Why can't we see the books?

The debate about the Federal Government's failure to publish revisions to the forward Budget estimates for 1996-97 and the subsequent two years has so far missed a key question;  if the Government was able, in February 1993, to publish revisions to the forward estimates for 1993-94 and the subsequent two years, why can it not in February 1996, publish similar revisions for the next three years?

The February 1993 revisions were published after the 1993 elections were called.  There can therefore be no question of any breach of the "caretaker convention" if the February 1996 revisions were to be published now (in any event, that convention is not really relevant, as the publication of revised forward estimates based on existing policy would not involve any new policy decisions).

Government spokesmen have been reported as suggesting that, as the 1996-97 Budget will not now be brought down until August 1996, it is too early for revisions to be made.  However, there was an August Budget in 1993, too.  If forward estimates revisions could be published in February 1993, when the next Budget was scheduled for August, there is clearly no reason why they could not be published in February 1996.

It is true that the revisions published in 1993 applied only to the expenditure side.  However, the revision process would have involved the compilation of forward estimates for GDP and other similar identities and such forward estimates naturally allow the compilation of revenue estimates.  Indeed, since 1993, the Government has moved to publish forward estimates of both expenditure and revenue, as in the May 1995 Budget.

There can therefore be no possible justification for failing now to publish revisions to the forward estimates for 1996-97 and the following two years, particularly as everybody knows that such revisions must already exist in some form on Treasury and/or Finance files.

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Government urged to issue missing estimates

The Government has rejected an Opposition request to issue any forward Budget estimates for 1996-97 and later years, claiming this would bring the estimates out of the normal Budget cycle.  Richard Wood says revised forward estimates should be available within the normal Budget cycle, and were made available at the start of the 1993 election.

AT a time when both major parties are making election promises that are adding to Commonwealth Budget expenditures and the deficit, it is vital that analysts have access to the official estimates for the Budget and the economy so authoritative assesments and critiques can be made of the possible future implications of the parties' policies.

This is all the more important given the now generally recognised need for the Commonwealth to become a net saver in order to reduce the constraints on private sector growth imposed by Australia's high current account deficits and high real interest rates.

Both parties need to state how and when they propose to achieve the "structural" surpluses that indicate that the Commonwealth has become a net saver.  Unfortunately, the Government is not providing the information needed to allow an informed appraisal.

The contrast in this regard with the 1993 election provides a striking indication of the decline in the Government's fiscal responsibility.

After announcing the election in 1993, the Prime Minister, Mr Keating, almost immediately launched the Investing In the Nation statement on 9 February, which included a range of measures mainly designed to improve the competitive position of small and medium-sized business.  These measures included a reduction in company tax from 39 per cent to 33 per cent and a new general investment allowance of 10 per cent.

The same day, 9 February 1993, the then Treasurer, Mr John Dawkins, and the then Minister for Finance, Mr Ralph Willis, issued a joint statement that revealed that the estimated Budget deficit for 1992-93 had increased by $2.5 billion to $15.9 billion.

Just as importantly, the statement also contained upward revisions to the forward estimates of expenditure for 1993-94 to 1995-96 as published in the August 1992 Budget, as well as new forward estimates for 1996-97.  These revisions reflected changes due to estimated slower growth as well as the effect of policy decisions since the 1992-93 Budget.

FOR the 1996 election, the Prime Minister again started by launching a new policy -- this time

on youth employment -- after announcing the election.  There, however, the similarity ends.

While the Treasurer, Mr Willis, has already issued revisions of the estimates for the current financial year for both the Budget and the economy, there has been no revision of the forward estimates of expenditure, revenue and deficit published in the May 1995 Budget for 1996-97 and the subsequent two years.

This failure has occurred even though the mid-year Budget review process has already been undertaken by Treasury and Finance and revisions of the forward estimates must therefore exist in some form.

Mr Willis says he has not received any revisions of the forward estimates.  However, in order for Mr Willis (and the Finance Minister, Mr Beazley) not to have "received" revisions of the forward estimates, either the minister(s) or their office staffs must have instructed respective departmental officers not to forward them.

Such an instruction must have been given or else the Treasury and Finance departments would have forwarded them.

In short, it is simply farcical for Mr Willis and Mr Beazley to claim that the best Budget estimates available for 1996-97 and the next two years are those published in May 1995.

Private-sector forecasters estimate that the Budget deficit for 1996-97 could now be as much as $6 billion-$7 billion, compared with the official May 1995 estimate of a surplus of $3.4 billion.

Such an upward revision would imply a "structural" deficit of around $9 billion-$10 billion in 1996-97 as well as in the current financial year.  For the Commonwealth to be a net drawer on savings to this extent would be unacceptable and would likely result in the economy continuing to underperform as a result of uncertainty about the Government's capacities to pursue policies that produce sustainable growth.

So, Mr Willis and Mr Beazley, how about producing those missing estimates which we all know are sitting in Treasury and Finance files?  This is the necessary first step to allowing the electorate to make an informed assessment of the macro implications of both parties' economic policies.

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Reading between the jobless lines

AUSTRALIA V NEW ZEALAND -- THE LABOUR MARKET SCORECARD

THERE has been much recent debate, triggered in part by the Federal election, about the respective merits of the workings of the Australian and New Zealand labour markets since the NZ Employment Contracts Act was passed in mid-1991.

In this connection, a paper entitled So You Want To Go To New Zealand? was recently published under the ALP's name.  It's real origins, however, were revealed by the fact it was released on January 18 by the ACTU President Martin Ferguson under cover of an ACTU press release.

This release claimed that, under the new regime, NZ has experienced "stagnating real wages and slow productivity growth" and that between 15 and 40 per cent of NZ workers have suffered reductions in one or other working conditions.  The paper paints a picture of the NZ worker struggling to conclude individual contracts in a "law of the jungle" setting while his Australian counterpart is being protected under the Accord and the award system.

Any comparison of developments in the two labour markets since 1991 needs to recognise not only that major changes in the regulation of employment conditions take time to have effect but that there are factors other than employment regulation that influence the demand for labour.  In particular, New Zealand has been pursuing considerably "tighter" macro-economic policies.  On conventional wisdom, these might have been expected to result in a more restrained demand for labour and a higher rate of unemployment.

In fact, since the Employment Contracts Act was passed in mid-1991, the NZ unemployment rate has dropped much more than the Australian.  Using OECD standardised unemployment rates, both countries had around 10 per cent unemployment in mid-1991 but, while Australia's rate is currently around 8 per cent (and likely to rise in the immediate future), in September 1995 (the latest date for which data is available) NZ was just below 6 per cent (and was showing every sign of continuing to fall).  Moreover, the rate of unemployment among the European section of the NZ population was only 4.3 cent.

Further, even with a slower workforce growth, NZ employment has grown at a fast rate than in Australia.  Again using standardised OECD data, between June 1991 and September 1995 employment increased by 12 per cent in NZ compared with 7 per cent in Australia (up to October).

This faster growth in employment may explain why there has been a slower growth in labour productivity in NZ:  instead of trying to squeeze more out of their existing work forces, NZ businesses have evidently taken on additional workers.

It is true that average real wages in New Zealand have been comparatively stagnant over this period, but the difference is not all that large.

Of course, with little change in average real wages some sections of the NZ labour force will have experienced declines in real take home pay.  Some have probably also done so in Australia.  Another report -- in this case a joint one by the ACTU and ACOSS -- claims that the low-paid in NZ are earning significantly less and the higher paid significantly more since mid-1991.  Whether such claims will be substantiated by later research remains to be seen.

However, even if there has been some increased inequality in the distribution of earned income, this has to be weighed against the improved employment situation.  Certainly, only a small reduction in earnings may be required to produce improved employment.  This is suggested by the result produced by the Treasury's model which indicates that an improvement in the functioning of the labour market which lowers the NAIRU (the rate of unemployment at which inflation starts to accelerate) would result in a substantial increase in employment with only a very small reduction in real wages.

A system that allows greater flexibility in real wages, as in NZ, is in any event arguably more equitable because it gives a higher proportion of the working age population the opportunity of becoming employed.  It should not be a function of the labour market to deliver an appropriate distribution of incomes.  That is the proper function of the tax and social security system.

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Mostly it pays to privatise government enterprises

PROFESSOR Quiggin (AFR, February 1) suggests the Coalition's proposal to use part of the proceeds from the sale of Telstra to finance "normal government activity" means that the "main motivation for the partial sale ... is to make the Budget accounts look good".  However, while the proposal is an inappropriate departure from the most desired approach, it only involves using $1 billion out of $8 billion in this way, the remainder being used to retire debt.

The important question is whether, in the overall wash-up, the election proposals by the Coalition and the Government will result in the Commonwealth becoming a significant net contributor to saving in 1996-97.  That remains to be seen.  Achieving such a position will be important to restoring the confidence of the private sector in the capacity of the economy to sustain a higher growth rate.

Professor Quiggin also makes the remarkable claim that, other things being equal, "privatisation makes the public worse off" because the rate of return demanded by private holders of equity is much greater than the rate of return on government debt.

The fallacy in this reasoning is that it says the cost of borrowing should determine value.  Taken to its logical conclusion, it implies that the Government should own everything.  For example, consider the possibility of the Government purchasing, say, BHP.  Because the Government would be able to borrow at, say, 8 per cent, could it then "afford" to pay a much higher price than BHP's value in the market?  Of course not!  Imagine the outcry from (among others) Professor Quiggin if it did.

All assets, whether government or privately owned, should be valued by reference to what they generate, including what the market assesses as their prospective earnings (appropriately discounted).

There is no basis for a separate valuation of assets according to whether they are government or privately owned, although government-owned assets are likely to have a lower valuation because they are less efficiently managed and therefore generate less income/ benefits.

That is, essentially, why it generally pays to privatise government enterprises and why there have now been 15,000 privatisations worldwide.

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Competitive Federalism Revisited: Bidding Wars or Getting the Fundamentals Right

The Federalism Project
Issues Paper No. 5

INTRODUCTION AND SUMMARY

One of the problems which stands in the way of discussions of Competitive Federalism in Australia is that most State governments are prepared to compete among each other with subsidies and other discriminatory measures.  Some States will go to extraordinary lengths to tempt an investor, a project or a spectacle away from another State.  So, Victoria pulled off a "coup" in getting the Australian Grand Prix transferred from Adelaide to Melbourne.  Or Victoria and New South Wales competed for a new film complex by bidding with hand-outs of government money.  Or scarce taxpayers' money is offered around for a paper factory, a minerals processing plant, a computer software centre, a flight-training facility, or the honour of being the home base of the Australian Stock Exchange.

After the event, it usually becomes clear that such "coups" had a high price.  The "victorious" State government has handed over a prime piece of real estate for next to nothing;  has guaranteed to build some costly infrastructure;  has offered a five-year holiday from payroll tax;  or has promised to buy most of the product from the preferred company ...  There are many variations on the theme.

Sometimes the voters are impressed -- or, if they are in the losing State, upset -- and sometimes they are not.  Voters have perhaps become more cynical, since long experience tends to indicate to them that the benefits are rarely all they were cracked up to be.  In the meantime, voters and established businesses have been paying the price for the politicians' initiative, and faith in the political process has taken another bad dent.  When artificially-attracted ventures finally fold, the politicians tip-toe away from the wreckage.

But isn't this what competition is all about?  Wouldn't we see a lot more of this if Australian federalism was more truly competitive?

The answer on both counts is:  No.  In fact, competition by subsidies to selected and well-connected new investors -- which one may call "bidding wars" -- is a product of the design faults which now plague Australian federalism.  Those faults actually encourage administrative and political irresponsibility, and a better-designed system would tend to lessen this defect very considerably.

To clarify these issues, we shall first briefly repeat here the arguments put forward in an earlier paper, Competitive Federalism:  Promoting Freedom and Prosperity, before making a case against "bidding wars" and discussing a way to end the practice.

This paper makes two major points:

1. Competition between State and local governments serves citizens, fosters prosperity and helps to nurture the tax base.  Many government functions should therefore be devolved to lower levels of administration where they are subject to the competitive discipline of inter-jurisdictional competition.
2. Certain means of inter-State competition are ruinous:  offering selective preferments and subsidies that discriminate between different firms and citizens should be banned.

