The Implications of Globalisation for Macroeconomic Policy

Vol. 7, No. 4

SUMMARY

Increased globalisation has led to claims that governments now have a more limited capacity to pursue "independent" macroeconomic policies.  However, before financial deregulation, financial markets also imposed constraints on such policies.  Concerns about financial deregulation derive importantly from the experience of the 1980s and largely overlook the poor policy performance of governments, including Australia's.

While globalisation is putting competitive pressure on Australian governments to perform more efficiently in the delivery of services, it does not provide any significant inhibition on "big" government where financing is not by borrowing.

Financial deregulation has resulted in a deepening of international capital markets and increased the scope for governments to pursue "flexible" macroeconomic policies.  It imposes less "discipline" on such policies than the pegged exchange rate regime.  Indeed, governments are now allowing the exchange rate to be used more as the adjustment mechanism and are pushing against prudent limits on debt, whether internal or external.

To reduce significantly the risk of major instability from volatile actions of international financial markets, and markedly improve the medium-term performance of the Australian economy, the following approaches should be adopted:

• The Commonwealth Government should state as a policy objective the achievement of an external situation with a much reduced risk exposure.
• The Commonwealth Government should become a significant net saver -- not by raising taxation but by reducing spending.
• Over time, social security and associated assistance should be reduced by concentrating them more on low-income and other genuinely disadvantaged groups.
• Price stability should be established as the sole objective of monetary policy by adopting a monetary policy framework similar to that in New Zealand.
• The Commonwealth Government should indicate that the savings and price stability objectives would not be varied when fluctuations occur in the domestic economy, except where there is a large exogenous "shock".
• A public programme of "education" should be implemented showing why governments do not have the capacity to prevent short-term fluctuations in the economy.
• Legislation should be introduced to make budgetary and monetary policy processes more transparent and accountable, and to constrain the power of executive government, along similar lines to New Zealand's fiscal/monetary legislation.

INTRODUCTION

According to the Bureau of Industry Economics, "the essential feature of globalisation is that firms pursue global strategies in which their international activities are linked and coordinated on a world wide basis". ⁽¹⁾  But the phenomenon of globalisation extends also to capital markets and has been an influence since at least the establishment of the euro-dollar market in the 1960s.  In those markets, financial institutions of various kinds, together with individual investors, are also pursuing global strategies in the investment of funds under their control.  Such globalisation may be viewed as both a cause and an effect of the increased interdependence of countries -- a cause in the sense that the natural tendency, in a world of vastly improved communications and transport, for entrepreneurs to extend their activities beyond national borders opened the eyes of governments to the potential advantages from allowing and encouraging such activities;  and an effect in the sense that the removal of restrictions on trade and capital flows encouraged further globalisation of national economies.

This growing interdependence is reflected in the increased ratios of international trade to GDP and of foreign private direct investment to total domestic business investment, as well as in the increased number and size of multi-national enterprises.  It is also reflected in the increased international capital flows of a shorter term nature.  Thus, between 1980 and 1992, world merchandise trade increased by an average of 3.9 per cent per annum in real terms, and world output by an average of 2.1 per cent per annum (Australia's foreign trade also increased significantly relative to GDP in the 1980s, as did its outwards and inwards foreign equity investment).  Between 1983 and 1992, total direct investment abroad grew at an average rate of 25 per cent per annum and, by the early 1990s, there were some 37,000 parent multi-nationals (of which BHP and News Ltd were among the 100 largest) which had over 170,000 affiliates. ⁽²⁾

Increased interdependence has naturally tended to increase the exposure of domestic economies to developments in other economies and to attitudes of investors from those economies.  In Australia's case, one recent study indicates an increasing correlation between Australian and foreign output growth since the early 1980s, although the author acknowledged that it is not clear how this has occurred. ⁽³⁾

These globalisation effects have, in turn, led to claims that national sovereignty has been reduced and that governments now have a more limited capacity to pursue "independent" policies.  Such claims relate to a wide range of policies.  In their more extreme form they even postulate that multinational enterprises and "financial markets" are now the controlling influence on domestic economies.

In the case of macroeconomic policies, financial deregulation may be regarded as the facet of globalisation which impinges most heavily.  The concern most frequently expressed is that governments have become excessively subject to either the "discipline of financial markets", resulting in excessive focus on economic efficiency at the expense of social equity;  or to the vagaries of such markets, resulting in disruption to domestic economies or forcing governments to implement unnecessary changes in policies.  For example, in a recent article, Mr Fred Argy, who was secretary of the Campbell Committee inquiry which recommended deregulation of the financial system, argued that the effect of financial deregulation has been to impose "a major constraint on the ability of governments to implement (through tax and transfer policies) the community's preferred set of social priorities", and that it has created "a strong policy bias in favour of low inflation and 'small government' ". ⁽⁴⁾  Reflecting concern at the potential for destabilisation from speculative capital movements, Argy went on to suggest that "The time has surely come for co-ordinated international action to better manage destabilising short-term portfolio capital flows across national borders".

GENERAL OBSERVATIONS

Changes in technology and improved communications have undoubtedly played an important role in the globalisation process, in the sense that they have both allowed and encouraged the process -- some would say, made it almost irresistible.  However, the increased exposure of most countries to international trade and capital flows also reflects decisions by governments to reduce the barriers to such flows:  indeed, without decisions to allow foreign direct investment, and to provide an environment conducive to it, multi-national enterprises would not exist.  Such decisions were made on the perception that net benefits would flow from them.  The great majority of economic and other informed analysts continue to perceive such net benefits.  Indeed, the liberalisation of capital flows has recently been portrayed as offering potential benefits not previously identified, at least by economic theorists. ⁽⁵⁾

It should also be noted, nonetheless, that many governments still retain extensive barriers to trade and capital flows. ⁽⁶⁾  Many also still have exchange rates which are either fixed or set via managed floats.  These governments have presumably decided that the potential benefits from more liberal regimes are more than outweighed by the costs.  Restrictions on trade and investment are often retained where greater exposure to foreign influence is judged as being likely to have detrimental effects on national "culture".

In Australia's case any move to return to a more "isolationist" regime, even as regards capital flows, would be most unlikely to find significant support.  Argy, for example, did not advocate financial re-regulation in his recent analysis and it is now widely accepted that such re-regulation would be impractical for a government that wants to ensure that the country's businesses and citizens play a significant role in the international marketplace.

The main issue, therefore, is whether anything can (or should) be done to reduce the perceived potential for adverse effects arising from globalisation.  This issue extends across a range of policies but, for present purposes, consideration is limited mainly to macroeconomic policy and financial deregulation issues.  As such, it also serves to raise the question of the role of macroeconomic policy itself.

IMPLICATIONS OF GLOBALISATION
FOR MACROECONOMIC POLICIES

Argy suggests that financial deregulation imposes a bias in favour of "small government".  However, international investors are much more concerned with whether social policies are soundly financed than with their extent.  There are already wide differences in sizes of government and extents of taxes and social transfers.  "Big" governments in this sense may be somewhat more susceptible to destabilising capital flows than are "small" governments.  But financial markets provide no serious inhibition to a country moving to a bigger government provided it does so in a financially responsible way.

Of course, if a country's government moved to extend income redistribution and, in consequence, reduced national productivity growth and the national propensity to save, that would, over time, necessarily be reflected in a lower real exchange rate and reduced relative living standards.  Such a process would also occur, however, if the country was less internationally oriented.  And, provided the extension of income redistribution was not financed by borrowings, there is no reason to expect that it would unleash forces that would destabilise the domestic economy.

Nor should such forces be unleashed solely because a country opts to provide a significantly greater proportion of services through the government sector.  While there is little doubt that globalisation is causing greater emphasis to be placed on improving the efficiency of the government sector, such action was (and is) needed in any event.

For macroeconomic policies, the main issue is whether financial deregulation has reduced the capacity to employ fiscal and/or monetary policies to "manage" the domestic economy and, if so, whether anything can or should be done about that.

In considering this, it might first be noted that there were many occasions prior to the 1980s when the excessive pursuit of interventionist macroeconomic policies, designed to achieve benefits in terms of economic activity and employment, produced adverse reactions from financial markets.  Indeed, the post-World War II era of pegged exchange rates, and highly regulated international capital flows, witnessed periods of balance-of-payments "crisis" and remedial demand-restraining action for many countries.  An OECD study of eleven major crises among OECD countries ⁽⁷⁾ -- of which the most notorious is perhaps the U.K. sterling crisis of 1976 which ended with the government signing a letter of intent with the IMF setting out fiscal and monetary targets -- clearly shows that such crises were serious and not infrequent prior to the 1980s.  The study shows that the underlying causes were bad domestic macroeconomic policies.  As noted, the globalisation of financial markets started well before the 1980s.

In Australia's case it was consistently argued by some analysts in the 1950s and 1960s that a chronic balance-of-payments problem existed, requiring more centralised economic planning.  Fortunately, the Menzies Government rejected this approach as recommended by the Vernon Committee in 1964.  Moreover, notwithstanding the existence of stringent exchange controls on capital movements, the period was far from being free from "speculation", which was always available through "leads and lags" in Australia's external payments.

It might also be noted that most Latin American countries experienced a massive debt crisis in 1982 when they allowed re-cycled petro-dollars to be injected into their economies without taking adequate countervailing action on fiscal or monetary policies.  Governments of these countries were subsequently forced to curtail domestic demand because foreign capital ceased to be available to finance large current account deficits.  The result was, as one observer has put it, "The 1980s was a lost decade for Latin America and not only in terms of capital inflows.  Growth was low or negative and, in several countries, annual inflation rose to three or four digit rate". ⁽⁸⁾

In short, prior to financial deregulation the capacity to use fiscal and/or monetary policies to "manage" domestic economies was constrained -- and was also subject to the "discipline of financial markets".  Arguably, the widening and deepening of international capital markets since financial deregulation now provides greater scope for countries to pursue policies which "stimulate" economic activity or which seek to maintain it in the face of, say, reduced export income.

Indeed, international investors appear to have a surprisingly wide range of tolerance.  This is reflected in the considerable spread of ratings which the credit rating agencies apply even to national governments. ⁽⁹⁾  What this says, in effect, is that international investors are prepared to lend to national governments even when those governments allow relatively high rates of inflation and borrowing, provided those governments are prepared to pay an additional risk premium.  Thus, governments do still have scope to pursue macroeconomic policies which differ quite substantially:  but, as one would expect, there is a cost of doing so which will be reflected in higher real (and nominal) domestic interest rates and lower private investment.  I believe that the credit rating agencies and international investment institutions are too tolerant of lax macro-policies, allowing governments to pursue those policies to the point of financial crisis.

The main concern about the implications of financial deregulation derives to a large extent from the experience of the 1980s, which ended in a quite severe recession and increased unemployment.  Those expressing concern about that period and its aftermath point to the apparent growing tendency for "financial markets" to react adversely -- and in some cases, extremely -- to economic developments which, while capable of being interpreted as sending a signal that a government is pursing macroeconomic policies that are too "lax", may also be open to the interpretation that they are a normal part of the business cycle.  (Australia's present current account situation might, arguably, be said to be open to such different interpretations.)  When such financial markets' reactions occur, a government may be "forced" to take action to curtail domestic demand when, it is argued, no such action is required if a longer-term perspective were taken by international investors.

The problem with those putting this position -- and arguing that "something" needs to be done about it other than to pursue better macroeconomic policies -- is that they fail to acknowledge the poor record of macroeconomic performance of governments not only in the 1980s but also in the decade or so leading up to that time and, in many cases, their continued relatively poor performance, particularly as regards fiscal policy.  In Australia's case, the macroeconomic policies pursued by the Labor Government in the first part of the 1980s were undoubtedly the most interventionist ever pursued by an Australian Government.  Thus, under an Accord with the trade union movement which provided for wage restraint, the Government sought, through a combination of fiscal stimulus and relatively "benign" monetary policies, to achieve a higher rate of economic growth than would otherwise have been the case.  The notion was that the Accord would prevent the wages upsurge which would normally be expected to occur as the economy approaches "full employment", and that the (newly floated) exchange rate would "absorb" any strain on the balance of payments.  However, the fact that productivity growth remained stagnant meant that the (stimulated) increase in national spending was not matched by an equivalent increase in national output.  This resulted in a "blow-out" in external debt and other foreign liabilities and, to retain the confidence of foreign investors, necessitated the severe tightening of monetary policy which produced the recession of the early 1990s and the associated steep rise in unemployment. ⁽¹⁰⁾

Against this background, and having regard both to the large foreign liabilities accumulated by the public and private sectors as a result of the 1980s experience, as well as to indications that Prime Minister Keating has been prepared to adopt a high risk strategy with regard to the operation of macroeconomic policies, ⁽¹¹⁾ it is scarcely surprising that international investors are "twitchy".  There is little doubt that pursuit of similar macroeconomic policies before financial deregulation would have resulted in a(nother) balance-of-payments "crisis" well before now and, importantly, a hauling back in the stance of macroeconomic policies.  In assessing the implications of financial deregulation, it is important that this increase in flexibility be recognised.

