contagion effects from what he described as the "Mexican events" while espousing the IMF's potential to work as an early warning system. The reality is that Mexico's current account deficit had been running at clearly excessive levels for some time before the "events" but the IMF did not issue publicly (or even, effectively, privately) any early warnings.
16. Differences between countries in productivity growth in the traded goods sectors would require exchange rate adjustments from time to time and, if these were not made, markets would seek to force adjustments.
17. Of course, with a freely floating exchange rate, it is not possible to have a net outflow of capital. But would the Government be prepared to live with the exchange rate and interest rates consequent on a loss of confidence?
18. The assumption here is that an increase in domestic savings will mostly be invested domestically rather than overseas.
19. Some proposals along these lines are set out in "Commonwealth Budget: Cut Spending by $15-16 Billion", Richard J. Wood, Backgrounder, 10 February 1995.
20. For further elaboration of this issue see The End of Macro-Economics, Professor David Simpson, Institute of Economic Affairs, Hobart Paper 126, October 1994.