* * *

Australian federalism has become more and more centralised since Federation;  at the same time, governments competed less and less with each other.  Fiscal centralisation was part of a set of inward-looking, dirigiste policies which became known as the "Australian Settlement".  It failed;  and most of its components have been progressively jettisoned since 1980.  As of the mid-1990s, the cartel of non-competitive Federal, State and local administrations is the major remnant from the past, and it is one of the main impediments in the way of more successful Australian responses to the challenges of globalisation.

After Federation, governments developed a selective and discriminatory style of development policy, relying on hand-outs to specific investors, instead of concentrating on effective administration, nurturing a competitive cost level for the benefit of all comers and cultivating the long-term revenue base by fostering broad economic growth.  They were able to do so partly because the country was isolated from world-market competition for such a long period.  But here as elsewhere, such "picking the winners" policies frequently ended up with politically-picked losers.  This style of policy corrupted politics, public administration and industry.  In the 1990s, as the competitive forces of globalisation are becoming more pressing, such policies seem even less promising.  Yet some State governments are resorting again, and more blatantly, to selective subsidy policies, even though this erodes their future revenue base and is grossly unjust to established residents.

Since the States claim that they are caught in harmful "bidding wars", this essay argues for a "treaty of subsidy disarmament" between Australian governments to ban selective hand-outs and to confine inter-State competition to general policy measures that offer competitive tax regimes and attractive public services to all comers without discrimination.  Disputes over the implementation of such an inter-governmental agreement should be adjudicated by an expert body such as the Industry Commission and need to be enforced by the collective action of all Australian governments.

Given recent experiences, and Australia's culture of selective interventionism, a ban on secretive and selective subsidy policies seems necessary, if the nation is to reap the great benefits that Competitive Federalism has to offer.

THE BENEFITS OF COMPETITIVE FEDERALISM RESTATED

In an earlier publication in this series, I argued for a more competitive approach to the Australian federation by State and Commonwealth governments (Wood, 1995).  I made the case for reversing the historic drift toward centralisation of fiscal affairs in Australia.  To be sure, centralisation had been part and parcel of the "Australian Settlement", a compact that emerged early this century under which governments promised to provide Australians with material security and equality -- by tariff protection, central wage fixing, the White Australia policy and other dirigiste devices (Kelly, 1992).  The "Australian Settlement" failed, and most of its elements have been discarded.  As of the mid-1990s, the centralised "cartel" of government administrations seems the only pillar of the failed "Australian Settlement" which still remains more or less intact.  It is now becoming a big hindrance to managing our national affairs in a more competitive, individualist manner and in a manner that allows us to take up the challenge of globalisation more successfully by trading and by attracting more capital, knowhow and enterprise.

A strong case can be made for devolving many of the tasks that the Commonwealth government has taken over, and to rely more on what has become to be known as subsidiarity, the maxim that the lower level of government should always carry out the tasks of governance unless there is a proven case for a higher level to take over -- if doing so, for example, reduces transaction costs or facilitates economies of scale (Wood, 1995).  The basic reasons for preferring subsidiarity are that governments which are closer to the citizen find it harder to act against the citizen's interest, and that the knowledge necessary for citizen- and business-friendly government can be more easily marshalled and monitored within smaller, lower level jurisdictions.  Moreover, decentralised government administrations are fairly open to horizontal competition with other local and State governments.  This exerts cost controls, favours small government, nurtures accountability, and controls well-known agent-principal problems in governance.  Should lower-level governments get captured by single-issue pressure groups and grant them preferment at the expense of the general taxpayer, this tends to be more readily exposed and controlled when administrations have to compete with other administrations than is the case when similar preferential deals are struck in distant Canberra.  States that have to compete -- a condition not always given in present-day Australia -- are therefore less likely to fall prey to selfish interest groups and less likely to engage in costly, grandiose schemes that taxpayers do not really want.

In the literature on business economics, it has been established that agents who manage the principals' capital -- that is, the appointed managing directors in a firm -- may disregard the principals' interest and opportunistically pursue their own agendas.  This is known as the "agent-principal problem".  But it has also been established that competition in capital and product markets acts as a powerful control of the agents' self-seeking pursuits.  Similarly, we can conclude that inter-jurisdictional competition of governments in a decentralised federation controls the self-seeking tendencies of the political and administrative agents and empowers the principals, namely the citizens and taxpayers (Kasper, forthcoming, 1996).

Subsidiarity has to be given substance by implementing a number of supplementary principles (for details, see Wood, 1995):

• Exclusivity:  The government's tasks have to be assigned exclusively to the various levels of government to avoid shirking and duplication and to enhance accountability and clear responsibility.  In Australia, the Federal government has usurped more and more functions -- in education, health, policing, environmental control and many other areas -- and now duplicates what the States are doing, often at great cost and with no improvement of service.  Now governments are able to pass the buck, and the citizen, when faced with government failure, no longer knows whom to hold responsible.
• Fiscal equivalence:  Each level of government is responsible for raising the revenues necessary to finance the tasks it has been assigned.  There should be a ban on vertical fiscal transfers.  This will avoid the "moral hazard" now observable, whereby State and local governments can initiate spending programmes without the discipline of having to raise taxes, and the "moral hazard" of voters who demand spending programmes and elect "generous" politicians without having to face the immediate tax consequences.  In Australia, fiscal equivalence will require a more broadly-based tax regime that frees the States from the present strait-jacket of artificially narrow revenue sources.
• Rule of origin:  In the interest of competition among producers in various States, it has to be ensured that a product or service which is legal in one State can be sold, without further ado, throughout the federation.  This encourages a competition between regulatory orders and exposes government controls to the verdict of the market.  It tends to lead to a streamlining of regulations, and would make Australia as a whole internationally more competitive.

We shall argue below for a further principle of policy that is needed to add substance to subsidiarity, namely, a ban on discriminatory interventions and subsidies to benefit selected beneficiaries, which are not available to all comers (universal measures).

Once such a system, which we call "competitive federalism", is in place, certain observed shortcomings of our present federation would be reformed.  For example, competing jurisdictions would find it in their own self-interest to be more open and accountable, disclosing information and adhering to stable, transparent rules in reporting their finances.  Once there is more leeway for competition, inter-State comparisons and public scrutiny of comparative performance would be carried out to a much greater degree than is the case at present, and the often secretive cartel of Australian governments would disintegrate.

In Competitive Federalism (Wood, 1995), we made the case that encouraging administrations to compete more independently with each other in providing the best administrative and infrastructural support services for citizens and producers, would produce a number of important advantages:

1. Governments would be forced, to a much greater extent than is now the case, to support productive efforts by people and businesses;  they would have to nurture their own long-term revenue base by nurturing economic growth within their jurisdictions.  This would make an important contribution to the general rise in living standards, a score on which Australia has not done well -- though not disastrously poorly either -- for most of this century.

2. In the present process of globalisation, in which free information flows and low transport costs have given highly-skilled people, capital and enterprises great mobility among nations and regions, Australia faces the novel challenge of having to become more competitive in attracting these mobile growth factors.  If State (and local) administrations competed more with each other, they would learn better how to lift Australia's overall attractiveness and competitiveness.  They would streamline cumbersome and costly regulations, find new administrative devices that attract productive people, capital and enterprises, and quickly imitate what works elsewhere, while jettisoning administrative solutions that will fail in the changing global climate.  The whole "culture of governance" would become more business- and citizen-friendly as a result (Giersch, forthcoming, 1996).

3. Governments that compete with each other serve their clients:  the citizen is king.  Government powers to make arbitrary, opportunistic decisions are controlled.  Under our centralised fiscal regime, Australian State and central governments have, as mentioned, often been able to act as self-seeking monopolies, frequently offering poor service at a high cost.  When what has been termed "systems competition" among various jurisdictions is introduced into fiscal affairs, parliamentarians and government administrations will become more efficient, just as most private monopolists, when exposed to competition, discover how to offer better service and cut costs.

   This point is clearly supported by historic experience.  Post-mediaeval Europe was transformed for the better when absolute power was brought under control as the small, open states and provinces of Europe had to compete for footloose producers (Weber, 1927 [1981];  Jones, 1987).  More recently, regimes with little innate respect for individual freedoms, the rule of law or democracy in capitalist East Asia, the socialist bloc and elsewhere have likewise -- and out of their very self-interest -- been induced to enhance liberty, to open up and to attract and foster mobile resources for growth.  In the process, they discovered that inefficient bureaucracies and power-centred politics are liabilities which have to be reformed for the sake of better competitiveness.  In a similar vein, the opening of the Australian economy after 1980 has led to some increase in the rivalry among Australian governments at State and local levels.  This, in turn, has begun to improve the efficiency of governments, and led to some, albeit reluctant, streamlining of administrative procedures.  But genuine Competitive Federalism is needed to ameliorate further the liberty of the citizen, to control corruption and insider dealing among political power-brokers, and to enhance the quality of our democracy.

4. Democratically-elected governments in virtually all Western countries have been making numerous promises which they have not kept.  This -- and the presumed sovereignty of parliaments to hand out privileges -- has eroded electoral confidence and given rise to a degree of voter disaffection with politics.  It could, in the long run, undermine the very stability of democracy.  Governments and leaders now face an empirically well-founded credibility gap with the voters.  While the disillusionment with government and democracy in Australia is less advanced than, for example, in Europe, Australian parliaments and governments will nevertheless have to earn public support for collective action and the voters' confidence.  They can do so by competing successfully with each other, striving to offer voters what they, the sovereign citizens, really want. ⁽¹⁾

To promote these goals, Australia's fiscal constitution would need to strengthen fiscal self-responsibility in the various jurisdictions and subsidiarity (Wood, 1995, pages 31-44;  also Walsh and Fletcher, 1994;  Glaeser, 1995).

The arguments in Competitive Federalism (op. cit.), though generally well-received, dealt insufficiently with one question, which some correspondents -- and events during 1995 -- laid bare:  What if State and local administrations compete with each other in attracting capital and enterprise by subsidising specific firms in "bidding wars", instead of getting the fundamentals of genuine competitiveness right?  What if politicians and administrators, when confronted with the growing mobility of capital and enterprise, resort to secretive case-by-case preferment and discriminatory interventions, and use special deals to reap political benefits which undermine general efficiency and equity in ways that are only too well known from public choice theory and the literature on rent-seeking (Downs, 1957;  Buchanan and Tulloch, 1965)?  What if State governments "buy themselves companies", only to discover later that they "invested" in the wrong assets, reaping poor growth, job losses, weak future revenues and budget deficits?  What if State governments grant specific suppliers a monopoly, on the condition that these suppliers set up production facilities in the State -- for example, by promising to buy all computer-support services from the one monopoly supplier -- only to rediscover the time-tested economic law that monopolies guarantee high costs and poor quality?

These questions pose serious challenges to the concept of Competitive Federalism.  They are the focus of the remainder of this paper.

GLOBALISATION POLARISES GROWING AND LAGGARD STATES

Globalisation exerts new competitive pressures on ailing regions and States that may have been protected in a closed economy and in an era where fiscal transfers to ailing regions were quasi-automatic.  Now, ailing States have to reform their approach, but frequently find it hard because they suffer from poor revenue, budget deficits and high debt burdens.  The "ailing region dilemma" for governments in charge of such areas cannot be solved permanently by more government borrowing:  nowadays, high public debts are seen by mobile investors as foreshadowing high future taxes, and thus become a direct competitive weakness.  Governments of economically ailing States and cities then tend to resort to desperate and dubious measures, which increase the probability that their leaders will become mayors of ghost towns and premiers of backwater States.  By contrast, prospering States and regions with competitive economic structures and good government attract more growth resources and become even more successful.  Their tax base grows, so that administrative services and infrastructures can be provided at relatively competitive tax rates, a factor that further enhances their competitive position.  This is the case in Queensland or in "growth poles", such as Singapore (see graph, page 7 below).