In short, contrary to the thesis that financial deregulation reduced the scope for adopting "flexible" macroeconomic policies, I argue that it increased it.  In particular, under the "fixed" exchange rate system, the need to change the rate was widely acknowledged as also requiring adjustments to other domestic policies at the same time.  By contrast, the move to floating rates gave governments greater scope to pursue "flexible" macroeconomic policies which, through the operation of relatively large budget deficits and/or relatively high rates of growth of monetary aggregates, have resulted in high and (in many cases) increasing ratios of public debt to GDP and/or of external debt to GDP.  In effect, governments have increasingly taken the easy way out and allowed the exchange rate, coupled with external debt accumulation, to be used as the adjustment mechanism when it is politically "too hard" to use macroeconomic policies.

Of course, increases in debt are not necessarily to be regarded as a "bad thing", if borrowing proceeds are used productively.  There is evidence to suggest, however, that, in Australia's case particularly, they have largely financed increases in consumption rather than investment.  In consequence, international investors are now making investment decisions against a background where governments and/or countries appear to be constantly pressing against prudent debt limits. ⁽¹²⁾  It is scarcely surprising, in these circumstances, that financial markets are volatile or that they are prone to take a set against particular countries and their currencies.

Economic theory in fact supports the view that financial deregulation has given to governments more flexibility in operating macroeconomic policies.  In principle, the move to a floating exchange rate allows a country to pursue an "independent" monetary policy because the supply of money is no longer affected by changes in the external situation.  Such changes are, instead, reflected in variations in the exchange rate needed to balance any change in the underlying demand/supply situation for a country's economy. ⁽¹³⁾

Thus, so the theory goes, a government that wishes to use its monetary policy to, say, effect a short-term stimulus to economic activity, or to maintain it in the face of, say, reduced export income, is able to do so without fear of losing external reserves, provided it is prepared (and able) to live with the consequential exchange rate and price adjustments, as well as the consequential deterioration in the current account deficit.  Equally, a similar use of fiscal policy will tend to have similar consequences.  What happens in these situations, in effect, is that there is an increased draw on overseas savings in order to finance an expansion or maintenance of domestic economic activity.

Under a "fixed" exchange rate regime, the pursuit of similar macroeconomic policies would also have increased Australia's current account deficit and draw on overseas savings.  Moreover, while that process would tend to have been reflected to a greater extent in drawing down overseas reserves (with consequential effects on the money supply), that did not necessarily prevent the exercise of flexibility in macroeconomic policies.  For one thing an expansion in domestic activity would tend to have attracted additional private capital inflow, thus offsetting the downward trend in reserves.  For another, it was open to the government to offset reductions in reserves by overseas borrowing.  In short, there was scope under a fixed exchange rate regime to exercise flexibility in macroeconomic policies.  But, as noted, that regime actually tended to impose a more disciplined approach to macroeconomic policy.

Comparisons between what happened or would have happened under a pegged exchange rate and exchange controls on capital movements, on the one hand, and what happens under the present floating regime to-day, on the other hand, are largely of academic interest only.  For those who wish the Australian Government to have macroeconomic flexibility, the main issue now is the price at which international capital markets are prepared to finance an increased current account deficit, whether that be from "expansionary" macroeconomic policies or reductions in exports due to an overseas recession.  If "financial markets" judge the external situation to be unsustainable, the result will be downwards pressure on the exchange rate and upwards pressure on domestic interest rates, with potential adverse consequences for domestic economic activity.

The reality is that, whatever the theoretical validity of the argument that there is now a greater capacity to pursue an "independent" monetary policy, limits still exist on the extent to which international investors are prepared to finance current account deficits even in a world which perceives (for the present) inflationary risks to be relatively small, particularly where such deficits appear to be driven to an imprudent extent by consumption expenditure.  Nobody knows what those limits are, and economic theory tells us that the current account deficit should not be a policy target. ⁽¹⁴⁾  Yet the sensitivity of financial markets to changes in Australian Government policies, and to various economic indicators, probably reflects the using up of a good deal of credibility in the 1980s and the apparent preparedness of the Government to continue to run high-risk policies in the 1990s.

CAN INTERNATIONAL CO-OPERATION HELP?

Whether or not globalisation has made it more difficult to "manage" the economy, the question thus arises as to whether anything can (or should) be done.

As noted, even quite strong critics of financial deregulation accept that the benefits outweigh the costs and do not wish to re-regulate.  Such critics do, however, point out (correctly) that assessments made by international investors of a country's economic position and policies are not only sometimes incorrect but also tend to be somewhat volatile.  The net result may be to add to the uncertainty of domestic economic decision-makers, or to cause exchange rates and longer-term interest rates to move out of line with economic fundamentals, with adverse effects on national economic performance.

One possible response to this situation is to strengthen international "co-operation" in one form or another.  Possible suggested areas of co-operation include greater co-ordination of macroeconomic policies and/or action to maintain exchange rates within a given range.  The International Monetary Fund is, for example, seeking to strengthen its surveillance of countries' economic positions and policies "in order to improve (the IMF's) capacity to work as an early warning system";  to obtain increased resources to avert crises similar to the recent Mexican one by strengthening its capital base "through a quota increase";  to "work on the role the SDR could play in putting in place a last-resort financial safety net for the world";  and "to make our most effective instrument -- the enhanced structural adjustment facility -- better suited to addressing the problems of poorer countries." ⁽¹⁵⁾  Another example is the agreement by the countries that are to form the European Union to standards of performance in regard to budget deficits and inflation rates as a pre-condition for the foreshadowed move to a common currency.  However, there has been little, if any, progress towards achieving the performance standards and those standards appear, in any event, to be minimal.  They are certainly of limited relevance to Australia, which has some different structural problems from those of European countries.

To reduce the potential for destabilising short-term capital flows through international co-operation, the minimum action that would be necessary would be for there to be agreement on a convergence in macroeconomic policies of at least the major countries and an implementation of the policies needed to achieve such convergence.  The domestic political difficulties of achieving that appear to be almost insuperable.  Yet measures which attempted to keep exchange rates within prescribed limits would be doomed to failure in the absence of such policy convergence, as European experience in 1992 and 1993 demonstrates.  Moreover, even with macro-policy convergence it is by no means clear that destabilising capital flows would not occur from time to time. ⁽¹⁶⁾

To be effective in a sustained way, international policy co-ordination would also need to be directed to medium-term objectives, such as price stability, public sector saving, and improved efficiency of the government sector.  Attempts by OECD governments in the 1970s to lift growth rates through co-ordinated stimulatory macroeconomic policies do not appear to have had any sustained effect on growth rates, and the higher inflation rates which resulted may have had counter-productive effects over the medium term.  At all events, such attempts have largely been abandoned, and OECD (and IMF) analyses and reports increasingly emphasise the need to (for example) reduce structural budget deficits.

Particularly having regard to the rather different structure of the Australian economy, it seems most unlikely that Australian governments would be able to obtain relief in the economic management task from increased international co-operation and policy coordination, at least for the foreseeable future.  As its representatives did in the OECD debates of the 1970s, the Australian Government should itself concentrate on encouraging international institutions to promote sound domestic economic policies among their members and to avoid international schemes, such as the IMF's pipedream for the Special Drawing Rights (SDR), that are more likely to induce a false sense of security and give international institutions undue and unnecessary power and influence, than to improve economic performance.  International economic and financial institutions do have some potential to assist in bringing greater stability to international financial and product markets and, hence, to domestic economies.  But that role is more of an information one -- of keeping markets informed and of sounding warnings -- than of a policy co-ordinator or a supplier of temporary financial support.  The recent public statement by IMF Managing Director Camdessus, made in the context of the sharp depreciation of the $US against the yen, that the US should tighten credit, is of particular interest in the context of his espousal of the IMF's role as an "early warner".  It appears that the G7 meeting at the end of April 1995 actually endorsed an enhanced role for the IMF in acting as an early warner.

WHAT ROLE SHOULD MACROECONOMIC POLICIES PLAY?

Given that international policy co-ordination/co-operation are most unlikely to alleviate problems perceived to be faced by Australian governments in managing the domestic economy in the context of increasing globalisation, what, if anything, should be done to reduce the risk of the Australian economy being adversely affected by international developments of one sort or another?  The posing of such a question raises the further, in some ways more fundamental, question of whether macroeconomic policy should seek to "smooth" fluctuations in the domestic economy.

One thing seems plain.  While it would not be appropriate to set a target or targets for the current account deficit, the Government needs to pursue policies that move the external accounts to a situation with a much-reduced risk exposure.  It is little short of astonishing that, after the disastrous experience of the 1980s of allowing the current deficit to "blow-out", deficits are again running at levels which expose us unduly to the vicissitudes of international capital markets.  We are, in effect, riding the high wire and, if something goes wrong, we have no idea how far below us the safety net may be.

While some argue that we are unlikely to indulge again in a splurge of overseas borrowings so soon after the experience of the 1980s, such abstention would not necessarily guarantee that we will avoid an externally-induced recession.  Running a persistently large current account deficit creates the constant risk of a loss of confidence in the sustainability of that excess-spending situation, and of a sudden difficulty in attracting the foreign capital needed to finance the deficit, not to mention the possibility of outflows of capital. ⁽¹⁷⁾  For Australia, a repetition of the 1980s experience of many Latin American countries is unlikely:  but we should nonetheless take careful note of the lessons from it.

One of two primary requirements is a higher rate of domestic saving.  Fitzgerald and others have suggested that the aim should be to increase domestic saving by about 5 percentage points of GDP, equivalent to over $22 billion in current prices.  That would take domestic saving back to around the average levels achieved in the 1960s and would allow, possibly even ensure, ⁽¹⁸⁾ the lift in investment which is needed to secure a sustainable increase in Australia's rate of economic growth.

This is not the place to examine all the various possibilities for increasing domestic saving.  It is sufficient for present purposes to make the point that a major contribution needs to come from the public sector.  There is, in fact, justification for the public sector becoming a net saver quite apart from the need to lift total domestic saving to reduce our call on overseas saving and increase domestic investment.  That justification derives from the large expansion in public spending on social security and associated forms of government assistance (such as health, education and housing) over the past 20-25 years in particular.  That additional public spending has had an anti-saving and anti-employment bias.  It has eroded the incentive to save and to work and has undoubtedly contributed both to the decline in private sector savings rates and to the increase in unemployment rates.  It has encouraged the attitude -- why save, and why try for a job, when the State will look after you?

What has happened, in essence, is that there has been an expansion in government social security and associated forms of assistance which has reduced the private sector's propensity to save.  Yet nothing has replaced that source of saving.  In fact, over the past 20-25 years during which this assistance has exploded there has been an increase in public sector deficits.  Thus, national savings have been hit by a double whammy -- reduced private and public sector saving.

The ideal response would be to cut back sharply on government social security and associated assistance, by concentrating such assistance to a greater extent on low income and other genuinely disadvantaged groups. ⁽¹⁹⁾  Large reductions in such spending may, however, require a good deal of public education and can probably only be achieved politically over a period.  In the meantime, the Commonwealth Government needs to move, as quickly as possible, to establish a Budget surplus of the order of 2-3 per cent of GDP as the public sector's contribution to raising the rate of national saving.

That should be attained not by raising taxes but by reducing Commonwealth spending, including social security and associated assistance.  Indeed, it should be a major policy objective to reduce spending sufficiently to both achieve a surplus of 2-3 per cent of GDP and to reduce taxation.  All too often the high costs of taxation -- the so-called deadweight losses -- are overlooked.  A recent study estimated that, in New Zealand, for every additional dollar raised from labour (or income) taxation the deadweight loss increases by 18 cents;  in other words, national income is reduced by 18 cents.  Such high deadweight losses from taxation at existing rates confirm the commonsense view that there would be considerable benefits in reducing the overall burden of taxation by, in particular, reducing the "churning" which leads to a net reduction in living standards.

The other main macroeconomic policy requirement is to operate monetary policy so as to try to maintain price stability.  Requiring the Reserve Bank to aim for an inflation range of 0-2 per cent per annum, as in New Zealand, would seem appropriate.  The attainment of such price stability could be expected to have a number of spin-offs, including increased saving and investment.

The two primary requirements proposed for macroeconomic policy imply that there would be a major shift in the objectives of such policy.  In particular, the policy targets of a significant positive public sector contribution to national savings and of price stability would be objectives to be maintained over the medium term, to the extent possible.  There would be no attempt to vary the stance of macro-policies to offset short-term fluctuations in the economy, either down or up, except where there was a large exogenous "shock", such as from a major change in the terms of trade.  In that event some attempt to smooth out the effects (but not to permanently offset them) could be appropriate.

Experience and economic analysis indicate the undesirability of governments varying macroeconomic policy settings in an attempt to induce changes in economic activity.  Particularly after the severe recession in many countries at the end of the 1980s and the long-term upward trend in unemployment, there is now a fairly widespread realisation that persistent attempts by governments to "smooth" the business cycle are likely not only to be ineffective but may also be counterproductive. ⁽²⁰⁾  In this regard, the analysis by David Gruen, referred to in footnote 3, suggesting that there is a strong causal link between changes in Australian output and in overseas output, is of some interest.  This seems to imply that attempts by Australian policy makers to smooth fluctuations in the domestic economy have been unsuccessful.  It also implies that, having regard to the lags between policy action and response, our policy makers would need to accurately predict the course of fluctuations in overseas economies if they were to succeed in smoothing fluctuations in Australia.  Moreover, there is little doubt that a definitive move to medium-term objectives of the kind proposed would have a major beneficial effect on the attitudes of international investors which would, in turn, reduce the risk premium on Australian interest rates and encourage additional private investment.

However, notwithstanding the potential for considerable benefits from establishing firm medium-term fiscal and monetary objectives, there is also little doubt that governments would be tempted to depart from such objectives from time to time, particularly as election time approached.  To counter such tendencies it would be desirable to make the process of budgetary and monetary policy-making much more transparent, and much more accountable, along lines similar to those adopted in New Zealand.

There, the Fiscal Responsibility Act 1994 legislates for Governments to report to Parliament on their longer-term fiscal objectives and requires regular fiscal disclosure by the Government.  The Act contains four main elements:

• a requirement for regular and explicit fiscal reporting (including immediately prior to an election);
• a set of benchmarks against which fiscal policies can be assessed (five principles of responsible fiscal management are set out);
• a move to a more open and transparent Budget process;  and
• a requirement for select committee review and Parliamentary debate of fiscal reports.

It might be noted that current New Zealand fiscal objectives include the use of budget surpluses (which are forecast to reach 7.5 per cent of GDP by 1997-98) to pay off government overseas debt before any consideration is given to reducing taxation.  Current fiscal projections provide for a reduction in the size of government to around 31 per cent of GDP over the next 3 years, from a peak of about 42 per cent in 1990-91.

New Zealand has also legislated to make the monetary policy process more transparent and accountable.  This legislation provides, in particular, for monetary policy to be directed towards the single objective of achieving and maintaining price stability.  It requires a written agreement between the Minister of Finance and the Governor of the Reserve Bank of New Zealand on the specifics of the price stability objective, and for that agreement to be made public.  The current agreement requires the Governor to maintain underlying inflation within the 0-2 per cent range, excluding the effects of certain exogenous shocks, and to publish at least every six months a comprehensive statement on the monetary situation.

Legislation along the New Zealand lines in respect of both fiscal and monetary policy should be an important objective for the Australian Government.  It would significantly reduce the risk of major instability from irrational or volatile action of international financial markets.

CONCLUSION AND SUMMARY

In considering concerns about the implications of globalisation, it is necessary to have regard to a number of points:

1. As it has with the private sector, globalisation is putting pressure on Australian governments to perform efficiently in the delivery of services as part of the process of improving competitiveness.  This was (and is) needed regardless of globalisation;
2. Globalisation does not provide any significant inhibition on "big" government or on expanding the size of government for income redistribution or other purposes.  Provided the financing is not undertaken by borrowing, the main adverse economic effects of "big" government (high taxation and less efficient services) will be reflected over time in lower real exchange rates and lower relative living standards;
3. Before financial deregulation there are numerous examples of the constraints imposed on macroeconomic policies (and adverse effects from ignoring those constraints) by financial markets, notwithstanding the existence of (often stringent) exchange controls on capital flows;
4. The concerns expressed about the effects of globalisation and, more specifically, financial deregulation, derive to a considerable extent from the experience of the 1980s.  However, those expressing such concerns appear largely to overlook governments' poor performance in the operation of macroeconomic policies and, in particular, the unrealistic and naive attempts to use those policies to maintain economic activity and employment at unsustainable levels.  In Australia's case the first four or five years of the Labor Government's period in office in the 1980s saw the adoption of the most interventionist macroeconomic strategy that has ever been pursued in Australia.  Given the outcomes (including particularly the large accumulated overseas debt), it is scarcely surprising that the credibility of macroeconomic polices with financial markets has been diminished, all the more so in Australia's case as (at least up until very recently) Prime Minister Keating has given the impression that there are no lessons to be learned from the 1980s;  and
5. Globalisation and financial deregulation have resulted in a widening and deepening of international capital markets and, consistent with economic theory, floating exchange rates allow countries to operate more "independent" monetary policies.  This has increased the scope for governments to pursue "flexible" macroeconomic policies and it imposes less "discipline" on such policies than the pegged exchange rate regime did.  Certainly, the wide range of international credit ratings indicates that (subject to paying a price for less disciplined policies) international investors have a considerable tolerance of differences in macroeconomic policies.  As a result, governments are now to a much greater extent allowing the exchange rate to be used as the adjustment mechanism and appear constantly to be pushing against prudent limits on debt, whether internal or external.

Whether or not financial deregulation has had this effect, however, the main issue now is what should (or can) be done to reduce Australia's exposure to (in particular) changes in attitudes of international investors.  While economic theory suggests that the current account deficit should not be a policy target, the reality is that the size of and/or trend in that deficit can operate as an important constraint on macroeconomic policies, and can lead to a recession if the appropriate policy response is not forthcoming.

To reduce the risk of the Australian economy being adversely affected by international developments (whether arising from globalisation or otherwise), the following approach should be adopted in regard to macroeconomic policies:

1. The Commonwealth Government should state as a policy objective the need to move to an external situation with a much-reduced risk exposure.  The idea that the 1980s experience of over-borrowing will not be repeated is misleading.  There is still a potentially serious external financing problem;
2. The Commonwealth Government should move as soon as possible to a budget surplus of 2-3 per cent of GDP, not by raising taxation but by reducing spending.  This is justified both as a contribution to the need for increased national saving as part of (i) and to increase domestic investment;  and, in its own right, as an offset to the adverse effects on private sector saving from the enormous increase in spending on social security and associated forms of assistance;
3. Over time there should be a major reduction in such assistance by concentrating it more on low income and other genuinely disadvantaged groups.  This would help reduce social welfare dependency (with consequent economic and social benefits) and would also allow a reduction in the significant adverse effects from existing levels of taxation;
4. Price stability should be established as the sole objective of monetary policy by adopting a monetary policy framework similar to that in New Zealand;
5. The Commonwealth Government should indicate that the budget surplus and price stability objectives would not be varied when fluctuations occur in the domestic economy, except where there is a large exogenous "shock".  (However, the budget surplus objective would be allowed to "absorb" cyclical fluctuations);
6. As part of a new policy approach that focuses on medium term objectives (for both macro- and micro-policies), a public programme of "education" should be implemented to the effect that governments do not have the capacity to prevent short-term fluctuations in the economy, that such fluctuations appear largely to be externally-induced (where they are not caused or aggravated by policy mistakes), and that fluctuations are a normal (and healthy) part of the operation of the market-oriented system in which we live.  Such a programme might include the publication of a Green Paper by the Treasury analysing the post-World War II fluctuations in the Australian economy, their possible causes, and the effects of policy interventions;  and
7. Legislation to make budgetary and monetary policy processes much more transparent, and much more accountable, along similar lines to New Zealand's Fiscal Responsibility Act 1994 and Reserve Bank of New Zealand Act 1989.  This would require, inter alia, specific statements of fiscal and monetary objectives and more comprehensive and regular reporting in regard to those objectives and the economic and financial situation generally.

An approach along these lines should significantly reduce the risk of major instability from irrational or volatile actions of international financial markets.  It should also result in a marked improvement in the performance of the Australian economy over the medium term.

---

ENDNOTES

1.  Bureau of Industry Economics, Globalisation:  Implications For Australian Information Technology Industry, AGPS, Canberra, 1989.

2.  Data from Professor Peter Lloyd's "The Nature of Globalisation" in Globalisation:  Issues For Australia, Papers and Proceedings from an EPAC Seminar, September 1994.

3.  "Globalisation and the Macro-Economy" by David Gruen, Reserve Bank of Australia, in Globalisation:  Issues For Australia, Papers and Proceedings from an EPAC Seminar, September 1994, concluded that international asset market links may have been the main way in which changes in foreign output in the 1980s were reflected in changes in Australian output, but could not establish this statistically.

4.  "Deregulation Expresses Conflict between Efficiency, Social Equity" by Fred Argy, AFR, 11 April.  The author's views are spelt out at greater length in Financial Deregulation:  Post Promise – Future Realities, CEDA Research Study, P42, April 1995.

5.  According to Professor Peter Lloyd, "There is a gain from freeing trade in primary factors over and above the gain from freeing commodity trade, assuming the latter does not equalise factor prices.  The result derives from differences in the countries in terms of the productivities of factors".  (From "Globalisation, Regionalisation and International Trade", paper to Economic Society, Victorian Branch, 29 March 1995.)

6.  There are wide differences between countries in the size of external sectors relative to domestic economies, and in many cases these differences reflect restrictions on trade and/or capital flows.

7.  Why Economic Policies Change Course:  Eleven Case Studies, OECD, Paris, 1988.

8.  "Globalisation and Financial Integration" by P.S. Anderson, Reserve Bank, in Globalisation:  Issues For Australia, Papers and Proceedings from EPAC Seminar, September 1994.

9.  For sovereign governments, the ratings agency Moody s has 19 international ratings, ranging from Aaa to C.  Ratings below Baa3 are categorised as "speculative".  Standard and Poors also has 19 international ratings, of which 10 are classified as "investment grade".

10.  For a more extensive account of the policies pursued in the 1980s and their effects, see "Can Monetary Policy Be Made to Work?" by Richard J. Wood in the publication of that name.

11.  While Mr Keating's public rhetoric has recently changed to acknowledgment of the potential for high current account deficits to create problems, it is apparent that his Government will do the minimum judged to be necessary to avoid a "crisis".

12.  For further discussion of debts limits and associated issues, and their implications, see Debt:  What Should Be Done, Richard J. Wood, October 1989.

13.  Of course, monetary authorities rarely disregard the exchange rate in deciding monetary policy and changes in the external situation do not only affect the money supply.  There may also be income effect6 (such as from terms of trade changes) and price effects (from changes in the exchange rate itself).  Note also that changes in the exchange rate in response to changes in the current account situation will, over time, tend to produce responses which return that situation to "normal".

14.  Interestingly, however, the Governor of the Reserve Rank has suggested that a current account deficit equivalent to about 3.5 per cent of GDP would be "sustainable".  This implies that Australia's net foreign liabilities would increase at about the same rate as the economy grows (so that the relative net foreign liability burden would stabilise), which has not been the case for same time.

15.  From an address by IMF Managing Director Michael Camdessus on March 7 at the United Nations World Summit on Social Development in Copenhagen, reproduced in IMF Survey, 20 March 1995.  It might be noted that the IMF has also been giving consideration to possible schemes for stabilising exchange rates to a greater extent by keeping exchange rate changes within bands.  It is somewhat ironical that Mr Camdessus expressed concern at the rapid contagion effects from what he described as the "Mexican events" while espousing the IMF's potential to work as an early warning system.  The reality is that Mexico's current account deficit had been running at clearly excessive levels for some time before the "events" but the IMF did not issue publicly (or even, effectively, privately) any early warnings.