In flexible market economies, the polarisation between prospering and declining regional polities tends to be overcome naturally by the decline in land prices and real wages in the ailing regions, and price-rises for land and labour in overheating growth regions.  Free markets eventually restore the regional balance in growth opportunities.  Local political interests, however, tend to mobilise against land-asset price deflation and real wage declines, so that political interventions occur against the restoration of equilibrium by market forces.  In the modern economy it takes bold leadership to rely on the self-healing forces of markets, instead of resorting to populist activism that deals with the symptoms, rather than the causes, of relative economic decline.

When a region or State is caught in a spiral of decline, and markets are hindered from reacting flexibly, unemployment results.  Workers then have to follow the investors to the attractive regions.  Their houses fetch poor prices, so that they suffer wealth losses.  From a social viewpoint, this is very much a second-best adjustment mechanism, but one that is in evidence among the Australian States.

In such a situation, governments often try to stem the decline by handing out selective subsidies to attract new investments, risking the erosion of the future tax base or incurring untenable public debts (See Table 1, below).  Experience shows that such political reactions to globalisation only add to future economic decline, but politicians and administrators are rarely that far-sighted -- or motivated to look that far ahead.  This is the context in which desperate, ultimately ruinous bidding wars break out in federations.

Table 1:  Selected Recent Bidding Contests

1993	New South Wales bids successfully for the 2000 Olympic Games, with the costs and net benefits to NSW citizens far from clear.
1993	Victoria bids the right to stage the Australian Grand Prix away from South Australia.
1994	The South Australian government announces an agreement under which computer software firm EDS will make South Australia its Pacific region base in exchange for a promise that most South Australian government contracts will in future be allocated to EDS, rather than be put to the normal, cost-controlling competitive tender process.  Subsequently, there are doubts about whether the deal will proceed.
1995 (March/April)	The Victorian government identifies the Fox film studios, proposed for Sydney, as a winner and makes a bid.  NSW responds successfully by granting pay-TV producer Foxtel a waterfront lease without the usual tendering.
1995 (May)	The State of Victoria buys the rights to the Australian motorcycle Grand Prix from 1997, after the Greiner government in NSW had attracted the loss-making venture to a government-provided racecourse near Sydney.
1995	Westpac is induced by the South Australian government, reportedly with massive tax-breaks and hand-outs, to relocate its loan-processing centre to Adelaide.
1995 (June)	American Express chooses Sydney as its Asia-Pacific regional operations centre.
1996 (January)	Despite subsidy bids from a number of Australian State governments, Cathay Pacific decides to retain its flight-training operations in Hong Kong.
1996 (January)	The NSW government offered $3 million to entice a defence aerospace project away from Victoria.

We shall argue that, in such a situation, there is much gain all around -- both for the prospering and for the lagging States -- if all competing governments can conclude an agreement that ends ruinous bidding wars with secretive and selective subsidies and which confines inter-State competition to the general, non-discriminatory measures which make the State attractive to all comers.  Such agreements are similar to industry agreements to ban ruinous competition.  But, different from industry agreements, government arrangements to ban ruinous competition deal with tax-funded entities and entities that are not directly exposed to the discipline of going bankrupt when they persist with ruinous strategies.

BIDDING WARS VERSUS GETTING THE FUNDAMENTALS RIGHT

To clarify further what is at stake when State and local governments resort to rampant interventionism to pick specific "growth winners", rather than pursuing non-discriminatory strategies to get the fundamentals of competitiveness right, and to suggest policies which could shift the ground away from the interventionism of "bidding wars", we have to refer to some basic economics. ⁽²⁾

What matters for the decision of the owners of mobile capital, knowhow and high skills and of entire enterprises when they consider a move to a new location, is the expected, long-term profit -- that is, the difference between sales revenues and unit costs (Wood, 1995, pages 22-27).  During much of this century, governments in Australia and elsewhere have tended to focus in their economic development policies on lifting the revenue (or demand) side of the profit equation.  They have tried either to secure the firms' income from sales (for example, through import protection), or to enable firms to lift their prices (for example, by granting specific producers a monopoly).  Where governments tried to lift profitability on the cost side of firms, they have tended to concentrate on selective firm- or industry-specific measures, such as granting specific tax concessions or providing free or subsidised land, finance or energy, to selected companies.  Universal supply-side policies, which lower costs for all producers across the board, have been neglected.

The fundamental problem with all selective policies to lift the profits of specific producers is that they require enormous amounts of detailed knowledge on the part of the policy makers and their bureaucratic advisors -- not only about the present, but also about a complex, changing future:  Which industry should be given a preference at the expense of all others?  Which particular enterprise in an industry should be given the preferment, and who should be refused?  Should government, for example, promote the production of medical instruments, or the use of electronic sensors?  If so, precisely what medical instruments and what sensors, and why not others?  What if technologies and commercial conditions change, and expected winners turn into losers?  The knowledge problem in a modern, fast-evolving, internationally-linked economy is such that no individual authority can ever hope even remotely to marshal and utilise all the necessary, useful information -- as Nobel Prize winner Friedrich Hayek showed many years ago (Hayek, 1945;  1963), and as the abysmal economic failures of socialism and central planning have more recently demonstrated beyond any reasonable doubt.  Nevertheless, most Australian State administrations pretend that they do have the knowledge, and dish out selective subsidies to specific firms and industries as a means of developing their respective economies.

Such specific industry policies the world over have, on balance, turned into costly failures.  Governments, in fact, tend to pick losers (Burton, 1983).  Some readers might point to the fast-growing East Asian economies, many of whom have indeed engaged in selective industrial development policies.  But formerly-poor, underdeveloped East Asian countries -- starting with Japan in the 1950s -- were simply able to emulate proven successes in economies further up the development ladder.  Despite benefiting from this advantage of the late-comer, the record of picking-the-winners policies in East Asia is far from clear-cut.  As Asian countries are approaching higher levels of technical and economic sophistication, they are now predictably shifting away from selective to universal, functional development policies.  They now aim to mobilise production factors by fostering education, capital formation and resource development, and helping businesses to improve productivity all round, as well as focusing on macroeconomic stability.  They have moved from selective interventionism to "getting the fundamentals on the supply-side right" (Kasper, 1994;  Hughes, 1995).  In any event, an advanced high-income country like Australia is not in a position to emulate what backward countries were once able to do.  We are squarely faced with the knowledge problem, and our State and Federal administrations should drop the pretence of knowledge.

The best possible, albeit imperfect and uncomfortable, human device to utilise, develop and test useful technical knowledge and commercial-practical knowhow is decentralised competition in dynamic, open and diverse markets.  Productive knowledge tends to be best found by competing, self-interested producers who seek to discover new knowledge and test its social acceptance through product and process innovation.  This does not mean that governments should be passive, minimal players who are confined to pure laissez-faire.  On the contrary, in the modern industrial world with a high degree of division of labour and division of specialised knowledge and high transaction costs, governments can do much to assist competitors in succeeding in the global market place:

• Governments should assist competitors with efficient, user-friendly infrastructures (for example, education, roads, ports and waste management), be it by operating these infrastructures directly or by facilitating the efficient, low-cost private supply of infrastructural services.
• Governments should provide simple, stable and transparent institutional rules which facilitate human interaction in markets and which lower the transaction costs of doing business;  for example, by promulgating user-friendly laws and regulations.  They must also enforce the rules convincingly and consistently.
• Governments have a role in ensuring macroeconomic stability, not least by providing non-inflationary money.

Governments that develop administrative systems which ensure a good supply of these "soft" and "hard" infrastructures to private industries and citizens will make a major contribution to overall economic growth within their jurisdictions.  They become valuable partners in international and national competitiveness.  They will help to attract increasing amounts of footloose capital and enterprise, thus further stimulating productivity and growth.  Political leaders who fulfil this role will earn the respect and the support of the electorate.  They will also discover that their tax base is growing, and that they are able to offer a good level of public service, whilst charging low tax rates.

Such a style of policy concentrates on the fundamentals of resource mobilisation, the protection of reliable institutions, stability and infrastructure support.  Under this type of policy, government services are made available universally, that is, to all comers without discrimination.  These policies are also called "functional policies".  They tend to focus on the supply side of the profit equation of firms, focusing on low cost prices and favouring productivity growth.  The key reason why such development policies have been highly successful -- as the East Asian evidence shows -- is that they require much less specific, technical and commercial knowledge on the part of politicians and administrators.  Governments which act on the simple principle that education and training are worth favouring, and that saving and capital formation should be supported by the tax regime, have a much easier job and are much more likely to succeed than governments which bid against each other to buy themselves specific ventures, such as car races, airline companies, casinos, or computer-support services.  Another advantage of the functional policy approach is that it offers politicians and bureaucrats much less temptation to engage in arbitrary discrimination and corruption.  Once secret hand-outs are available and closed envelopes are passed around, both business people and politicians are subject to huge temptations, and public life sooner or later becomes corrupted.

The reason why the non-discrimination principle should be made a touchstone of judging inter-State competition is that governments are simply not equipped to succeed in case-specific promotion.  Politicians and administrators simply do not have the incentives to take the proper business risks that are necessary to turn specific ventures into durable gains in employment and output. ⁽³⁾

WHY AUSTRALIAN STATE GOVERNMENTS
SHOULD NOT OFFER SPECIFIC SUBSIDIES

When pursuing their legitimate interest in developing economic activity and jobs, State and local governments have a choice between

1. making attempts to attract new businesses with up-front subsidies and similar measures for specific businesses, and
2. concentrating on reducing the general costs and productivity impediments for the benefit of all comers, along the lines of universal, functional supply-side policy.

This is a genuine choice because a concentration on specific measures and "subsidy bidding" inevitably detracts attention and scarce political and administrative resources from improving the general business climate.  The availability of government assistance also diverts business efforts from competing in markets (or "performance competition") into competing for political favours (or "rent-seeking").  Because of this conflict, the limited administrative and budgetary resources of State (and local) governments should be used to streamline and implement cost-cutting microeconomic reforms rather than to attempt the impossible task of outguessing markets as to which products and firms might in future be of greatest benefit to the State's economy and handing out privileges to known firms and groups.

In policy-making, an important distinction has to be made between universal and specific measures:

Rules, as well as spending and tax measures, are called universal if they are designed to apply to an unknown, unlimited number of cases or groups of citizens.

Rules, as well as spending and tax measures, are called specific if they are designed for selected citizens or circumstances which the policy-maker determines, and from which similar cases or groups of citizens are excluded.

As noted, there is a long, deeply-engrained tradition of specific interventions by Australian State (and local) governments and a corresponding neglect of functional policies.  All State governments have, at one time or another, broken the maxim of non-discrimination, and have engaged in "picking the winners" interventions, bidding with subsidies or monopoly rights to attract specific producers or industries that they happen to know.  Industry ministers or State premiers often even proudly advertise that -- by this tax concession or that subsidy -- they have "created" so-and-so many new jobs, only to become strangely reticent when the venture fails.

It is, therefore, important to list the detailed reasons why trying to pick winners and resorting to bidding wars for specific ventures will weaken long-term growth and job creation and why the -- often less glamorous and more onerous -- functional style of State development policy promises better long-run results.  Firm- and industry-specific hand-outs by State governments should be abandoned in favour of functional, non-discriminatory development policies by Australian States for the following reasons:

1. Selective and discriminatory industry development policies have been a world-wide failure, as already briefly mentioned.  This includes the Australian States, where firm-based assistance has been the dominant modus operandi of industry policy and where the States with the most interventionist industry policies in the past now have the weakest economies.  By contrast, the predominantly functional approach of such economies as post-war West Germany, a growing number of East Asian countries, and -- more recently -- New Zealand, tends to deliver rapid growth and job creation (Kasper, 1996).  This style of development policy is therefore being increasingly emulated -- and successfully so -- by some Australian States, in particular Queensland.