16.  Differences between countries in productivity growth in the traded goods sectors would require exchange rate adjustments from time to time and, if these were not made, markets would seek to force adjustments.

17.  Of course, with a freely floating exchange rate, it is not possible to have a net outflow of capital.  But would the Government be prepared to live with the exchange rate and interest rates consequent on a loss of confidence?

18.  The assumption here is that an increase in domestic savings will mostly be invested domestically rather than overseas.

19.  Some proposals along these lines are set out in "Commonwealth Budget:  Cut Spending by $15-16 Billion", Richard J. Wood, Backgrounder, 10 February 1995.

20.  For further elaboration of this issue see The End of Macro-Economics, Professor David Simpson, Institute of Economic Affairs, Hobart Paper 126, October 1994.

Real "threat" of big govt

SIR, In jumping on the bandwagon of those putting the blame for the Oklahoma City bombing on critics of big government, Malcolm McGregor (AFR, May 1) has gone overboard and indulged in the frequent habit of those on the Left who try to put all such critics into one basket.

A parallel would be if critics of the Left were to caricature the NSW Labor Party Right as Trotskyite revolutionaries.

The fact is that a large and growing portion of the population of most developed countries is coming to believe that the role of government has to be reduced if we are to overcome the economic and social problems of modern societies.

It is in this sense that many see present levels of government as a "threat" to their futures.

The fact that a few lunatics also view even democratic governments as some kind of physical threat cannot be used to reject that reality, or blacken the vast majority of those who are concerned.

McGregor might care to further explain his extraordinary analysis (sic) that the Republican leadership pitched last November's election campaign to "America's lunatic fringe".

Is he suggesting that the majority of American electors who returned the Republicans constitute a lunatic fringe?

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A job for the private sector

SIR, Dr Quiggin refers to my proposals to reduce net government spending on education and health ("Categories set up hurdle in savings debate", AFR, March 20).  He claims that I justify such proposals by "critiques of human capital theory", by arguing that "education is really a form of consumption" and by claiming that "reductions can be made without affecting either the quantity or quality of output".  Such sweeping and unjustified assertions are difficult to rebut in a short letter.  Dr Quiggin fails to understand the basis of my proposals.

First, there is a need to increase national saving.  Reductions in net government spending on, say, tertiary education and health that are achieved by requiring most middle- and higher-income groups to meet their tertiary education and health costs will reduce government dissaving, and also tend to increase private saving, regardless of whether or not education includes an investment element (which it does).

Second, such action will avoid the need to increase taxation and the adverse effects which that would have on the incentive to work and save.  Dr Quiggin seems to assume (wrongly) in all his writings that existing levels of taxation, let alone higher levels, have no adverse effects on economic activity or unemployment.

Third, my approach would, I submit, be more equitable in that it would focus government tertiary education and health assistance on lower-income groups.

More broadly, contrary to the assumption implicit in Dr Quiggin's analysis, a reduction in the provision of health and education services by government does not necessarily mean a reduction in total spending on such services.  Australia has substantial private-sector involvement in such services and there is little doubt that, particularly if tax burdens are reduced, these will grow.  Total Australian health and education spending (that is, both government and private) is broadly in line with total spending in other countries with comparable income levels.

Government has proved a relatively inefficient provider of education and health services.  The more that such services are left to the private sector to provide, the better we are all likely to be.

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Evatt report flaws exposed

The States -- how they rate

THE Evatt Foundation's attempt to assess the performance of State Governments, in its The State of Australian Government 1994-95, is an excellent idea, but as a piece of research it is seriously flawed.

The report endeavours, among other things, to assess and compare the performance of the States and Territories on a broad range of policy areas, and to produce an overall ranking of State performance, using published data.

The task is a worthy one, but the exercise is only as good as the methodology and data employed.  The old adages of "garbage in, garbage out", and "lies, damned lies and statistics" both apply.  Unfortunately, the Evatt Foundation's assessment runs foul of both.

Its main conclusion, that governments that spend most -- SA, ACT and NT (Victoria, the pariah of union movements, is the exception) -- perform the best, may be what the report's main sponsors (the Community and Public Sector Union) wanted to hear, but it's a statistical delusion.

The report relies mainly on data from the latest Commonwealth Grants Commission Report.  This data has been used extensively over the last half-decade, in a number of studies including audit commissions in Tasmania, Victoria, WA and SA.  Surprisingly, these studies have, using the same data, reached conclusions opposite to those of the Evatt report.

The trouble with the Evatt Foundation's use of these figures is that above-average levels of spending, as measured by the Commission, may arise from "better" services or greater inefficiency.  Likewise, below-average levels of spending could arise in the converse way.

For analysis to be credible, one must look beyond the Commission's data to assess the relative policy position of the States.  The Evatt Foundation report failed to do this.  Instead, it assumed that above-average spending is good and below-average spending bad.

Numerous studies have looked beyond the Commission's data, and, not surprisingly, found that efficiency and effectiveness are major determinants of the spending differentials identified by the Commission and that much of the above-average spending is wasteful, particularly in the States the Evatt report ranks highly.  They have also found that many areas of under-spending, particularly in Queensland, which is accorded a low rank in the report because of its low spending levels, are justified on efficiency grounds.

Enough research has now been done in areas such as health and education to confirm what common sense always indicated;  that high spending does not mean better or more services.

The report makes a big song and dance about the high level of spending on culture and recreation by the SA Government (66 per cent above the all-State average), and claims that because of this public-sector largesse SA is the cultural capital of Australia.  However, the Grants Commission does not adjust for the differences in private-sector supply.  Victoria and NSW, which have relatively large and profitable private-sector entertainment industries, are justified in spending less public funds than does the relatively isolated SA.

Similarly, the report's assessment of public transport provision is flawed.  It gives the smaller States poor assessments on public transit services, because they spend substantially less than is spent on such services in Sydney and Melbourne.  Of course, it would be absurd for Tasmania to adopt a mass transit system designed for a large city.

The Evatt report does not canvass the full range of available and relevant data, and its failure to do so materially affects its conclusions.  It does not consider public sector capital expenditure, user charges, or a whole range of other revenue-raising measures.

It also fails to consider data, provided by all governments, on forward estimates of spending, taxing and deficits, and important transition factors.  It is therefore judging governments on their inheritance rather than their own policies.  The report weights factors in a manner that is clearly absurd.  It says it applies no system of weights so as to avoid imposing judgements about the importance of categories, but value judgements are necessary, have been made, and lack credibility.

The Evatt Foundation's 1994-95 assessment is not worth the paper it is printed on.  The project is well worth doing but only if done well.  So back to the drawing board they should go -- and next time ideology should not get in the way of methodology.

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Jobs growth caution

SIR, Publication of the February employment figures has led to much throwing of hats into the air by ministers, on the basis that the Government has met, a year ahead of time, its February 1993 Accord "commitment" to increase jobs by 500,000 over three years.  But one wonders whether it is, in fact, a cause for celebration to produce such a rapid rate of jobs growth.  The last time that happened was in the 1980s -- and we all know what happened at the end of it.

Employment has been growing much faster than the labour force, and, with unemployment beneficiaries now exceeding the ABS figures for unemployed, it appears that it is now considerably easier to stay on the dole.  This makes it more difficult to "attract" those on the dole into employment than it was in the 1980s.

Thus a continued rapid growth in employment would have to come largely from increased participation in the workforce, which now stands at 63.7 per cent.  There are limits to how far this can go, at least in the short term.  The present level is moving close to the peak reached at the end of the 1980s (64.1 per cent in June 1990).

This reinforces the case for quickly slowing down the growth in domestic spending by, at the very least, eliminating the Budget deficit of $7.4 billion now said to be in prospect for 1995-96.  Failure to do so will raise the real prospect of a repetition of Australia's disastrous experience under the Accords of the 1980s.

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More "competitive" but it's at a high cost

FOLLOWING his election as Opposition Leader, John Howard was soon involved in a head to head parliamentary debate with Prime Minister Keating in which both participants made claims about their own, and their opponent's, record in Government.

One of Mr Keating's proudest boasts in that debate has been to claim that "the Australian economy today is 40 per cent more competitive than when he (John Howard) was in office".  Allowing the Prime Minister some parliamentary debate licence in rounding up, this claim is broadly correct:  the Treasury's index of international competitiveness based on changes in relative unit labour costs shows an increase of 37 per cent between March 1983 and September 1994 (an average increase of about 3.2 percentage points a year).

Note that, on Mr Keating's basis, Australia's international competitivness also increased during the period of the Fraser Government, in which John Howard was a senior minister (though not Treasurer until 1978).  Australia's "competitiveness" then increased by about 11.3 per cent (about 1.6 percentage points a year) between December 1975 and March 1983.

The more important observation about the Prime Minister's claim relates to the way in which the increase in competitiveness has been achieved.

Changes in international competitiveness mainly occur in one of two ways.  First, Australia's costs (or prices) can increase at a faster or slower rate than those of our trading partners;  secondly, our exchange rate can depreciate or appreciate relative to the (average) rates of our trading partners.

Taken in isolation, $A depreciation tends to increase our international competitivess by making it easier for Australian producers to compete against higher priced imports and by making it more profitable to export because of higher prices (in $A).

However, an exchange rate depreciation-induced improvement in competitivess also indicates that Australians have experienced a relative decline in living standards because we have to sell an increased quantity of exports in order to purchase the same quantity of imports.

In point of fact, this is exactly what has happened under the Hawke-Keating Labor governments.  Mr Keating's 37 per cent improvement in competitiveness is more than accounted for by the depreciation of 45 per cent in the $A.  He can hardly claim credit for an improvement in "competitivess" that simply reflects the response of financial markets to changes in Australia's external trading position and changes in our relative prices and costs.  Indeed, about 15 per cent of the 45 per cent depreciation was needed just to offset the faster growth in Australia's unit labour costs than in our major trading partners -- more a cause for hanging one's head in shame rather than boasting about it.

Thus, on closer analysis, Mr Keating's boast turns out to be a hollow one.  Labor's policies of wages restraint under the Accord actually resulted in a continuing rise in our labour costs and a deterioration in our real capacity to compete internationally.  That deterioration was recouped by a depreciation in the exchange rate, which also had to depreciate quite a lot further in order to keep our international accounts even in the poor shape they are now in.

Note that, during the Fraser Government's period in office, Australia's unit labour costs also increased about 19 per cent faster than those of our major trading partners.  However, this deterioration occurred in that Government's last two years, when the union movement deliberately engineered the wages "break-out" that Mr Keating himself later publicly condemned as a major cause of the large jump in unemployment in 1982-83.

The reality is that measures of changes in "competitiveness" such as that apparently used by Mr Keating in trying to score off Mr Howard are not necessarily a good indicator of a Government's policy performance.  Such misuse of data does not engender confidence in the Government's ability to make sound policy decisions.

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The Case For Privatisation

Vol. 7 No. 3

SUMMARY

In Victoria there is a renewed debate about privatisation, centred around the Kennett Government's proposal to privatise the SECV and the State Labor Opposition's claim that this is against the public interest.

The debate occurs against the background of recent World Bank research indicating that there have been 15,000 privatisations of state-owned enterprises worldwide (most since 1990);  that most clearcut success stories come from high- or middle-income countries;  and that recent evidence suggests (contrary to earlier academic theory) that there are positive benefits from private ownership as well as from establishing a competitive market structure.  Further background includes the rapid changes now occurring in the structure of the electricity industry worldwide which involve increasing exposure to private sector competition;  the poor performance by the Victorian electricity industry (BIE data up to 1992 show Victoria then had the worst efficiency among the States);  and the fact that Federal Labor is continuing to pursue a privatisation programme.

The criticisms of the Victorian Government's privatisation programme include arguments such as that public assets are held in trust and cannot be sold;  that privatisation will increase income inequality;  that privatisation has not worked in the UK;  that there will be "exploitation" by private monopolies;  and that it would be wrong to allow foreigners to run "essential" services such as electricity.  This Backgrounder shows these arguments to be wrong or based on false reasoning.

It concludes that, properly implemented, privatisation is in the public interest and that those opposing it are supporting narrow sectional interests.  The test of whether privatisation will be beneficial is not whether there will be a net gain in State revenue, or even lower consumer prices, but whether goods and services are likely to be supplied at a lower cost in terms of use of resources.