2. The investment of taxpayers' money in hand-outs to attract specific businesses should be assessed like any commercial investment or mortgage, not for short-term political gain but the long-term economic rate of return.  State governments have often been tempted by "painless", "quick-fix" approaches to economic development.  But this approach has frequently provided only transitory economic stimulus at the cost of mortgaging the State's future.  As already noted, governments and administrators are simply not equipped to make commercial investment decisions.  Without the capacity to collect and analyse large bodies of commercial and technical knowledge, policies designed to buy the State another enterprise depend on chance, the inclination of certain ruthless entrepreneurs to hunt for subsidies, and their access to credulous politicians and bureaucrats.  Industry-specific subsidies are therefore often dominated by short-run political considerations at the expense of long-term economic and commercial objectives, with the inevitable outcome of budget losses, slower economic growth and poor job creation.

3. Even where government, by offering an investor a specific preferment, helps to create permanent jobs and revenues, it may undermine job growth in other companies.  If, for example, a State government offers a monopoly contract for the computer services it buys to company A on condition that that company locates in the State, companies B, C and D, who were previously also competing for State government business, may shut down and quietly relocate out of the State.  The gross gains in company A that politicians like to talk about are therefore seldom equal to the net gains to the State in terms of jobs and output.

4. Up-front subsidies to new ventures enhance the profitability of companies only temporarily.  That may, of course, be welcome in the costly start-up phase of a new business.  But such subsidies do nothing for sustained, long-term profitability and competitiveness.  Indeed, as mentioned, they may boost cost levels by promoting rent-seeking and lessening the inclination of administrators and businesses in the State to address the fundamentals of profitability.  Many well-managed companies -- including firms that were once attracted to certain States by forceful bidding and now regret it -- have learnt the bitter lesson that up-front subsidies only lure them into dangerous traps.  Globally-competitive businesses therefore tend to avoid jurisdictions that readily offer them hand-outs.  Instead, they search for environments where the profit fundamentals are sound.  This is documented by the good correlation between the ratings in the annual World Competitiveness Reports, which measure the fundamentals of the business climate (IMD-WEF, passim), and subsequent investment flows and economic growth rates.  This is also borne out in the close correlation between economic liberties and economic performance documented by a 1995 study published by the Fraser Institute in Vancouver, Canada. ⁽⁴⁾  In deed, the offer of firm-specific grants by government tends to signal widely that there is something badly wrong with the economic fundamentals in the jurisdiction which is making generous offers and shows great eagerness to engage in bidding wars.  Nevertheless, most investors like to pocket a subsidy even if it is not decisive to their decision-making.  Politicians are therefore rarely told by business that "settlement subsidies" are not effective!

5. Companies have learnt from bitter experience that political hand-outs are rarely free.  Internationally-experienced business leaders now know that, sooner or later, they will be called on to reciprocate for government favours received.  In today's information society, the practice of accepting hand-outs often leads to serious public-relations perils for subsidy recipients in that an increasingly sceptical public and press may, rightly or wrongly, suspect preferred firms of giving kick-backs when these businesses subsequently interact with the politicians and governments.  We should also note that direct interventions are dangerous for politicians and bureaucrats.  Hardly a day passes without the international press reporting the forced resignation of a politician or civil servant for reasons of illegitimate kick-backs and corrupt favour-selling.

6. There are other perils in "picking the winners" strategies for political leaders and administrators.  The investment of taxpayers' money establishes a degree of political co-responsibility for a business.  In the case of a subsequent failure of politically-preferred businesses and the dismissal of workers by politically-sponsored firms, activist politicians face public criticism.  Subsidies can then easily turn into a political liability.  In these circumstances, there is of course a danger that politicians and administrators will try to throw good money after bad, attempting to stave off the failure of uncompetitive ventures which they originally attracted by a subsidy and amidst much public relations fanfare.

7. Production facilities in a growing number of industries are highly mobile these days and cannot be pinned down for long.  Much of industry has become very lightweight and footloose.  Many a modern "factory" can be packed into a few containers and moved if local conditions no longer meet expectations, or if an establishment subsidy has been "harvested". ⁽⁵⁾  Another reason for the greater mobility of enterprises is the shift to service industries, which can easily unplug their computers and telephones.  If the economic fundamentals are not right, and State governments merely rely on hand-outs to cover up the existing locational weaknesses, then businesses are now often able to pack up and go.  Selective up-front subsidies may have made sense in the era of heavy industry and high relocation costs, but they seem fairly futile in the fast-changing, movable global economy of the twenty-first century.

8. Getting a hand-out from politicians or administrators normally imposes considerable compliance costs on business people.  Normally, only firms of a certain size and with the necessary government-relations capabilities are able to respond to preferential policies aimed at picking winners.  Small firms, who create most new jobs, cannot afford the lobbying and the form-filling;  they thrive only where the fundamentals are right.  For this reason, firm-specific development policies bias development in the direction of big enterprises and against small firms.  Yet the world-wide historic trend is for big industrial dinosaurs to scale down and for flexible networks of small, agile producers to grow fastest (Naisbitt, 1994).  That is where the most dynamic job and wealth creation occurs.  Picking-winners policies therefore create a selection mechanism in favour of less dynamic types of firms.  Government then discriminates against the profitable exploitation of the networking advantages, which the communications revolution now offers, and the innovation potential of the many small firms.

   If an Australian State wants to attract dynamic small enterprises, and wants to become an oasis for the new brain-based service providers, it should not promote economic development through necessarily cumbersome, administrative approval procedures for subsidies -- a style of administration developed for the slow-moving steam age.  It simply has to ensure a good general economic and regulatory environment for all comers, without cumbersome government agencies getting involved in the technical and commercial detail of specific businesses, and without all the apparatus of form-filling, slow-moving inquiries and committees.

   Those responsible for designing policy strategies should be aware that reliance on universal, functional policies avoids a clash between the culture of small business enterprise and the culture of government administrations.  Administrators are of necessity bound by accountability, consensus, precedent and orderly procedure.  When they offer subsidies they have to impose this administrative culture on business people, whose normal modus operandi is to respond quickly to emerging market opportunities and to act on mere hunches.  For this reason alone, specific subsidies often fail to attract the small, competitive businesses on which much of economic dynamism nowadays depends.

9. The ready availability of subsidies lures types of entrepreneurs to the State whom one might call "specialist subsidy-getters".  They harvest hand-outs, but are not necessarily the best innovators, competitors and job creators.  Selective "political entrepreneurship" may thus bias a State's entire business culture in the direction of subservience and compliance, and away from rugged self-reliance.  Then, the impression easily develops that all businesses are naturally on the take and that economic development can occur only thanks to pro-active, selective economic development agencies!  The long-term consequence is an ailing economy with a bias to political connections and establishmentarian back-scratching, full of protectionist sentiments and misgivings about the success of other, more openly competitive States.

10. Offers of up-front establishment subsidies to specific newcomers are widely considered an injustice by long-established firms who have been paying their taxes and who resent the fact that scarce budget resources are handed out to other firms.  It is also considered unjust that government subsidies for the development of new industrial land depress the asset values of existing industrial sites, which established firms are using as asset backing or which owners may wish to sell.

11. In all business communities where specific favours are dished out by State or local governments there is considerable disquiet about the non-transparency of subsidies, about competitors being given an unfair advantage, and government agencies hiding all too often behind a veil of assertions of alleged "commercial confidentiality".  This relates directly to the point made earlier that burgeoning specific interventionism leads to growing disaffection with electoral democracy and political leaderships.

Readers may object, by pointing out that subsidy grants to potential industrial settlers which reduce land, construction, transport or tax costs, are justified on the grounds that they make remote States more attractive by reducing the cost of producing in that location.  Low unit-costs of the immobile production factors -- land, government administration, and labour, together with transport costs to the market -- are, after all, decisive in attracting mobile capital and enterprises (Wood, 1995).  This argument can, however, be mounted only if the cost reduction by subsidy is available to all potentially interested firms on a non-discriminatory basis, including those who have not bothered to make themselves personally known to the Premier, the industry minister or some economic development authority.

OF BAD HABITS AND PRISONERS' DILEMMAS

It may be tempting to argue against the position taken here by saying that all national, State and local governments the world over violated have violated first-best non-discrimination principles, and that the elimination of specific subsidies is neither feasible nor desirable for the following reasons:

1. In a world of imperfect knowledge, the offer of preferments to new industrial settlers may be seen as an advertising tool to signal a State's interest in attracting business and to initiate negotiations about settling in the State.

   There is some merit in this point, but it has to be weighed against the fact that competitive and experienced firms who would make a lasting contribution to a State's economy and tax revenue, almost never make long-term locational decisions on the basis of a government hand-out, indeed that "subsidy advertising" attracts industrial rent-seekers who are less focused on succeeding in open, global competition.

2. It may also be argued that each Australian State would be better off without offering subsidies, but that States which desist from matching the competition in hand-outs would lose out.  In other words, it may be argued that a typical "prisoners' dilemma" arises:  no State can afford to discontinue the harmful and costly practice for fear of losing out to other States. ⁽⁶⁾

   Prisoners' dilemmas (such as the post-war nuclear armaments race between the super powers) can be resolved by cooperation and direct negotiations of a framework agreement.  In the case of State subsidies to industry, which many State politicians decry in public, there is indeed often a double prisoners' dilemma:  businesses, too, may not wish to accept hand-outs, but they fear disadvantages as compared to other firms if they do not seek subsidies.  Thus, both governments and businesses may be tied to harmful practices despite their better judgement.  It should therefore be possible for Australian governments to agree on a set of rules that ban the harmful practice and allow the monitoring of violations of such a "subsidy-disarmament agreement" (see below).

3. Selective interventions may of course be in the interest of those ministers and government departments that administer them.  In several Australian States, large economic development bureaucracies have been built up for the sole purpose of picking winners.  They are likely to come up with elaborate rationalisations as to why a picking-winners style of policy cannot be abandoned.

   Yet experience in East Asia also shows that the abandonment of discriminatory industry policies and supporting bureaucracies has regularly led to gains in competitiveness, investment and economic performance (Hughes, 1995).

4. If one starts from a tradition of firm-specific intervention -- as is the case in Australia -- and if there is a lack of confidence that a State's general competitive position is adequate, a case can be made for a gradual withdrawal from selective interventionism, as and when the fundamental cost conditions have improved.

   It is often argued that the sudden shock of discontinuing specific subsidy policies could undermine economic performance and thereby harm long-term competitiveness.  Given the strong, organised interests of industrial and bureaucratic lobbies with a stake in the status quo, gradualism may, however, become self-defeating.  What is needed in cases like nuclear disarmament and weaning interventionist Australian governments from the picking-winners habit is a clear expectation of how the prisoners' dilemma will be resolved and how a better arrangement will be enforced.  This requires a rational, negotiated agreement, monitored for violations and with clearly stipulated sanctions.  All of this, of course, is predicated on the availability of transparent information about the dealings of government, an analysis of violations within a shared framework of rules, and an understanding of the importance of the non-discrimination principle in Competitive Federalism.

5. Picking-winners policies may be defended by making the point that any government intervention -- even of a general nature -- distorts specific industry structures and competitive conditions.  If, for example, a State builds good roads, this benefits transport-intensive industries more than others, and good education policies are likely to benefit the knowledge industries more than low-skill activities.

   Nonetheless, the effects of such universal, functional policies differ greatly from preferments for specific firms.  A State may, for example, choose to subsidise all inter-State telephone costs from its budget to overcome the handicap of being in a peripheral location.  The principle of non-discrimination is satisfied if all citizens or businesses in the State automatically get the telephone subsidy.  It is violated, and should be proscribed, if the subsidy is handed out only to specific companies and people with political connections.  In this context, there was much controversy in mid-1995 over the Queensland move to reduce stamp duties on share transactions, and over the South Australian move to subsidise the data processing centre of a big bank.  In the first case, the criterion of universality was satisfied:  all share purchasers got the advantage of lower stamp duties.  In the latter case, the principle was violated:  the (undisclosed) subsidy to the bank was only available to that bank.

6. An argument may be made in favour of selectivity and discrimination by Australian States, because their revenue bases are extremely narrow:  most taxes have been earmarked for the Commonwealth government.  Consequently, they simply cannot afford universal, non-discriminatory policies and have to rely on identifying and subsidising perceived winners.

   There is some truth in this, and it would seem urgent to broaden State revenues (Wood, 1995).  Nevertheless, States can do much to enhance attractiveness by streamlining regulations, by implementing development-friendly land and labour regulations, by enforcing existing laws equitably, and by disciplining bureaucrats, who are often anti-business, and forcing them to act in a responsible, expedient manner.  Even casual conversations with business leaders quickly reveal that most Australian States have not exhausted the potential to enhance their locational attractiveness in general, functional ways, and that many State officials still live in a world in which industry was protected and capital outflows were controlled by foreign-exchange regulations.

7. It may be further argued that certain specific interventions, for example, State government subsidies to the gambling and the "eventing" industry, promise great external benefits to other industries, for example, tour operators and the hospitality industry.

   The claim of externalities has of course always been the blanket excuse for all sorts of selective interventions.  At the very least, a case has to be documented that the cost of administrative effort and public expense for such support is credibly outweighed by total revenue growth.  Greater accountability is needed to expose such specific government activities to genuine scrutiny, using proper accounting principles and independent assessors -- and not the usual evaluations by hired consultants and project promoters.

8. Finally, it may perhaps be said in defence of selective subsidies that foreign governments will not abandon "dirty" subsidy competition and that, therefore, Australian States cannot either.

   This is a variant of the prisoners' dilemma case.  The argument is based on a fallacy familiar from the tariff debate of years past.  Protectionists argue for limiting tariff cuts to cases of reciprocity, conveniently overlooking that the main tariff burden falls on fellow citizens!  It should be realised that the biggest victim of State subsidies is the present and future taxpayer of that State.  When States break with the subsidy habit, taxpayers and citizens are relieved of future tax burdens and begin to benefit from a more open, more competitive climate.

Much could be gained for overall business confidence in Australia if the underlying, first-best principles of genuine Competitive Federalism were better understood and if each successive tactical move to do away with State subsidies were explicitly related to the overall goal of "subsidy disarmament" and non-discrimination.

A STRATEGY FOR SUBSIDY DISARMAMENT

If the States are genuine in claiming that they are the victims of a vexatious prisoners' dilemma, they should readily come to the table and negotiate a ban on the ruinous practice of preferential bidding wars.

Prisoners' dilemmas exist only in closed environments and among few actors.  The situation for inter-State subsidy competition has been changed by globalisation in general, and by the presence in the local market of one independent and subsidy-averse government, that of New Zealand, since the implementation of the Closer Economic Relationship (CER) agreement.  To the extent that the opening of the Australian economy proceeds, subsidy addiction of State governments is likely to be increasingly harmful because durable gains from redistributive subsidy bidding are less likely.

Moreover, a cooperative agreement can protect the States from squandering future and present revenue on selective subsidies, or from granting costly monopolies to suppliers.  Such cooperative agreements will, however, only come about when the States are made exclusively responsible for certain tasks of governance and for financing those tasks by the revenues which they raise themselves.  How such responsibility can be achieved was discussed in Competitive Federalism (Wood, 1995).  Once a fundamental framework of Competitive Federalism is in place, all States will have an interest in agreeing in principle on a ban against firm- and industry-specific subsidies and against licensing monopolies.  An inter-State agreement to that effect could be concise and simple, stipulating openness and non-discrimination, possibly with some exemptions to allow interventions after positive externalities have been proven.  The agreement has a better chance of working if it rules out certain types of government actions than if it prescribes positive guidelines as to how the States may legitimately compete.

Individual oligopolistic actors can, of course, expect gains from breaching a non-discrimination agreement.  This is illustrated by the theory of industrial cartels.  If one supplier can secretly break a cartel agreement, he tends to gain market share and profit.  But the analogy with private industry is limited, since private competitors, such as cartel-breakers, are always exposed to the discipline of profit and loss.  Governments, by contrast, can hardly go broke when they compete with selective subsidies.  Moreover, industrial competition tends to foster innovation and bring other gains to society, whereas inter-State competition, if it is not conducted with universal instruments, tends to be socially harmful and destabilising of State finances.  Therefore, breaches of the non-discrimination rule should be monitored and sanctioned by an inter-government agreement.  In the Australian federal system, it would make sense to include the Commonwealth government in such an inter-State agreement to ban selective State subsidies, and to entrust a Federal agency with the power to monitor breaches.  The most appropriate organisations in Australia to take on the monitoring task would seem to be the new National Competition Council or the Industry Commission, which already has the task of monitoring certain competitive actions of the States in implementing the Hilmer reforms (Hilmer et al., 1994), which is a repository of top-rate economic analytical talent, and which has a successful history of making complex economic issues transparent.  An inter-State agreement against selective subsidies could simply stipulate that the Industry Commission, on its own initiative or when requested by a State government, investigate State-industry dealings to find out whether or not a proscribed subsidy was handed out.  An alternative might be the new Australian Competition and Consumer Commission.

If the public and the press become educated and perceive selective State subsidies as ruinous and illegitimate burdens to the future budgets of the various States, mere findings by the monitoring agency would carry considerable weight.  Different from the present situation, in which ministers brag publicly about having given handouts to certain firms, such actions would meet with instant public opprobrium and cost the subsidisers electoral support.

Nevertheless, enforcement of an agreed non-discrimination rule seems advisable.  This could be done by the governments, on the basis of formal findings, possibly through the Council of Australian Governments (COAG).  The instruments of enforcement could be direct financial penalties imposed on recalcitrant States (similar to such penalties payable to Brussels under arrangements now in place within the European Union).

END PIECE

There are strong economic arguments, and there is widespread public agreement in principle, that subsidising specific firms and industries is a dangerous political addiction.  The habit is harmful to future State revenue.  Such subsidies weaken a State's economic growth potential and they certainly violate principles of justice and equity.  What is missing is a device which bans the harmful practice.  If the States are serious in asserting that they regret being hooked on the subsidy addiction, it should not be beyond the capabilities of Australian statecraft to resolve that dilemma.

If we wean State governments from being selective and discriminatory, our Federation will be more worthwhile and serve our liberty and efficiency better than is now the case.  Public support for collective action and respect for government and the law will be enhanced, because the citizens will consider State government actions to be in their interest -- rather than in the interest of some well-connected business or politician.

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REFERENCES

Buchanan, J., and G. Tulloch (1965), The Calculus of Consent (Ann Arbor:  University of Michigan Press).

Burton, J. (1983), Picking Losers ...?  The Political Economy of Industrial Policy (London:  Institute of Economic Affairs).

Downs, A. (1957), An Economic Theory of Democracy (New York:  Harper).

Giersch, H. (forthcoming, 1996), Economic Morality as a Competitive Asset (Sydney:  Centre for Independent Studies).

Glaeser, E.L. (1995), "The Case for Competition Among Local Governments", Policy, vol. 11:3 (Spring), pages 16-19.

Hayek, F.A. (1978), "Competition as a Discovery Procedure", in F.A. Hayek, New Studies in Philosophy, Politics, Economics and the History of Ideas (London:  Routledge Kegan Paul), pages 179-190.

Hilmer, F., M. Raynor and G. Taperell (1994), National Competition Policy (Canberra:  AGPS).

Hughes, H. (1995), "Why Have East Asian Countries Led Economic Development?", Economic Record, vol. 71 (March), pages 88-104.

IMD-WEF (passim), World Competitiveness Report 19xx (Lausanne-Geneva:  IMD-World Economic Forum, annual publication).

Jones, E. (1987), The European Miracle, 2nd ed. (Cambridge:  Cambridge University Press).

Kasper, W. (1994), Global Competition, Institutions and the East Asian Ascendancy (San Francisco:  International Center for Economic Growth).

—— (1996), Free to Work (Sydney:  Centre for Independent Studies).

—— (forthcoming, 1996), "Competitive Federalism for the Era of Globalization", in G. Radnitzky (ed.), Values and the Social Order, Rule by Order and Order by Rules (Aldershot:  Avebury Publishers).

—— and E. Streit (1994), Lessons from the Freiburg School:  The Institutional Foundations of Freedom and Prosperity (Sydney:  Centre for Independent Studies).

Kelly, P. (1992), The End of Certainty (Sydney:  Allen & Unwin).

Naisbitt, J. (1994), The Global Paradox (Sydney:  Allen & Unwin).

Walsh, C., and C. Fletcher (1994), The Subsidiarity Principle and Decentralisation:  Perspectives Drawn from Australia's Federal Experience (Canberra:  ANU Economics Division Working Paper No. D1 94/4).

Weber, M. (1981, English originally 1927, German original 1923), General Economic History (New Brunswick, N. J.:  Transaction Books).

Wood, R.J. (1995), Competitive Federalism:  Promoting Freedom and Prosperity (Toowoomba).

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ENDNOTES

1.  An example that should warn Australian leaders about the growing loss of confidence in government and spreading cynicism about political life, though distant in time and place, is the Weimar Republic in Germany after the First World War.  Elected politicians engaged in blatant favouritism for their clients and thereby destroyed the underlying, shared institutions of society.  The calamity of the Second World War began with the parliamentary and administrative disregard for the common law and genuine power control and with the politicisation of economic life by the political power brokers who used their monopoly to the fullest (Kasper and Streit, 1994).

2.  We define "picking winners" here as an industrial policy design that discriminates between alternative economic activities, be it for political reasons, for reasons of perceived externalities or on the basis of an analysis of conditions that are seen in one part of the economic literature as amounting to "market failure".  The opposite are "universal policies", that is, measures that apply generally to an unknown multiple of cases and people.  Such universal policies enhance a growth-promoting economic order.

3.  For the same reasons, post-war national governments based the international trading system on the non-discrimination principle through the "most-favoured nations clause", obliging national governments to treat all members of GATT as well or as badly as the nationals of the most preferred country.  The principle has had enormous growth benefits for the world economy and the individual members of the agreement.

4.  J. Gwartney, R. Lawson and W. Block, Economic Freedom of the World 1975-1995, Fraser Institute, Vancouver, 1995.

5.  The story of the Hong Kong garment maker whose knitting machines have been attracted in sequence to three different provinces of China, then to Indonesia, then to Bangladesh -- each time with a subsidy -- may be invented, but it shows that government officials nowadays are under an illusion if they think they will be able to lock industry into a permanent location.

6.  The term "prisoners' dilemma" derives from game theory which has studied the case of two prisoners held in isolation, each of whom may get reduced sentences when informing on the other prisoner.  If they could collaborate and stay silent about their crime, they might even go free for lack of evidence.  But fear that the other prisoner incriminates them will induce each to speak out and incur a sentence.

Profit, Income & Living Standards

I. -- PROFITS

"THE PROFIT-MOTIVE"

The desire for personal gain and the urge to better the position of their families and dependants are common to the great majority of men.  The unskilled labourer aims to increase his wages;  the business manager his salary and profits;  the leading medical specialist the income from his fees.  Apart from a very few exceptions, all people desire to increase the rewards they receive for their work.  This is the real meaning of the much criticised "profit-motive".

BUSINESS PROFITS

The profits of the business enterprise are only one aspect of the "profit-motive", although a very important one.  Profit in this sense, or more strictly the prospect of profit, is one of the major driving forces in the economic life of a community in which free enterprise is encouraged.

Men invest capital and establish businesses largely in the hope of reaping a reward which will compensate them for their efforts and risks.  When the prospects of profit are good, the formation of new enterprises and the extension of old ones proceeds apace.  If the outlook for acquiring a profit is bleak, then little new activity occurs and there is a tendency to retrenchment in the existing fields of business.  This, at best, aggravates the problem of employing all the labour forces of the community, and, at worst, leads to widespread unemployment.

Profit, being the balance remaining after all other business expenses are deducted from revenue, is subject to wide variation.  High profits in an industry encourage business men to enter that particular field and, provided enterprise is free, competition and increased output tend to lower prices to the consumer and reduce the margin of profit.  Low profits result in a movement of capital away from a depressed industry, ultimately bringing about decreased production and higher prices and profits for those remaining in it.

Rates of profit fluctuate widely through the different industrial fields, and from time to time in individual businesses.  Heavy losses are by no means uncommon.  But in the public mind spectacular success tends to be remembered, whilst the failures are soon forgotten.