BACKGROUND

Viewed in historical terms, the worldwide privatisation movement is not really something new but a return to the more normal situation where private enterprise was the main supplier of a range of what are now described as "government services".  After World War 11, there was an enormous expansion in the rôle of government as most economists (and many others) argued that society would benefit if governments were to intervene more to correct for what was known as "market failure".  For example, it became widely accepted in the community that lower income groups should have reasonable access to health and transport services, that the private sector would not necessarily provide this, and that the way to achieve it was for the government to become a major, if not the sole, supplier of such services.  Government monopoly was also seen as better than private monopoly because it would protect the individual from "exploitation".

However, since the early 1980% there has been a growing realisation that, while "market failure" certainly occurs in the private sector, there is also a phenomenon which has come to be known as "government failure".  The realisation came that the large expansion in the rôle of government in the economy had not overcome the problems perceived as justifying government intervention and that, in fact, new problems had emerged.

In the public enterprises area, their performance was not only poor in terms of financial results but also left a lot to be desired in terms of the standard of services delivered.  Thus, as stated in a June 1994 comprehensive review of privatisation in The World Bank Research Observer:

Since the big expansion in state ownership in the 1960 and 1970s, the number of state-owned enterprises (SOEs) worldwide has been shrinking at an accelerating pace:  more than 15,000 SOEs, at a conservative estimate, have been privatised, most of them since 1990.  Years of disappointing SOE performance and a history of half-hearted and ineffectual attempts at reform have impelled many governments ... to launch privatization programs. ⁽¹⁾

It is relevant to the current debate in Victoria that most Asian and Latin American countries have moved in recent years towards the operation of electric power stations by private enterprises;  and that the California Public Utility Commission recently announced that it is considering a similar model to that being pursued by the Victorian Government.  It is not an understatement to say that the electricity industry worldwide is going through a considerable process of change involving the exposure of the industry to the pressures of private sector competition.

The World Bank review also points out that it has not simply been that public enterprises have yielded a disappointing return on the capital invested in them, but that their inefficiency has slowed the growth in the private sector too.  It is worth recalling that the principal objectives of the World Bank Group are the promotion of economic development and the reduction of poverty.

In considering the case for privatisation, it is important to recognise why this failure of government intervention has occurred.  Public choice theory points out that, as politicians and bureaucrats benefit from building up their own empires, their natural instinct is to expand their power and influence by responding to organised pressure groups in the community that seek to obtain concessions.  For each individual in the community, the cost of granting such concessions is small and is therefore unlikely to produce organised opposition.  But the cost to the community as a whole can be considerable.

Australia has had a long history of such concessions.  For many years, parts of the rural and manufacturing sectors were recipients, to the considerable cost of the rest of the community.  But particularly in Victoria, we have also had much experience of over-manning and inefficiency in the public sector, mainly as a result of the protection which that sector has had against competition and of the capacity of the powerful trade union movement to extract concessions from governments of all political persuasions.

Just as the free trade movement fought "McEwenism" in the rural and manufacturing sectors in the interests of the community as a whole, the privatisation movement can be seen as doing the same thing -- but this time the force of conservatism resides with those vested trade union interests which are so dependent for their power and influence on retaining a strong public enterprise sector.  It is relevant that well over 60 per cent of the public sector is still unionised compared with less than 30 per cent of the private sector.

IMPROVED P.T.E. PERFORMANCE

It must be acknowledged that in Australia there has been a significant improvement in recent years in the performance of public trading enterprises (PTEs).  Productivity and profitability have picked up considerably, though analyses show that most PTEs are still performing below international best practice.  The latest Bureau of Industry Economics analysis of the electricity industry, for example, shows that the total factor productivity gap between the Australian and US industries in 1992 was still around 27 per cent, with Victoria the worst performer among the Australian States. ⁽²⁾

The improvement reflects the fact that the trade union movement was forced to accept that the internationalisation of the Australian economy required large cutbacks in staffing in order to reduce the costs of services provided by public enterprises.  There is also no doubt that the threat of privatisation played an important, indeed vital, part here and, in a limited number of cases, actual privatisations have occurred. ⁽³⁾  The Federal Labor Government has even been "brave" enough to pursue a privatisation programme, though union opposition has been a major inhibiting factor in the full privatisation of such enterprises as the Commonwealth Bank, Qantas and the Australian National Line, not to mention Telecom (which is not scheduled even for what I call a Clayton's privatisation -- that is, a partial sale but with the government still in control).

THE CORPORATISATION ALTERNATIVE

These improvements in the performance of PTEs, which include significant improvements in the performance of Victorian PTEs, raise the question of whether, rather than proceeding with their privatisation, PTEs can be "reformed from within" by a process of corporatisation.  Such a process gives the enterprise a greater degree of independence from political interference and, in essence, replicates a private sector business in most respects except that it remains government-owned.  In short, can the perceived deficiencies of PTEs be remedied without changing ownership?

Some analysts have concluded that competition and regulation are more important than ownership in determining economic performance.  This view is reflected to some extent in the Hilmer Report, which, while not opposing privatisation per se, emphasises "reforming the structure of public monopolies to facilitate competition" rather than changes in ownership per se.  According to media reports, the (leaked) draft report of the Industry Commission analysing the effects of implementing the Hilmer proposals suggests that they would produce considerably cheaper food, housing and electricity prices.  Electricity charges would fall by 26 per cent by the year 2000 for big business users and by 11 per cent for households.  Such a conclusion would apply to an even greater extent to a properly implemented privatisation programme.

There is, indeed, a major unanswered question here:  namely, if Hilmer and others agree that PTEs should be restructured to operate in the same way as private sector businesses, what justification is there for continuing to operate those enterprises in the public sector?  Is it not better to privatise and keep the sticky hands of government away from such businesses?

OWNERSHIP IS IMPORTANT

The World Bank researchers had little doubt about the answer.  Their conclusion was that

[M]uch experience of the past two decades shows that, in practice, markets and public ownership are linked in ways that can reduce competition, even without a significant market failure ... state ownership, created to overcome or correct market failure, can sometimes aggravate or perpetuate it.

An earlier World Bank review was even more specific, viz.:

First, private ownership itself makes a difference.  Some state-owned enterprises have been efficient and well-managed for some periods, but government ownership seldom permits sustained good performance over more than a few years.  There is a higher probability of efficient performance in private enterprise, and that needs to be considered in choosing whether to invest public funds in SOEs -- or in health, education, and other social programs.

Second, the process of privatization, though not simple, can and has worked;  this is true for a variety of enterprises in a variety of settings, including in poor countries. ⁽⁴⁾

In short, it may not simply be a matter of, for example, breaking up a State monopoly, such as the SECV or Melbourne Water, into corporate units which engage in some form of competition against one another.  Ownership does matter, and private ownership is most likely to succeed.

WHY PRIVATE OWNERSHIP IS BETTER

This is not to deny that, by restructuring public enterprises and requiring them to operate as if they were in the private sector, considerable improvements can be obtained in efficiency, quality of service and profitability.  Nevertheless, the gains are likely to be limited by the continued operation of the enterprises within the public sector.  There is an inevitable and on-going conflict between operating on a fully commercial basis and either taking unjustified advantage of government ownership or being subjected to political pressures not to make commercial decisions.  For the Government, there are also considerable accountability problems.

The retention of an enterprise within the government sector in a corporatised form gives that enterprise the appearance and form of being a body that is outside political control and influence.  At the same time the Government, and some Minister within the Government, has to accept final responsibility for its outcomes.  In these circumstances, a situation can be created that offers the worst of all possible worlds -- a body that has the potential to exploit its privileged position as a government body and its arm's-length position from the Minister to take unjustifiable risks, to squash potential private sector competitors, or generally to pursue policies that are not in the interests of the community, and a Minister who is told that he should not interfere.  In the end, however, the Minister is accountable and has no alternative to taking action to stop the pursuit of what are judged to be politically inappropriate policies, thus destroying the image of independence and recognising the reality that the Government has ultimate responsibility.

The reality is that it is difficult for the Government and the Minister to avoid having a significant direct and indirect influence on the key policies to be pursued by corporatised public enterprises.  The Board has to be appointed by the Government/Minister, as generally is the Managing Director, and Board Members rely on the Minister for re-appointment.  There is also a tendency to choose Board appointees from among those who are sympathetic to the Government of the day, and/or who are representative of interest groups which have particular barrows to push.  This is not likely to produce the most satisfactory commercial outcomes.  Beyond that, the Government can exploit the monopoly position of a corporation by using it as a vehicle for collecting additional tax revenue through the guise of "dividend" policy, which is usually determined by the Minister or the Treasurer.

Apart from this, the Board and management of the enterprise may operate policies that are inconsistent with the underlying commercial interests of an enterprise simply because they judge it "impolitic" to change policies.  They may judge that any such change will result in the Minister directing that it not be made, or failing to reappoint them.

THE MAIN PURPOSE OF PRIVATISATION

It is important to recognise the point that the main purpose of privatisation is to improve the efficient functioning of the economy.  There is a close parallel between the privatisation of PTEs and the elimination of protection against imports, which is now accepted by all major political parties.  Both are designed to expose the respective sectors of the economy to greater competition and, through that, to allow that good or service to be supplied at a lower cost in terms of the use of resources.

That process is now almost universally accepted in the economics profession as leading to an improvement in average living standards in the community, even though the initial effects may include a reduction in employment.  The dynamic effects flowing from the encouragement to private investment, because of the lower costs which businesses face, are likely to provide additional jobs in due course.

THE EFFECT ON GOVERNMENT REVENUES

It follows from this that the test of whether a privatisation will be beneficial is not whether the State Government will have a short-term gain in revenue in net terms. ⁽⁵⁾  While such a gain is likely in many instances, though not necessarily in the case of the much-discussed SEC, whether or not such a gain occurs is relatively unimportant in the overall scheme of things.  If the privatisation is done in a way that allows scope for improvements in efficiency, there are likely to be benefits to the Victorian community.  In the case of the SEC, for example, the unbundling of the distribution and generation arms into a number of distinct units, and the creation of a framework within which competition can occur, offer the potential for resources to be freed for other purposes and for investment to be encouraged by lower costs and improved service.

EXPERIENCE WITH PRIVATISATION

In considering the potential for benefits from privatisation in Australia and Victoria, it is relevant to examine what has happened with privatisations in other countries.  The World Bank Research review points out that, until very recently, studies undertaken of industrial economies largely attributed superior efficiency in private over public firms to market structure rather than to ownership.  The review also states, however, that

[M]ore recent evidence, which compares SOE performance before and after privatisation, shows considerable economic benefits resulting from properly structured privatisation, even when the privatised firms were monopolies.  (page 251)

It also makes the points that

Most clearcut success stories come from high or middle-income countries ...

and that

the privatisation process is harder to launch in least developed countries, and the chances of failure are greater.  (page 252)

SOME CRITICISMS OF PRIVATISATION

Criticisms made about privatisation include the following:

1. Loss of Value

   One accounting analyst sponsored by the union movement has suggested that the value of a public asset is reduced when it is sold because a private sector purchaser faces a higher cost of capital and is liable to pay company tax.  Most accounting analysts consider this to have no validity and a moment's thought would suggest that there has to be something wrong with an analysis that implies that values of assets can be increased by moving private sector assets into the public sector! ⁽⁶⁾  Why don't BHP shareholders offer the company to the Government and take "the Paris option"?  Why hasn't anyone involved in the 15,000 privatisations that have occurred realised the "loss" that occurs?

2. Public Assets are Held in Trust

   The argument here is that certain public assets are so "strategically" important that they must be regarded as being held in trust in perpetuity by the public sector.

   It is difficult to understand the basis of this argument.  BHP is strategically important to the economy and the welfare of the Australian people but nobody suggests it should be in the public sector.  There is certainly no legal or historical basis for the "trust" claim.  An analogy could be drawn with public assets that are held in trust as part of the national heritage, but such an analogy scarcely seems applicable to a PTE!  The reality is that it is open to the Government of the day to sell or purchase assets and, provided such action is consistent with its enunciated policies (as was the case for the Kennett Government prior to its election), it should be entitled to do so.

   It may be that, behind this argument, there is a concern in the minds of some people that privatisation will lead to a loss of some service or a disadvantage to some group.  However, if that is the case, and if the loss or disadvantage is regarded as justifying compensation or offsetting action of some sort, it is open to the Government to take such action.  In the case of job losses arising from privatisation, for example, there now appears to be an accepted policy of redundancy payments at the taxpayers' expense even though the equity of such arrangements is dubious (given that the jobs should in most cases never have existed in the first place).

   There is also widespread acceptance that, where justified, community service obligations (CSOs) should continue to be met for low-income and disadvantaged groups.  Indeed, an advantage of privatisation is that these CSOs are brought more into the open and exposed to public debate as to their justification, instead of being hidden in the accounts of PTEs.

3. Income Inequality Will Increase

   The argument that privatisation will lead to an increase in income inequality appears to be based to a large extent on the alleged increase in income inequality in the UK under Conservative Governments since 1979.  However, income inequality as normally measured has also increased significantly in Australia since the early 1980s, and we have had relatively few privatisations compared with the UK.  The US experience has been similar to Australia's, but a recent analysis by McKinsey's reports that a smaller proportion of individuals in the US is below the poverty line than is the case in major European countries. ⁽⁷⁾

   Analyses suggesting increased income inequality over a particular period also need to be treated with caution.  In particular, if the "income" received from free or subsidised government services or from home ownership is included, that can change the picture considerably.  Also, as most people start their working lives in lower income groups and move up as they become more experienced, many of those in the lowest income group at the start of the 1980s would not still be there today.

   The fact is that there is no evidence to suggest that privatisation increases income inequality, except in so far as there is an increase in executive salaries in new enterprises.  Within limits, such increases are an example of an increase in inequality that is justified.  The new enterprises have to compete in the market for corporate executives, and the fact that PTEs were previously run by executives on lower salaries is scarcely a good recommendation for continuing such a practice, given their generally poorer performance than comparable overseas bodies, not to mention private sector companies.

4. Privatisation Did Not Work in the UK

   Critics of privatisation have argued that privatisation has failed in the UK and that this "proves" that it does not work.  This "line" chooses to ignore the success of privatisation in just about every other country and to overlook the fact that, as the UK was the first in the field, others have been able to learn from UK experience.  Even Victoria might do so!

   A major criticism of the UK privatisation process is that it was far too cautious in exposing former PTEs to competition, and this has limited the improvements in efficiency.  A further criticism is that, in order to widen the distribution of share ownership in the UK and to gain support for privatisation from PTE employees, many of the PTEs were sold at less than market value.  But these approaches do not have to be followed in Australia.

   In any event, it is far from clear that privatisation has not been successful in the UK, if account is taken of improvements in efficiency and in both consumer and taxpayer welfare.  As to direct benefits to consumers, there is little doubt that, even with the lower level of competition, the UK consumer has benefited from lower prices and from improved standards of service since privatisation.  There has, for example, been a large real fall in gas prices to industrial consumers and also in the main telephone prices.

   In the UK electricity industry, contrary to some misinformation put around in Victoria, comprehensive information supplied to me by the UK Treasury shows that, since privatisation in 1989, there has been a substantial real fall in average prices for industrial consumers and a modest real fall in average prices for household consumers.  The real fall in average prices overall during this period is probably greater than the real fall in average electricity prices in Victoria of about 5 per cent since 1979!  Other benefits in the case of UK electricity privatisation include:

   • Enormous improvements in productivity as a result of the elimination of excess staffing and improved work practices (employees in generation have been reduced from 47,000 to 26,000 and in distribution by 20 per cent).
   • The average lost supply-time per customer has been reduced by more than half.
   • Disconnections of customers for non-payment of electricity have fallen to a fraction of the level which previously existed, mainly due to the introduction of more flexible payment schemes.
   • There has been a significant fall in the number of complaints received by the Regulator (OFFER).

   Ironically, possibly the biggest "mistake" made by the UK Government in electricity was grossly underestimating the efficiencies that would be achieved following privatisation.  As a result, shareholders in the new companies received large gains, and consumers did not realise the potential for large price reductions.  This is not a criticism of privatisation per se but of the process of undertaking it.  The Victorian Government approach, of using the threat of privatisation to try to make the companies as efficient as possible before they are sold, should provide a better balance between shareholder and consumer gains in the future.

   The main exception to the consumer benefits story in the UK is in respect of water, where prices were considerably increased.  However, this reflected the factthat, before privatisation, consumers were not paying a sufficient price to allow adequate provisions for the depreciation of capital and to meet desired quality standards.  The increase in prices post-privatisation thus largely reflected the prior inefficiency of the public sector in operating the water supply system.

   This example illustrates, incidentally, the point that the benefits of privatisation are not to be measured simply by reference to whether prices for consumers are reduced.  In the case of British water, the benefits have come from ensuring the future provision of an improved quality of supply.

   Another benefit from UK privatisation has been the elimination in the cost to taxpayers -- who, after all, are also consumers -- of the operating losses of nationalised industries.  In 1979, losses of nationalised industries were costing UK taxpayers 50 million pounds per week;  today those industries are paying 60 million pounds in taxes on the profits they earn as private sector companies.

5. The Dangers of Private Monopolies

   Opponents of privatisation highlight the potential problem that it could lead to the establishment of private monopolies.  However, there have been some important changes in the economy since public enterprises were first established to run various government services, and there is now a reduced risk of private sector monopolies developing in such areas.  For one thing, technological change has increased the scope for competitive units to be established.  This is particularly true in telecommunications.  Improvements in information technology have been important in creating scope for greater competition in the electricity industry, by allowing the creation of a regulated market -- such as is envisaged by the Victorian Power Exchange.  Developments in economic theory since the public monopolies were established also suggest that, where there is the threat of entry from another competitor, this can impose an effective discipline and prevent, or at least inhibit, the development of monopolistic practices.

   Also, even where the likelihood is that privatisation will lead to the establishment of private monopolies, there is now a much greater capacity and experience on the part of governments in controlling and limiting attempts by private sector companies to levy monopoly profits.  The model of an independent regulator who keeps monopolistic practices at bay, but which allows the benefits of private ownership to be obtained, appears to be a considerable success.

   It can now reasonably be argued that it is in fact better to have a private-sector monopoly than a public-sector monopoly.  A private sector monopoly faces the test of the capital market whenever it needs to raise capital, and it is subject to the threat of take-over if its performance slips.  This operates as an important discipline on management, a discipline which does not exist in the public sector.  The fear of domination by large monopolies might be somewhat diminished if it were realised that large firms often have fairly short lives.  Of the 100 firms heading Fortune magazine's list of US's largest firms in 1956, only 29 were still there in 1992.  This is a reflection of a dynamic business sector, not a failure of large businesses per se because they may have been replaced by new and often larger businesses.

   Of course, as the Hilmer Report effectively proposes, it is desirable wherever possible to avoid simply transferring a public monopoly into a private monopoly.  That goes almost without saying and it justifies the pursuit of structural changes before privatisation.  Further, if a private-sector monopoly cannot be avoided, it is important to establish an appropriate regulatory system.  But privatisation should not be avoided simply because of the possibility of monopoly.

6. Foreigners Will Run Our Essential Services

   Concern has been expressed in some quarters that privatisation will lead to foreigners running "essential" services, particularly those (such as electricity) which require large lumps of capital.  It is not clear why such concern should exist, provided there is a competitive situation or one which is subject to an independent regulator.  Under the existing foreign investment policy of the Federal Labor Government, new foreign investment in the public enterprise sector is treated as "non-sensitive" and welcome, and is subject only to a "contrary-to-the-national-interest" test.  The precedent of the Gladstone Power Station and Loy-Yang B take-overs by foreign investors implies that a foreign "take-over" of publicly owned electricity enterprises in Victoria would not be rejected by the Federal Government as contrary to the national interest (which is the test that would be applied). ⁽⁸⁾  Indeed, it will be recalled that the present Federal Labor Treasurer, Ralph Willis, "launched" the Loy-Yang B "take-over" by Mission Energy.  The State Labor Government's decision to sell Loy-Yang B, incidentally, was partly motivated by the desire to do something to reduce the entrenched position of the union movement.

   One aspect of the alleged monopoly "problem" from privatisation that is often overlooked is the potential for foreign investors to reduce the scope for monopolistic practices after privatisations.  As a general rule Australians should not be concerned if foreigners take over former public monopolies or units of former monopolies, provided that the result is not simply to establish a private monopoly that is protected from the threat of take-over.

CONCLUSION

Overseas evidence suggests that privatisation is to be preferred to corporatisation.  There is a high probability that privatisation will benefit both efficiency and consumers, and it is not correct to suggest that a private monopoly is as bad as a public monopoly.

Those who oppose privatisation are acting contrary to the public interest and in support of narrow sectional interests.  Much of the opposition to privatisation in Australia is, in fact, a reflection of outdated ideological hang-ups and a desire to hold on to entrenched positions of power and influence, than a concern for improving living standards, jobs and national efficiency.  In particular, the very strong opposition to privatisation by the Australian trade union movement reflects the fact that the PTEs are the power base of the union movement and that unions are resisting any undermining of that power base.

The need now is for Commonwealth and State Governments to recognise the likely benefits from privatisation and to restructure their PTEs as quickly as possible so that they can be privatised.  Australia has been dragging the privatisation chain and we need to catch up with most of the rest of the world in this important area of the economy.

---

ENDNOTES

1.  Sunita Kikeri, John Nellis and Mary Shirley, "Privatization:  Lessons From Market Economies".  The World Bank Research Observer, Vol. 9, No. 2, July 1994, pages 241-72.

2.  "International Performance Indicators.  Electricity Update 1994".  Research Report 54, Bureau of Industry Economics, page 42.

3.  These include the State Banks of NSW and Victoria ($576m and $1.6 bn respectively), the Government Insurance Office in NSW ($1.2 bn), the Gladstone Power Station ($753m), the TAB in Victoria ($609m), and Aussat.

4.  "Privatization:  The Lessons of Experience", Country Economics Department, The World Bank 1992.

5.  Media reports suggest that the Industry Commission has concluded that the reform of the pubic enterprise sector along lines recommended by Hilmer would produce longer term gains in net revenue from the effects of faster growth on indirect tax revenues.  Such a conclusion would also apply to the privatisation of such enterprises.

6.  The true "social opportunity cost" of capital employed by the public sector is the additional wealth such funds could have earned in the private sector.  The same opportunity forgone drives the cost of capital to the private sector.  Thus, the cost of capital to both private and public sectors is the same when the projects being compared are of equivalent risk and are operated with the same degree of efficiency.  The fact that the public sector can borrow funds at lower rates of interest than private borrowers is not relevant because the real cost of capital to the public sector is more than the cost of debt.

If the investor is tax exempt then so must be the alternative investments;  therefore discount rates and net cash flows must be before taxes.  The converse is true for the taxed investor;  both net cash flows and the discount should be after taxes.  The net result is that there will be no difference between what a taxed investor and a non-taxed investor will be prepared to pay for assets, assuming no budget constraints and no other comparative advantage/disadvantage of one investment relative to another from the investor's viewpoint.

7.  William W. Lewis, "Where the Jobs Are -- And Aren't", Wall Street Journal, 7 December 1994.

8.  While the sale of a State-owned asset is not subject to the foreign take-overs legislation, in most cases it would involve the establishment of a new business and would thus be subject to foreign investment policy

Economic Irrationalism

Education and Public Policy in Australia
by Simon Marginson
Cambridge University Press, 1993.

The stated purpose of Education and Public Policy in Australia is to contest the dominance of economic rationalism in education policy.  Its author argues that under economic rationalism "the market economy is substituted for democratic politics and public planning as the system of production and co-ordination" (p.56).  He equates economic rationalism with "free-market liberalism", especially the views of Friedman and Hayek, which he claims dominate the economics profession in Australia.

The book claims that "economic rationalism has installed a free-market economic agenda at the heart of public education policy" (p.55).  This is an extraordinary claim, especially when the author gives no examples of free-market reforms introduced in Australia.  Instead he quotes the forming of the Department of Employment, Education and Training, "an interventionist and regulatory higher education policy" (p.129) introduced by Dawkins, and the emergence of "corporate managerialism" in the public service which has "brought education under the immediate operational control of ministers [and] created a more centralised and strategic approach" (p.56).  In Chapter 7, competency-based training reform, which emerged from big business and union pressure, is labelled "a new form of economic rationalism in education" (p.144).

These changes have little to do with the policy recommendations of free-market economists, who advocate decentralised decision-making.  When Friedman's reform proposals are considered, it is clear that they have not been embraced in Australia.  Friedman recommends free entry of private schools into the education system, the privatisation of public schools, and the introduction of full-cost fees in higher education and at the school level, or failing that, vouchers.  It is doubtful whether these views dominate even the economics profession in Australia.