HOW LARGE ARE PROFITS?

With the development of corporate enterprise, in the form principally of limited liability companies, the ownership of businesses has tended to become, in some degree, divorced from management, and hence the notion has developed that shareholders gain a large share of the available profit without contributing commensurably to its acquisition.  On the other side, the idea that labour has been the main contributor to the making of profits has gained increasing sway.  Consequently it is widely believed that the worker should get at least a substantial part of the profits accruing to industry.

Profits are commonly thought to be so great that, if distributed among those earning say less than £300 a year, standards of life could be greatly improved, the basic wage much increased, and hours of work reduced.  Against this, employers claim that many businesses are just paying their way, and that the overall return on capital invested in industry is not greatly above normal interest rates.  How do these two views compare with available information?

THE AVERAGE RATE OF PROFIT

A survey of 617 companies, conducted by the Commonwealth Bank of Australia, shows that the average rate of profit as a percentage of shareholders' funds, after payment of tax, had declined from 6.8% in 1939 to 6% in 1944.  These companies covered a wide scope of industrial activity and included many businesses subject to considerable risk such as pastoral and mining companies.  Taking into account companies that sustain temporary losses and businesses that fail to return even the capital Invested in them, the average rate of profit over the whole field of business would probably be nearer 5% than 6% -- and quite possibly less than 5%.  This seems a very moderate profit rate when it is realised that the rate of interest offering on Commonwealth inscribed stock in the last Victory Loan was 3¼%.

TOTAL OF COMPANY DIVIDENDS

The official statistics of national income presented with the Commonwealth Budget last year show that £30m. was paid in dividends in 1938-9, and £38m. in 1944-5.  Of the £38m. distributed in 1944-5 a substantial sum, possibly amounting to about £20m. was paid away in taxation by the recipients.  If all company dividends were to be redistributed among the lower income groups, then on the assumption that government revenue from taxation was maintained, only about £18m. would be available for this purpose.  This sum would provide two million income receivers with an extra 3/6 a week each.

UNDISTRIBUTED PROFITS

What of the additional company profit which was not distributed to shareholders, but was retained in the businesses concerned?

In war time undistributed profits have been increasingly held in the form of government securities, owing to the inability of private industry to invest in new plant and equipment.  In normal times these profits are used to extend the physical and working capital of industry.  The expansion of capital, plant and equipment is the main single factor behind industrial progress and improved standards of life.

Unfortunately there are no statistics in Australia which show accurately the proportion of company earnings paid out in tax, distributed as dividends, and retained in business.  Factual information of this description should be available, and it is a reflection on business interests that it is not prepared.  A Central Council for Industry, with an expert economic and industrial secretariat, as we proposed in our statement of policy "Looking Forward", would help to meet this important need.

However, while no reliable statistics of undistributed profits are available, it is possible to arrive at a rough approximation.  The proportion of profits retained by industry for re-investment varies greatly between different businesses according to the nature, financial circumstances, degree of development and judgment of the directors of the business concerned.  For the purposes of this article it is assumed that, over the whole field of industry, on an average something like 25% of the profit remaining after payment of tax is set aside for retention in business enterprise.  This percentage is undoubtedly on the high side.  It is very probable that the average of undistributed profits is closer to 12½% than to 25% of the total of profits, after payment of taxes.  However, we use the larger figures so as to be certain that we are not understating the total of profits earned by industry.  If the proportion of undistributed profit to total net profit is roughly 25%, then the amount set aside out of profit and "ploughed back" into industry would represent about one-third of the amount paid away in dividends.  In 1944-5 £38m. was paid away as dividends to shareholders.  The total of undistributed profits for that year would therefore be of the order of £15m.

£15m. of undistributed profits divided among two million income receivers would allow an addition of 3/- a week each to their weekly incomes.  If all company profits -- dividends and undistributed profits -- were divided among those now receiving £300 a year and less, then individual incomes might be increased by 6/6 a week.  This surely contradicts the popular view that there are immense sums of money in company profits which, if divided up among the community, would bring about a great improvement in incomes and standards of living.

THE ELIMINATION OF PROFITS

But, assuming that it was decided to transfer, in one way or another, the profits of industry to the community, what would be the result?  The confiscation of all dividends would mean that there would be no incentive to invest in business, particularly in those industries where there is any risk of loss of capital.  Some other method of financing industry would therefore have to be found.

So far as undistributed profits are concerned, these have provided the chief means by which companies have purchased additional plant, buildings and stock, and generally expanded their capital equipment.  A good part of the industrial development of the last hundred years has been rendered possible through the process of "ploughing back" profits into industry.  The general consumer has benefited in the form of lower prices and an increased quantity and variety of goods on which to spend his income.

The confiscation of these retained profits would mean that some other method would have to be found to accumulate savings for use in improving and expanding the productive assets of the community.

INCREASED PRODUCTION

Clearly there is no hope of any large advances in standards of living through the sharing up of the profit surplus.  Equally clearly, any attempt to do this would have to be accompanied by a complete reorganisation of our economic life, which would be costly, confusing, and, in the end, disastrous.  The conclusion is plain.  To improve our material standards we must turn to the great problem of increasing production, and of improving the efficiency of our productive methods.  The benefits of this increased production should be shared fairly, in one form or another, between all those who contribute to making it possible.

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II. -- INEQUALITY OF INCOME

PROFITS

Those who attack profits do so from one, or both, of two standpoints.

First, there are those who oppose any form of profit, who criticise the "profit motive" as anti-social, as against the interests of the community, and as encouraging the baser tendencies of greed and selfishness.  Second, there are those who, while not objecting to the "profit motive" as such, claim that exorbitant profits are made by business at the expense of the wage-earner and consumer.

The first criticism raises deep moral and philosophical issues.  The second cannot be sustained by any fair-minded examination of the facts.  Industrial history no doubt reveals numerous instances of excessive profits earned by companies and private individuals, but generally over the whole field of business the figures show the average profits earned to be exceedingly moderate.  Reference was made to these figures in the first article.  If the whole of the profit earned by industry in Australia, including that part used for the replacement and development of capital equipment, were re-distributed among the community, the immediate gain to the lower income earner would be very slight.

INEQUALITY OF INCOME

Business profits must not be confused with the "profit motive", The former is but a limited aspect of the latter, and is confined to a limited field.  The "profit motive", on the other hand, operates practically throughout the whole range of economic affairs.  The wage earner in his desire for higher wages, the professional man in his ambition to earn a greater income, are as much actuated by the "profit motive" as the business man or investor who aims to increase the profits of his business.

The "profit motive", the quest for personal gain, is clearly to a large degree responsible for the significant differences in individual incomes which are so strongly criticised by many people.  These critics contend that there can be no ethical, or for that matter economic, justification for great inequality of income.  They point to the contrast of great wealth, on the one hand, with desperate degrading poverty on the other.  They claim that this should not be tolerated in a Christian community.  They urge that the desire for personal advantage -- the motive of self-interest -- be replaced by the motive of service to the community.  They argue that the rewards of effort should be closely related to the economic and social needs of the individual, and take as their guiding star the Marxist dogma "From each according to his ability, to each according to his need".

Now the Marxist rule is in stark contrast to one of the basic elements of a capitalist, free enterprise economy.  Under free enterprise rewards are distributed in proportion -- a rough and ready proportion it is true, and one capable of great improvement -- to contribution:  that is to the work, initiative and ability of the individual.  Since some people work harder than others, and because some have greater ability and more enterprise than others, this leads to great divergences in the rewards received by different individuals.

What justification, if any, is there for substantial inequality of income as between individuals?  In our view, inequality of income can be supported on three grounds -- ethical, economic and social.

ETHICS SUPPORT INEQUALITY OF INCOME

From the ethical standpoint, it is entirely sound that a man should be rewarded by society in proportion to the contribution he makes to society.  Those who contribute outstandingly to economic progress should gain an outstandingly high reward.  It is not easy to assess the tremendous benefits conferred by a Ford, a Kayser or a Leverhulme on their fellow human beings.  Should genius of this type receive no greater -- or only a slightly greater -- reward from society than that accorded the man lacking inspiration and initiative?  But one has no need to go to such extremes to support the principle that it should be primarily contribution and not need which should determine the reward of the individual.  Is it not right and just that the hard-working, thrifty and enterprising should reap a greater return than the lazy, self-indulgent and cautious?  Why should hard work be compelled to subsidise sloth?  Why should slackness be rated as highly as diligence, incompetence as competence?

The broad principle that reward should be based on contribution rather than on need admittedly requires qualification.  No general principle can be successfully applied to practical affairs without modification and adaptation.  In a society which can afford it, every reasonable citizen should be free from the curse of want, and from the fear of want.  All those prepared to work should, so far as possible, be provided with an income sufficient to support themselves and their families at a reasonable level of life.  This we have attempted to do in Australia through the institution of a minimum wage, and through the recent extension of our social services to assist more adequately the family man and the aged, the sick, the unemployed, and all those who for various reasons outside their control are unable to earn a sufficient income to support themselves.  But once this necessary and just concession is made to the needs of the individual, then the ethics of the case demand that contribution be the deciding factor in the determination of income.  Once the minimum has been firmly established, then those who give great services should be rewarded by high prizes.

ECONOMIC ARGUMENT FOR INEQUALITY OF INCOME

The economic argument in favour of inequality of income is based on the compelling fact that, human nature being what it is, men will not work their hardest and put forward their best efforts without the prospect of satisfactory reward.  Apart from exceptional cases, men will not give extra work, take greater risks, launch new businesses, bear additional responsibilities, unless they stand to gain something for their trouble.  Will John Smith willingly work eight hours a day if he stands to receive only the same income as Tom Jones, working six hours?  Will men be prepared to invest their savings in risky ventures if the prospective return on their money is little or no greater than that to be gained from government securities?  Who will undertake a heavy load of worry and responsibility if his reward is to be no higher than that of the man content to carry a lighter burden?  Who will attempt the treacherous route to great achievement unless there is the prospect of rich reward to lure him on?  If the potential industrial or business genius is to receive no more than the uninspired and unadventurous, where then is the incentive to high attainment?

The economic justification of inequality of income is that without it the higher standard of life, to which most of us aspire, cannot be realised.  More than this, the elimination of incentive, which would necessarily follow a policy of levelling up rewards, would rapidly lead to a greatly reduced all-round standard of living.

AUSTRALIA NEEDS RESURGENCE OF ENTERPRISE

The tremendous formative period of American industrialism, the era of "rugged individualism" was marked by boundless opportunities for those who had the vision and the courage to seize them.  True, there was a great deal of unscrupulous exploitation and economic brigandage, but the fact remains that in those days were laid the foundations of the richest material civilisation the world has known.  Time has made many desirable modifications to the lusty American economy of the 19th century.  But one lesson America has never forgotten:  that men will respond, as they will to nothing else, to the stimulus of opportunity, of great rewards for great enterprises.  This is a lesson we in Australia will have to relearn if we are to solve the legacy of problems bequeathed by the war.  How are homes to be built quickly and at low cost?  How are our industries to be modernised, expanded and made more efficient?  How is a better standard of life for all to be achieved?  How are we to develop the resources of this young country?  How are we to successfully absorb tens of thousands of new immigrants?  Can any of these things be accomplished unless there is prospect and hope, and unless incentives are offered to encourage the maximum of enterprise and work?  In Australia we need a great resurgence of enterprise, of the spirit of adventure -- things we have temporarily lost.  They can be regained if high prizes are there to be won by those who merit them, and if opportunities are broadened so that all have an equal chance to start in the race.

SOCIAL ASPECTS OF INEQUALITY OF INCOME

The social case for inequality of income has two aspects.  One has been pointed to by Lord Keynes, the most eminent living economist, in his book, "The General Theory of Employment, Interest and Money".  Keynes points out that dangerous human instincts, the desire for personal power and self-aggrandisement, can be directed into comparatively harmless channels by the existence of opportunities for money-making and private wealth.  If these opportunities do not exist, then the baser tendencies in the human character may find their outlet in cruelty and the reckless pursuit of dictatorial power.  In his own words:  "It is better that a man should tyrannise over his bank balance than over his fellow citizens;  and whilst the former is sometimes denounced as being but a means to the latter, sometimes at least it is an alternative."