Marginson lumps both centralist policies and free-market policies under the heading "economic rationalism", and then proceeds as if the faults of centralist policies are a criticism of free-marker liberalism.  He writes:  "there are limits to the efficacy of policies based on economic rationalism.  Governments (and economists) are nor all-seeing, all-knowing and all-powerful" (p.63).  He draws attention to flaws in the Dawkins approach, such as the assumption that government can determine subject areas that will be in demand.  These criticisms of central planning are exactly those made by free-market economists for years.

PUBLIC SPENDING

Chapter 1 provides an overview of the Australian education system, which selectively presents statistics to allege "in resource terms the inputs are in decline" (p.11) and calls for more government spending on education.  Public expenditure is presented as a proportion of GDP and Marginson laments its fall since the mid-1970s.  He expands on this in a later chapter claiming that Australian education "now faces serious resource problems" (p.83) and compares unfavourably with other developed countries.  In fact, the figures Marginson presents show that Australia's public spending exceeds the OECD average, above countries like Japan and Germany.

What Marginson does not mention is that real expenditure per primary and secondary student increased markedly over the 1980s (by 35 per cent in 1984-85 prices).  In contrast, when Marginson turns to higher education he focuses on the decrease in real expenditure per student over the 1980s and compares per student funding growth in Australia unfavourably to other countries.  He neglects to mention that, by international standards, Australia spends a high proportion of its GDP on higher education.  Over the past five years, government funding (in real terms and as a proportion of GDP) has risen substantially (although not as fast as enrolments).

Of course, claiming that those who spend the most have the best education system is like awarding the Melbourne Cup to the horse that ate the most oats.

Marginson attempts unsuccessfully to refute the consistent empirical finding in the economics literature that there is no relationship between outputs (usually academic achievement as measured by standardised test scores) and inputs (such as expenditure and class sizes) under our current system.  He presents a confusing review of the literature on the relationship between class size and output.  It is never made clear what outcomes are being measured.  Teacher time per pupil and teacher attitude seem to be the "outputs" in two of the studies.

Why have extra resources not improved academic performance under the current system?  One possibility is that the extra resources are wasted -- in employing an excessive number of bureaucrats, for example.  Another possibility is that the resources benefit someone other than parents and students -- teachers, for example.  Since 1970, student-teacher ratios in Australia have fallen by about one-third;  class sizes have not fallen by as much.  Part of the increased staffing levels has been used to reduce teaching loads and to increase leave entitlements.

MISREPRESENTATIONS

The presentation of economic theory in the book is full of misrepresentations.  Marginson presents a distorted caricature of human capital theory, claiming that it measures people in terms of their monetary value and that "the practice of human capital ... began in slavery" (p.31).

Human capital theory recognises that education affects future well-being;  that is, costs are borne now for future gain, and so education is an investment.  The future benefits produced can be pecuniary or non-pecuniary.  One future benefit from education is the enjoyment gained from reading throughout a lifetime.  Economics is not only concerned with pecuniary benefits, but they have been the focus of empirical work because they are more easily measured and quantified.

Human capital is the stock of skills and productive knowledge embodied in people, the present value of past investments in the skills of people, not the value of people themselves.  The theory that people invest in themselves by acquiring skills has nothing to do with slavery.

According to Marginson, economic rationalism insists that "the purposes of education can all be traced back to one overriding rationale -- in this case the development of a productive economy" (p.233).  This is a misrepresentation.  Economists have championed parental choice in a free market.  Parental preferences, they believe, should determine the goals of schools.  Experience suggests that for some parents at least, religious matters will be paramount.  Even in the education reform literature to which Marginson refers, the economists concentrate on factors that will raise academic achievement, not on education's pecuniary benefits.

To investigate the economic value of education is not to claim priority for economic ends, but to say that the economic effects are important.  For better or for worse, many students and parents take a keen interest in the employment opportunities opened up by successive educational qualifications.

Space does not permit a catalogue of the misunderstandings, errors and inconsistencies in the book.  The failure to understand what economists mean by efficiency in the discussion of "productivity policies and eficiency policies" in chapter 5 provides a further example.

Marginson evinces a clear preference for government schools over non-government schools.  The former, he says, are "democratic and egalitarian:  They provide the broadest experience.  The high achievers help the low achievers.  Formally speaking, everyone in public education is equally valued (p.201).  He presents no evidence to back these claims.  It is not clear that the government system does much to promote social mixing or that everyone is equally valued.  In practice, government schooling involves segregation by residential neighhourhood, with the rich neighbourhoods often having the best teachers and the best schools.

It is not even clear that there really is a gain to low-ability students when pooled with high-ability students.  The result could be to increase feelings of worthlessness among the low-ability students and to reduce individual attention from teachers.  The effects on high-ability students must also be considered.  In practice, the result of grouping students of markedly mixed abilities may, depending on the teaching methods employed, be education pitched at the lowest common denominator.  In the sporting arena, streaming by performance is readily accepted.

Marginson reports that a majority of Australian parents "would prefer to enrol their children in private schools" (p.202).  He downplays dissatisfaction with government schools as a reason for parents choosing private schools, by claiming "there is no hard evidence for what used to be frequent claims about public school deficiency in achieving numeracy and literacy" (p.203).  There is, of course, no hard evidence because of teacher union opposition to its collection.  Surveys indicate that private school parents do nominate poor academic quality in government schools as a significant reason for moving their children to the non-government system.

He comes down firmly against the view that freedom is the absence of government restraint, and in favour of the view that "to exercise freedom it is necessary to have the material means to do so" (p.59).  However, on the issue of school choice, Marginson's conception of freedom implies that the legal freedom to attend a private school is not enough, and only the government providing the means to attend a private school for all provides "real freedom".  Under current policies, only the wealthy have the means (and so according to Marginson the freedom) to choose private schooling.  Yet Marginson is against extending this freedom to all through a voucher scheme, something which a long line of free-market liberals, beginning with Milton Friedman, have advocated.

PRODUCTIVITY

Marginson doubts that education raises economic productivity.  According to screening theory, which Marginson employs, the role of education is a sorting device used to categorise people, rather than to develop them.  If the theory is correct, then education expansion merely results in "credential inflation", decreasing the significance of educational qualifications, with little economic benefit.

Empirically resting whether education contributes to productivity is almost impossible, but the view that education only screens individuals according to their pre-existing talents is an extreme one, and implies that schooling teaches no vocationally useful skills.

If his view is true, the case for subsidising education is diminished and the expansion of education may actually harm equality by throwing up more barriers for a poor person to overcome in order to obtain an opportunity demonstrate his ability to do a job.

At first sight, Marginson's view that education expansion has led merely to credentialism seems inconsistent with his commitment to universal participation in higher education.  If everyone were in higher education, wouldn't that result in more credential inflation?  But, according to Marginson, "the problem in the economy-education relation lies in the economy, not in education" (p.134).  He asserts that deregulating industry policy and cutting back the public sector have depressed the demand for educated labour.  Again, no evidence is presented.  In fact, the public sector has been increasing its employment of educated labour, and not too many graduates were employed in car factories and clothing mills.  His recommendation:  "What is needed is a reconstruction of Australian industry, so that high levels of skills in science, technology and engineering become more relevant" (p.134).  So when the central bureaucrats get their skill predictions wrong, it is the rest of the economy that should be changed.

FEES

One of the few actual policy changes Marginson analyses is the reintroduction of fees in higher education, which he passionately opposes.  He claims:  "The case for the return to fees rested on the human capital assumption that education was the direct cause of earnings" (p.182).  But the debate in Federal Cabinet he quotes is all about the equity effects of fees.  Marginson's argument that higher education fees should be abolished could be no better illustration of the rhetoric of equality of opportunity and the reality of middle-class subsidies.  It is a fact that graduates have above-average life-time incomes.  It is also true that those in higher education come from relatively well-off families, whether measured in terms of socio-economic status, wealth or income.  Free higher-education involves a regressive transfer from the average taxpayer to a privileged group.

A more effective way to help the poor would be to target subsidies to them, rather than to give free higher education to all those who qualify.  In particular, subsidies could be redirected to disadvantaged primary or secondary school students, many of whom do not go on to higher education.

It is our current democratic political process that has produced the policies that Marginson disapproves of, such as an obsession with economic ends and cost-cutting.  But a market system caters for diverse viewpoints, including opposition to economic rationalism.  Under a market system, Mr Marginson could choose to send his children to a school that did not engage in cost-cutting or emphasise economic objectives if his views were shared by even a relatively small number of parents.  A market system helps avoid the social conflict that arises in a public system run through the political process.  The market system promotes diversity (a value which Marginson says he supports).  Parents are able to choose between different types of schools;  suppliers have an incentive to seek out and satisfy consumer demands, to match quality to consumer preferences, to respond to diverse needs and to innovate.  Even in Australia's current limited private sector, there is diversity in religious instruction to match diversity in beliefs, which reduces social conflict over religious instruction in public schools.

How would Marginson reform the education system?  He recommends weakening competitive selection:  "Selection is inherently competitive, and competition automatically generates inequalities of outcome.  The best contribution education policy can make to equality of educational outcomes for all social groups is to weaken the selection function, rather than focusing all efforts on trying to make selection fair" (p.243).  Of course, abolishing selection does not result in equal outcomes, it merely hides differences;  nor does it abolish society's demand for the information provided.

Marginson suggests separating academic assessment from selection for work.  He thinks that employers should determine selection for work by competency tests "administered at the point of entry into work (p.250).  This would free the schools, TAFEs and universities "to concentrate more effectively on their other tasks" (p.250).  What if an employer is interested in finding out about a potential employee's academic achievement?  Perhaps some employers may be unwilling to formulate and administer tests themselves, or have found academic achievement a useful indicator in the past.  Marginson recommends the removal of grades from transcripts.

Marginson criticises economic rationalism for being destructive of other educational objectives.  Yet he would abolish the credentialling aspect of university and any benefit employers and students get from that process.  He is not concerned whether credentialling serves any valuable purpose.  He admits that credentials are an incentive for students, but fails to explain how students would be motivated in his reformed system.  Nor does he explain how weakening selection in the education system, and replacing the credentialling function with employer-administered tests, would result in more equal social outcomes or prevent the competition for advantage.

He writes:  "In the democratic framework education is a form of common property, free to be used by all citizens for their own advantage, like common land in medieval times or common air today.  In the market framework education is a form of private property.  People are excluded (p.79).  Of course, the fact is that education is costly to produce, and more education means less of something else.  Some people may prefer less education spending and more health care, arts funding, sports facilities, housing, food or many other alternatives.  All have economic and non-economic benefits and all may be better ways of helping the poor.  Not everyone in a democracy would agree that satiation in education is the best way to spend the community's resources.

Blaming others for the shortcomings of the education system is a common tactic of the education lobby.  Marginson's attempt to incriminate free-market liberalism in the failures of our current highly-centralised, government-run education system is a blatant example.  Reading this book, particularly its destructive policy recommendations, is an exasperating experience.  Rut it does provide a useful compendium of misunderstandings and misrepresentations of economic theory, and an insight into the agenda, tactics and arguments of the education lobby.  Because weak intellectual and empirical foundations do not seem to stop the policy prescriptions derived from them being put into practice in Australia, the book will no doubt provide one more citation for influential educationalists to present as proof that their views are correct.

Liberals' Crisis Has Deep Roots

The Liberals
by Dean Jaensch
Allen & Unwin

It is easy to exaggerate the current problems in the Australian Liberal Party.  Five years ago, the prophets of doom seemed to have ample justification for their dark forebodings.  Now they have far less:  there is a Liberal or Coalition government in six of the eight States and Territories, and several of those seem likely (at least from this distance) to be returned at their next elections.  On any assessment, therefore, there has been something of a Liberal renaissance, one which seems reasonably sustainable.

Achieving sustainability is, of course, one of the problems that the various Liberal Parties must address;  and their electoral success at the State level may indeed hinder reasonable and necessary efforts at institutional reform.  But the central problem, the problem addressed here by Dean Jaensch, is the performance of the Federal Liberal Party.  With defeats in five successive Federal elections recorded since 1983, it is now probably not an exaggeration to describe it as being in crisis.  The record is still not nearly as desperate as Labor's nine successive defeats between 1949 and 1972, but there may be reasons -- perhaps mostly historical -- for believing that the Liberal Party is less able to cope with continuous defeat than Labor.