"THE CULTURAL INCOME"

A more powerful argument on social grounds for disparities in income lies in the fact that, apart from exceptional cases, the highest type of leadership can be produced only under conditions of substantial inequality.  To be fitted for leadership, a man requires a long period of expensive education.  Not merely while he is being educated but throughout his life, he must have ready access to the best in literature, art and scientific thought.  He must have the time for reflection and study.  He should not be required to wash dishes if he can better serve society by reading Plato, or by studying the implications of atomic energy, or by working out ways to increase the efficiency of his business.  This is what Bernard Shaw calls "the cultural income", which he says must be retained.

EFFECTS OF TAXATION

Over the last few years in Australia, the heavy, steeply-graded taxation made necessary by the war has already gone a long way towards the levelling of income.  During the war, this could not, for the most part, be avoided.  Then it was not a question of economic ethics, of industrial progress or of social consequences, but of national sef-preservation.  But with the return to peace, all these questions again become of first importance.

DISTRIBUTION OF INCOME IN AUSTRALIA

What are the facts regarding the distribution of income in Australia?  Is there any substance in the widely held belief that the standards of life of those on low incomes could be substantially raised by transferring to them part of the income which now goes to those on higher incomes?

The following table gives the figures for 1941-42, the latest year for which official statistics are available: --

INCOME DISTRIBUTION -- YEAR 1941-42.

Income Group.	Number of Income Receivers.	Amount of Income Received. £m.	Tax Assessed 1942-43 £m.
Under £200	1,300,000	160	1
£200 - £400	1,480,000	430	17
£400 - £1000	270,000	160	22.5
£1000 - £1600	26,000	31	7.3
£1500 - £5000	22,000	51	21
Over £5000	2,000	18	13.2

These statistics of income show that 50,000 people had incomes above £1,000 a year, their aggregate income being £100m. from which £41.5m. was paid in income taxes.  There were 320,000 people with incomes of £400 and over, their total income being £260m. of which £64m. was paid in income taxes.  People on incomes below £400 numbered 2.8m.  If all incomes were limited to £400 a year, there would be another £132m. available for distribution among the 2.8m. with incomes lower than £400.

The figure of £132m. is arrived at as follows: --

320,000 people at present receiving a gross income of	£260m.
320,000 people to receive £400 a year each = a gross income of	£128m.
Balance remaining for distribution	£132m.

But those whose incomes had been reduced to £400 would now pay only about £10m. in taxes instead of the £64m. paid previously.  Therefore, in order to maintain government revenue from taxation, the 2.8 million people previously receiving £400 a year and less would need to pay an additional £54m.  The net gain to these income receivers would thus be only about £78m., or an average of £28 a year each.  This would give an additional 11/- per week to each income earner at present receiving less than £400 a year.

CONFISCATION OF INCOME ABOVE £1,000 A YEAR

Or to take another example:  confiscation of all incomes above £1,000 a year would give a surplus of £50m, for redistribution, but of this about £30m. would have to be provided in taxes by other members of the community.  Thus the net gain would be about £20m.  This would give and additional £15 a year, or about 6/- a week, to income receivers below £200 -- or £7 a year to those below £400 -- that is less than 3/- a week.  A redistribution of income of this kind would thus bring only limited gains to those on lower incomes.  And these gains would be short-lived.  The destruction of incentive would be followed by the death of hard work and the decay of enterprise.  This would rapidly bring about a decline in the national income and a fall in the standard of life.

BARRIERS TO SAVINGS

A policy tending toward the equalisation of incomes would raise serious barriers to the accumulation of savings.  These savings are the source from which the productive assets of the community -- plant, equipment, buildings, commercial vehicles -- are maintained and extended.  Before the war, gross investment in private industry amounted on an average to about £150m. a year.  It will need to be raised to a considerably higher figure -- at least £200m. -- if we are to provide for the capital assets we need to improve our standards of living and swell the flow of goods and services.  A good part of this, about 50%, would have to be found from the personal incomes of income earners.  Most of the savings which have made possible the industrial and social progress of the English-speaking countries have been provided by the upper and middle-income groups.  If the higher incomes were to be largely eliminated, then a large volume of savings would have to come from those now on low incomes.

If the people on low incomes continued the saving habits developed during the war years, it is possible that most of the capital required by private industry could be voluntarily provided.  That, however, is doubtful, to say the least.  And even assuming that the lower income earners continued to save a good part of their incomes, a further obstacle would have to be overcome before their savings could be made available for investment in risk-taking private industry.  At the present time, small savings are deposited in the main with financial institutions, precluded by law from investing in undertakings to which an element of risk is attached.  Whether the small saver could be encouraged to invest his savings directly in a field where there is the possibility of loss is a debatable point.  The alternative would be some form of planned savings and investment in which compulsion would have to be exercised.

GREATER PRODUCTION IS THE ONLY WAY

The most drastic redistribution of income conceivable could do little to improve the immediate lot of those on low incomes.  And any gains achieved would be temporary.  In the not so long run, the destruction of incentive would cause a fall in national production, and eventually lower the incomes of all.

A far wiser policy would be to concentrate on raising the level of productive efficiency in all our industries, in order to expand the volume of goods and services available for distribution.  This is the only road which can lead to a permanent increase in real wages and salaries and a worth-while improvement in living standards.  In a progressive society significant discrepancies in the income of its members must remain as a stimulus to resource, initiative and adventure.

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III. -- IMPROVEMENTS IN THE STANDARD
OF LIFE OF THE LOW INCOME-EARNER

HAVE THE STANDARDS OF THE WAGE-EARNER IMPROVED?

It is often claimed that, while higher productive efficiency has made possible a much enlarged national income, little if any of this improvement has redounded to the advantage of the worker and the lower income groups generally.  Critics point on the one hand to the vast strides made in scientific progress, and contrast this unfavourably with the comparatively low standards of life still endured by great numbers of people.  An extreme view argues that the effect of the capitalistic private enterprise economy is inevitably to concentrate wealth into fewer and fewer hands, with the result that the rich get richer and the poor get poorer.  A more moderate opinion takes the stand that the great advances in industrial productivity, due to science and the increasing use of machines and mechanical devices of all kinds, have not been paralleled by a commensurate advance in the standards of the wage-earners.  Critics of the Australian system of wage fixation have argued that the worker is kept on a minimum wage and gains no advantage from industrial progress.  It is often contended that there has been little increase in wages since a basic wage was first established under the Harvester Judgment of 1907, and that the large expansion of the national income, which has taken place since that time has been accomplished by small, almost negligible improvements in the rewards of the wage-earner.

Is there any substance in these various claims?  Is it, in fact, true that the low income earners have shared to only a minor extent in the material progress of the last 30 or 40 years?  Is it a fact that the wage-earner is little or no better off today than he was at the beginning of the century?  Has the great part of the 400% increase in the national output, which has occurred since 1900, gone into the pockets of the well-to-do and those already enjoying high incomes?

THE BASIC WAGE

Let us first of all examine the matter of wages and see to what extent, if any, the real wage, as distinct from the money wage, of the worker has grown since a basic wage of £2/2/- was first established in 1907 by Chief Justice Higgins in his famous Harvester Judgment.  No material alteration was made to the wage set by Chief Justice Higgins until 1922, when 3/- a week was added to compensate the worker for the lag incurred in adjusting the wage upwards to cope with the rising costs of living.  This is known as "the Powers 3/-".  There are two schools of thought on "the Powers 3/-".  One holds that it represented a real increase in the basic wage over and above the Harvester wage;  the other claims that it did no more than maintain the real value of the wage at the level of the Harvester wage.  It is to be noted that the worker was allowed no increase in his wages on account of higher prices until 1913 when the Commonwealth Court, on application by the unions, commenced to adjust wages to rising costs of living.  In 1922 cost of living adjustments were placed on an automatic basis, so that wages were adjusted regularly every quarter in terms of retail prices.  The intention, and for the most part the effect, of cost of living adjustments was to maintain the real value of the basic wage -- that is, its value in terms of the commodities and services it could purchase -- at the level set in 1907.

THE 1934 JUDGMENT

In the meantime, however, other alterations in addition to "the Powers 3/-" were made to the level of the basic wage itself.  The calamitous depression of 1929-33 forced a reduction in wages of 10% in conformity with reductions in all other kinds of income.  This took place in February, 1931.  In April, 1934, the Commonwealth Court determined a new basic wage.  The effect of this award was to restore the 10% cut in wages made in the depression, but to withdraw from the worker the advantage of "the Powers 3/-".  The consensus of opinion is that under the 1934 Judgment the value of the basic wage had virtually again become equivalent to that of the wage set by Chief Justice Higgins in 1907.

In 1937 the Court added a 6/- "prosperity loading" to the basic wage, which represented a real increase over the 1907 standard.  During the war, wages were further raised by the addition of "war loadings", estimated at about an average of 6/- a week, and by the increase over a wide area in minimum rates of pay for women from 54% to 75% of the male basic rate.  The basic wage-earner today is therefore better off, both so far as the real value of his income is concerned and because, from 1913 onwards, he has had the advantage, which he did not possess in 1907-12, of cost of living adjustments.

It must be admitted, however, that by and large these improvements represent only a comparatively small increase in wages since the early years of the century.  But the full story has yet to be told.

MARGINAL RATES AND SPECIAL PAYMENTS

In 1907 Chief Justice Higgins established the practice of awarding marginal rates of pay over and above the basic rate for various types of skilled work.  Thus some skilled workers, notably fitters and turners, were entitled to 18/- a week above the basic wage.  Over the last thirty years these marginal rates for special skill have been very substantially increased and their application widened.  For instance, the margins granted by the Courts for some types of work are now over £2 a week.  The Courts also began to make special allowances for work, which by its nature, was particularly onerous, unpleasant or dangerous.  There can be no question that the increase and wider application of marginal rates and the payment of extra rates for disagreeable work have meant a very material improvement in the average real earnings received by the wage-earner.  Another source of improvement has been the increase in rates of pay for overtime work.  Practically all overtime is now paid at time-and-a-half rates or, under some circumstances, at double time.

INCREASE IN AVERAGE REAL WAGE

The Labour Report published by the Commonwealth Bureau of Census and Statistics, shows that over the period 1911-43 average money wages per week increased by over 130%, while average real wages -- wages in terms of the goods and services they can purchase -- increased 23% The Report also reveals the average weekly wage paid over the whole field of industry to be about 20% above the basic wage.  These figures merit a little reflection.  The fact that the rise in the real basic wage since 1907 has been relatively slight does not mean that the average wage-earner today is not earning considerably higher wages than he was forty years ago.  The skilled worker is now receiving a much higher wage than in 1907, because the remuneration "the marginal rate", he is paid on account of his special skill has been greatly increased.  Also, the proportion of unskilled to skilled workers has been reduced.  In addition, many grades of workers who thirty or forty years ago were regarded as unskilled are now classified as skilled, and accordingly receive extra marginal rates.  Of the total number of wage-earners, there is today a much smaller percentage than in 1907 receiving only the basic wage.

REDUCTION IN WORKING HOURS

The history of wage increases gives by no means the full story of the advances which have been made in the standards of life of the lower income groups.  Higher wages have been accompanied by a long list of other advantages, all of which have combined to greatly better the lot of the wage-earner.  Outstanding among these is the progressive reduction of working hours which has permitted greater time for leisure, recreation and self-improvement.  In 1914 the average 'hours of work over the whole field of industry were 49 per week;  in 1943 the average working week was 43.6 hours.  This reduction in the working week has meant that hourly rates of pay -- real wages per hour -- have risen by 37% over the last thirty years.  It is worth noting that Australia was the first country in the world to achieve a 48 hour working week in industry.

In 1900 annual leave for the wage-earner was almost unknown.  Today there are few industries which do not provide an annual holiday with pay.  Moreover, the length of the holiday has been steadily increased.  At the present time a big proportion of workers in industry enjoy a holiday of ten days or two weeks a year.  The effect of recent awards will be to increase the length of annual leave, and to extend a fortnight's holiday to great numbers of workers.  In addition, the Australian worker is entitled to about ten statutory holidays in the year, for all of which he receives the full rate of pay.  This compares with five statutory holidays in Great Britain, six in the United States and six in Canada.  In many industries in these countries the worker is not paid for statutory holidays.

In the matter of leisure time, determined by hours of work and annual leave, there is little doubt that the Australian is better off than the workers of any of the other English-speaking countries, with the possible exception of New Zealand.

WEEKLY HIRING

The principle of weekly hiring, observed in most of the awards of the Commonwealth and State Industrial Tribunals, brought further material benefits to the wage-earner.  First introduced in 1920 in Commonwealth awards by Chief Justice Higgins, it is applied to industries where the work is of a regular nature.  The implications of weekly hiring are well summarised by Mr. George Anderson in a paper, "Industrial Tribunals and Standards of Living".

"In an industry subject to weekly hiring, employees are engaged from week to week, their employment is terminable by a week's notice on either side, they receive payment for certain public holidays in the year, for abscence from work on account of personal ill-health up to six days in a year, and for time lost in any week if they are ready and willing to work, and the loss of work is due to a cause for which the employer can be reasonably held responsible."

"The principle underlying weekly hiring is that the basic wage is fixed for the needs of the worker for the fifty-two weeks of the year, and that if a worker were not paid for loss of work due to public holidays, sickness and broken time, he would receive for an average week's work less than the basic wage."

WORKING CONDITIONS AND FACTORY WELFARE

Over the last few decades, there has been a pronounced improvement in conditions of work.  Factories are cleaner.  Work is safer.  Improvement in design and lighting and the provision of adequate sanitary and washing facilities have contributed to a more healthy life for the wage-earner.  In many organisations the worker is provided with free medical and dental services.  With the new recognition given to the importance of nutrition, some businesses have recently introduced canteens to provide the worker with a hot, well-balanced meal.  Many of these things were unheard of not so many years ago.  All must be paid for out of the national income.

In many of the larger organisations the worker has benefited through schemes of financial assistance to cover contingencies such as sickness, medical expenses, injury, unemployment and retirement.  These schemes have been improved, and have become more widespread in industry with the passage of years.  Private industry in Australia is subsidising superannuation schemes for the benefit of employees (administered by life insurance companies) to the extent of well over £2,000,000 annually.  This does not include the subsidies paid under schemes privately administered.

In ways such as this, the lot of the low income-earner has been greatly bettered by comparison with his position near the beginning of this century.  The increasing adoption of annual bonus payments, profit sharing, and the widening application of systems of payment by results in industry have all helped to swell the income of the wage-earner.

The bare increase in average weekly wages thus gives an entirely inadequate and misleading measure of the improvements that have occurred in the standards of life of the industrial worker over the last few decades.

GREAT EXPANSION IN SOCIAL SERVICES

One of the most striking indications of the extent to which the low income-earner has participated in the gains of industrial and scientific progress is provided in the figures of expenditure on social services.

Government expenditure on social services is of such a nature that it assists mainly people in low income groups, while it is paid for mainly -- or at least in good part -- by those with higher incomes.  In 1901 less than £4m., or about £1 per head of the population was spent on social services of all kinds.  In 1925-26 the social services expenditure of Commonwealth and State Governments totalled about £30m. or about £5 per head.  By 1944-5 the total cost of social services throughout Australia had risen to over £100m. or £14 a head of the population.

Most social services, because they benefit mainly the low income-earner, and because they are financed from taxation which falls more heavily on the higher income grades, represent a transfer of income from the richer to the poorer.  To arrive at any accurate assessment of the real advantages of social services expenditure to the wage-earner, it is necessary to set against the many benefits derived the contributions made by the wage-earner to the cost.  It has been estimated that in 1935-6 wage-earners gained a net benefit from public expenditure of £16.8m.  This sum represents in effect a transfer of income from the higher to the lower income groups, and a real addition to the income of the wage-earner of an average of £9 a head per year, or nearly 4/- a week.

In recent years there has been an immense expansion of social services of all kinds -- pensions, child endowment, unemployment and sickness benefits, expenditure on health and education.  The following table shows the increase in social service expenditure which has taken place over the last twenty years: --

Social Service Expenditure

	1925-6 £m.	1944-5 £m.
Commonwealth   War Pensions   Old Age and Invalid Pensions   Child Endowment (1941)   Health Department   Widow's Pension (1942)   Social Service Department   Maternity Allowances   National Welfare Fund (1943)	7    8    -    .2 -    -    .7    -    15.9	12    21.7 12    .4 .3 .4 2.5  27.3 76.6
	1925-6	1943-4
State   Education   Public Health and Recreation   Hospitals   Charitable Institutions   Other	9.6 .6 2.9 1.3    -    14.4	14.7 1.2 6.7 3.8    5    31.4

While only minor disbursements were made from the National Welfare Fund in the financial year 1944-45, it is possible that eventually round about £20m. a year will be paid out of this fund to cover unemployment and sickness benefits alone.

NET BENEFIT TO THE LOW INCOME GROUPS

The great expansion in social services planned during the war means that the net benefit to the wage-earner from public expenditure will be considerably higher than in 1935-6, when it was estimated at £16.8m. a year.  Since 1935-6 expenditure on social services has been doubled, and a good part of this -- pensions and unemployment and sickness benefits -- is subject to a means test.  In 1935-6, with a total social services expenditure of £50m., the net gain to the worker from public expenditure -- as has just been mentioned -- was estimated to be £16.8m.  It would seem reasonable to suppose that of the new additional expenditure about 50% or £25m. will amount to a net benefit to the wage-earner.  Thus, under the new scale of social services and public expenditure, the lower income groups may be in receipt of a total net money gain of something like £42m. or £20 per head per year.  This would represent income transferred from the pockets of the better off to those of the less well off sections of the community.

In the light of facts such as these, it is manifestly absurd and false to argue that the low income-earner has not shared greatly in the material progress of this century, or that income has not become more evenly distributed with the passage of time.

MORE EVEN DISTRIBUTION OF INCOME

The following table throws a revealing light on the advances made in the standards of the low income groups, and on the extent to which the national income has become more evenly divided over the last twenty years.

	% of all income receivers
	1920-21	1941-42
Persons under £200	59.0%	39.0%
Persons between £200 & £400	35.5%	47.7%
% of National Income going to £200-£400 group	37.6%	50.5%

From these figures several conclusions can be drawn.

1. Since 1920-21 there has been a great reduction in the percentage of income receivers getting under £200 a year, and this in spite of the fact that the increase in the number of pensioners in latter years would tend to swell the proportion of income-receivers in this grade of income,
2. There has been a remarkable increase in the proportion of the working population receiving between £200 and £400 a year, and in the share of the national income going to this income group -- 37.6% in 1921 to 50.5% in 1941-42.
3. In the period 1920-21 to 1941-42 the total national income was doubled.  Therefore the total income received by the £200-£400 group was much more than doubled, while the number of income-earners in that group increased by only 80%.  The two years in question form a good basis for comparison, because the level of prices in both was roughly the same -- in 1920-21 slightly above that of 1941-2.

It is undeniable that there has occurred in this century a really significant improvement in the living standards of the wage-earner and lower income sections of the community.  The average real wage has risen by over 20% since 1907.  Hours of labour have been considerably reduced.  Holidays have greatly increased.  The conditions and the financial security of the worker in the factory have advanced.  The scale of social services have multiplied many times.  Those who, for one reason or another, are unable to earn an income are far better protected today than forty, or even ten, years ago.  Public expenditure on health and education has grown.  There, is a much more even distribution of income over the whole population.  In the light of these facts, the claim that those on low incomes have not participated in any material degree in the rising productivity of industry falls to the ground.

STANDARD OF LIFE NOT SATISFACTORY

At the same time it is not suggested that the wage-earner today enjoys a fully satisfactory standard of life.  Nor is it suggested that the present standard cannot be greatly raised.  On the contrary, there is both pressing need and ample scope for further improvement.  But this improvement will not be brought about by a policy based primarily on the redistribution of some imaginary surplus of income and wealth -- a surplus that does not, in fact, exist.  A higher standard of life for all can be won only by a higher standard of production and enterprise by all.  To be successful, economic policy must be founded on truth, not on fantasy or prejudice.  The falsity of the oft-repeated assertion that the position of the wage-earner has not measurably improved since 1900, therefore needs to be exposed.  It does not stand up to the facts.

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SIGNIFICANT POINTS FROM THESE ARTICLES

"PROFIT-MOTIVE"

1. The desire, common to practically all men, for personal gain and advancement, is the true meaning of the term "profit-motive".  The profits of business are only one limited aspect of the "profit-motive".  The wage-earner in his desire for higher wages is as much actuated by the "profit-motive" as the businessman in his search for new avenues of profit.

   
   

   COMPANY PROFITS

2. A survey of 617 companies conducted by the Commonwealth Bank for the year 1944 shows the average rate of company profits as a percentage of shareholder's funds to be 6%.  Over the whole field of industry, and taking into account companies that sustain losses and those that fail to return even the', capital invested in them, the average rate of company profits is possibly nearer 5% than 6%.

   
   

   COMPANY DIVIDENDS.

3. If all the income, after payment of taxes, received by investors from company dividends in the year 1944-5 had been redistributed among those with incomes of £300 a year and less, the addition to their income would have been about 3/6 a week each.

   
   

   DIVIDENDS AND UNDISTRIBUTED PROFITS.

4. If all company profits for 1944-5 -- comprising dividends and undistributed profits -- after payment of tax, has been divided among those receiving £300 a year and less, the individual would have received at the very most an extra 6/6 a week.

   
   

   REDISTRIBUTION OF INCOME.

5. If, in the year 1941-2, all income above £400 a year had been confiscated and redistributed among those previously receiving £400 a year and less, the net gain to the individual would have been of the order of 11/- a week.

6. If, in the same year, all income above £1,000 a year had been confiscated and redistributed among those receiving £200 a year and less, the individual would have gained an extra 6/- a week.  If all income above £1,000 a year had been redistributed among those receiving £400 a year and less, the individual would have gained about 3/- extra a week.

7. The most drastic redistribution of income conceivable could do little to improve the lot of those on low incomes.  And any gains achieved would be temporary.  The destruction of incentive would lead to a fall in national production, which would eventually reduce the incomes of all.

   
   

   STANDARDS OF THE WAGE-EARNER

8. Has the lot of the wage-earner improved since the beginning of the century?

   The wage-earner today is better off in the following ways: --

   1. Average money wages for men have increased by over 130% since 1911;  average real wages -- that is wages in terms of the goods and services they can purchase -- have increased by 23%;  hourly rates of pay -- real wages per hour -- have risen by 37%.
   2. In 1914 the average weekly hours of work of men in industry were 49;  in 1943, 43.6.
   3. In 1900 annual leave for the wage-earner was rare.  Today the great majority of workers enjoy an annual holiday with pay.  The length of the holiday is progressively increasing, so that in the matter of leisure time determined by hours of work, annual leave and statutory holidays, the Australian workers are today much better off than the workers of almost any other country.
   4. Working conditions and factory welfare facilities such as free medical and dental services and canteens, have improved out of recognition.
   5. Private industry has consistently advanced the financial security of the worker through schemes to cover contingencies such as sickness, medical expenses, injury, unemployment and retirement.  Private industry is subsidising superannuation schemes (administered by life insurance companies) to the extent of over £2 millions annually.
   
   

   SOCIAL SERVICES

9. Social services, which benefit mainly those on low incomes, have multiplied many times.  In 1901 social services expenditure amounted to about £1 per head of the population.  In 1944-5 the provision for social services was over £14 per head of the population.

10. In spite of great improvement the wage-earner does not yet enjoy by any means a fully satisfactory standard of life.  This standard can be greatly and rapidly raised provided we concentrate on enlarging the national output and income instead of on redistributing the inadequate income that exists.