The principal strength of this study is that it does offer a historical dimension to the recent turmoil:  roughly the first third of the book is a useful thematic summary which brings us up to the Fraser years.  Jaensch's approach is clear from his first sentence, where he states that "The Liberal Party is 100 years old".  This mildly provocative beginning enables him to demonstrate how very long-standing some of the elements of the current crisis are:  the loose, quasi-federal structure of the party;  the vague and problematic nexus between the lay and parliamentary parties;  the reliance on leadership as a substitute for durable institutional structures;  and, not least, the ideological disparateness inherent in the party.

The last point is in some ways the most fundamental.  Jaensch reminds us -- most convincingly in the case of the 1909 Fusion between Deakinite and Reidite, and less so, perhaps, of the preceding years -- of the curious hollowness at the core of the successive Liberal Parties.  So much of the impetus for their foundation and continuing existence has been the need simply to have a non-socialist party.  The resulting process of perpetual loose coalitions tends to explain most of the other elements identified by Jaensch.

By one of life's grosser ironies, the ideological problem is now pressingly acute for the Liberal Party.  The effective death of socialism as an idea in good currency (however strongly it survives in practice) may well turn out to have removed the principal raison d'etre and unifying principle of the Liberal Party.  At the very least it has lent a considerable urgency to the need to settle on some acceptable ideological identity, a need scarcely felt in, say, the first five or six Fraser years.

In the longer run this phenomenon may have fatal consequences;  in the short run, the economics of party organisation will ensure that something like the present party will survive.  (Voting systems are important here:  the introduction of proportional representation in New Zealand may well see the emergence of a fairly conservative party which could form marriages of convenience with rather smaller "libertarian" or "social market" parties).  Whether by accident or design, the ALP has managed the post-socialist transition much more successfully, having succeeded so far in recreating itself -- in image if not in substance -- as the natural party of the centre, of responsible economic management, of suburban Australian conservatism.

POLICY ANALYSIS

In the meantime, the stresses of failure seem likely to continue for some time to prevent the Liberals from achieving even the flimsy policy consensus of the Fraser years.  Policy paralysis since the 1993 defeat seems nearly total;  not least because the grossly mendacious overkill of Labor's campaign has effectively sterilised some quite significant areas of policy.  (Labor is, of course, paying a high price for this:  in the light of its severe fiscal problems, for instance, closing off the option of a new broad-based consumption tax must now seem pretty stupid.  Its inability to affect the rate of unemployment by even a smallish amount of labour market deregulation must now, too, seem a high price to have paid for the ACTU's support).

Lacking other, more formal means for arriving at that consensus, and with serious tensions not only between "wet" and "dry", but also between "progressive" and "conservative", the traditional way of achieving policy unity -- essentially to impose it from the Leader's office -- still seems to be the obvious resort.  With Hewson a seriously weakened leader, the obstacles were apparently insuperable.  It is still too early to tell how Alexander Downer will cope;  but it does seem likely that the desire to avoid the Fightback! dilemma, and thus to deal only in very broad policy generalisations, may serve the second purpose of avoiding too much internal policy squabbling.  That, of course, can only be a temporary strategy.

Very much the same difficulties apply to the Party's organisational problems.  Indeed, in terms of the Party's long-term needs, John Hewson's greatest failing may turn out to be not that he lost the unlosable election but that he failed to use his immense personal authority, in 1990-91, to force reform of the Liberal Party's structures.

Personality -- not being all that amenable to the normative theoretical constructs of standard political science -- does not play much of a role in Jaensch's book.  This makes for a curiously bloodless tone throughout.  It also leads him, perhaps more importantly, to overlook the key difficulty of the last few years.  For while the Federal Liberal Party does have to reconcile its ideological problems, and to settle on a credible and appropriate ideological identity, the root cause of its instability since 1983 has been in personalities.  In this sense, the Party's essential task has been to find a way of burying forever the apparently irreconcilable rift between Andrew Peacock and John Howard.  It may well be that the elevation of Alexander Downer marks the completion of that task.

There are other, fairly basic, problems with book.

It is not well edited, nor adequately proofread.  A faint air of second-hand fact pervades it, as if there was too much hasty recourse to old newspaper files.  The grasp of fact is not always sure.  (Western Australian readers will be surprised to learn -- on page 199 -- that a "wet" Liberal Reform Movement emerged in that State in 1991).

It is not at all clear at whom the book is aimed.  It comes equipped with Harvard references, and an academic superstructure of models and taxonomy.  But it seems, on the basis of style and seriousness, to be directed at a more or less popular audience, perhaps even including concerned members of the Liberal Party, who might want to find some answers to the obvious questions.  The difficulty is that the academic models are descriptive, and far from being prescriptive of success.  The academic camouflage tends to hide from the reader the fact that Jaensch has no more good advice to offer the Liberals than most commentators, and somewhat less than a few.

Like many, he barely conceals his distaste for economic rationalism and has considerable difficulty in separating the technocratic rationalism of Fightback! from any more authentic version of liberal market economics.  And like many, he seems unable to see that his advocacy of the politics of inclusion is a poor substitute for a policy framework which actually does something about our major problems such as unemployment.  Of course the Keating ALP is better at cuddling up to every conceivable interest group and at locking in their votes, but the resulting policy paralysis -- all too evident in Labor's impotence on unemployment -- carries with it the implications of much more serious failure.

Good Sense

The Moral Sense
by James Q. Wilson
The Free Press

James Q. Wilson is a distinguished American public philosopher writing on crime, bureaucracy and many aspects of social behaviour.  His reminds one that, despite the corrupting effects of the audio-visual media and of university cliques almost at war with the sentiments of ordinary citizens, the United States can still produce writers of a spacious and commanding integrity.  The title of Wilson's latest book, The Moral Sense, is almost misleadingly modest.  He might have more appropriately adopted a Lockean title such as An Enquiry into Human Conduct.  Wilson has produced a very wise book, lucid in both argument and language and rich in well-digested reference and anecdote.

Alas, it is hard to do justice to an analysis which leaves so few elements of our moral and social behaviour unexamined, except to note that The Moral Sense achieves the rare fear of evading both undue Panglossian optimism and a Hobbesian pessimism.  It shows us that there is hope for the development of social decency, moral principle and some sense of warm social affinity in most people.  Both nature and social conditioning provide the moulds in which our plastic human clay is shaped, but the essence of that clay still defies our categories.  Wilson demonstrates that only the most damaged of men and women lack potential for a moral response.  While whole societies may periodically display psychopathic tendencies, as in the case of Nazi Germany or contemporary Yugoslavia, only a minority of individuals can be persuaded to behave amorally for more than short periods, and usually under strong outside pressure or inducement.  Wilson carefully considers the nature of these warping pressures and how far they can extend.

From a personal perspective I am convinced that tension between individual autonomy and the demands of social conformity can only be resolved by realising that the poorly-developed individual also comes to be a corruptible and unreliable citizen.  Only the sufficiently mature in judgment and moral sentiment can serve the family, institutions and the state in a sound and fairly consistent manner.  In either sharply-polarised or indolent social situations the mature citizen is forced to be a non-conformist whose aloofness is often condemned by the herd as unfriendly.  The vital distinction then to be made by society and peers is between the disruptive and criminally-alienated trouble-maker and he/she who has the courage to be solitary while working within "the system" to leaven the communal lump.  Usually lacking any strong moral sense, political messiahs are often in a hurry for a transforming upheaval.  The true redeemer has no illusions about the capacity of mass society for rapid change or high vision and works on a spiritual or psychological plane with the responsive few.  Otherwise the world would experience no difference between Jesus and Marx, Confucius and Pol Pot.

James Wilson tackles the typical relativist habit of trying to smudge over the whole concept of morality with that of "clarifying values".  From that point it is only a short distance toward believing that one system of social values is as good as another and the modern absence of commonly accepted transcendent absolutes allows us to justify any sort of behaviour which renders us socially approved.  In this the author quotes Adam Smith:  Man naturally desires not only to be loved but to be lovely.  How true.  Here lies a basis for both expedient immorality and a paradoxically ashamed return to morality.

SYMPATHY

Wilson also agrees in part with Smith that the ancient origin of most practical moral conduct is in sympathy, of imagining ourselves to be in the position of others.  When we sympathise we judge, reacting to the worthiness of other persons and their behaviour.  From this comes not only respect, but, more vitally, comparative self-respect, something which so many people in urban admass cultures never fully attain.  Self-respect, of course, has its roots in primary associations, in families and in close friendships.  From this rootedness in solid early affinities the child moves from the primitive tit-for-tat reactions of the playground to more careful judgments of human need and value.  Again, an erosion of primary sympathies and early kinship loyalties tends to preserve the tit-for-tat mode of morality into adult life.  Our prisons are full of morally primitive people who have known only how to menace others out of their lack of self-respect.

The author deals fairly but sceptically with the social Darwinist morality of necessity.  Darwinian explanations simply do not show why so many people behave altruistically in a manner contrary to their genetic programming or biological self-preservation.  Saving a grandmother who is elderly, disagreeable and long past child-bearing serves no genetic purpose whatsoever.  Moreover, adoptive parents frequently make as many sacrifices and show as much affection for children as do natural ones.  (Though it lately seems, amid the present vogue of single motherhood with serial male partners, that children are far more likely to be treated with moral indifference or even molested by step-fathers than by natural sires).  In this writer's view, the less modified by the social and moral customs of high civilisation (East as well as West), the more families are likely to revert to raw tribal imperatives with a moral indifference towards the higher responsibilities of individual nurture.  Morality becomes diluted by some real or conceived necessity.  The fashionable habit in the Christian churches of sanctifying the poor too often glosses over tribal harshness and exploitation of children as resources which linger in those traditional communities that unregulated procreation can produce.

Wilson moves to the other separate sinews of moral conduct, such as fairness, duty and self-control.  "Fairness", of course, brings us back to the tit-for-tat privileges and forfeitures which underpin our modern clamour for "rights".  Rights must be in balance with duties.

The recently fostered social guilt which prompts liberally-minded white Australians to bow to every demand for Aboriginal rights, overlooks the duty of even black Australians to obey the law and accommodate to the structures of the European culture which now strives to offer them restitution for past wrongs.  The recent bald assertion of an Aboriginal advocate that rights are intrinsic, they cannot be conferred, shows to what grotesque lengths the Jeffersonian assertion of 'inalienable rights' can now be taken.  Even Rousseau, the philosophical father of this fallacy, had to admit in The Social Contract, that all rights must stem from social consensus.

Without a primary acceptance of personal and social duties (by rulers as well as ruled), no meaningful judgment about rights can be made.  Civil duties thus have a deeper moral basis than civil rights, and also a longer history.  Rights are mainly contractual and various governments and legal systems interpret them according to different cultural norms.

The United Nations Declaration was created by the Western powers in a fit of democratic fervour, but only a few member states have ever given more than lip service to its observance.  Morality can only be demanded politically in limited situations, something which Mr Michael Lavarch and his Prime Minister appear not to have understood.  As Tacitus long ago wryly observed:

"The more corrupt the government, the greater the likely number of its laws".

THE FAMILY'S ROLE

Wilson's most important chapter relates to the role of the family and the moralities it both embodies and transmits to the wider community.  He makes an all too common sweeping judgment against Freud.  He is equally critical of the behaviourist amoralism of H.J. Eysenck that the conscience is merely a conditioned reflex.  Freud established the beneficial effect of studying infant pleasure-seeking (with or without sexual undertones) with remarkable accuracy for his time, and his notes on aggression in male children have since been amply confirmed.  Clinically, it has been repeatedly established that self-control can be a double-edged moral demand.  Too much control, as Carl Jung eloquently illustrated, and normal aggression can one day explode out of the nursery on to the battlefield.  Meanwhile, too little self-control produces the unresourceful, media-dazed youth of today, often repelled by its own lack of moral reference points while secretly craving for the reasonable ethical boundaries and ideals its baby-boomer parents never learned.

Wilson himself sagely recognises that dysfunctional families usually blunder along at one of two extremes or in the worst instances zig-zag wildly between the two.  He remarks:  "Though the human infant is a remarkably resilient creature, protected by redundant systems from many kinds of misfortune, it is vulnerable to the excesses of both rule-obsessed and laissez-faire parents".  How well supported this is by research, but how often disregarded by ideological zealots or amoral slobs at either extreme of the parenting spectrum.  Since the Greeks, we have admired moderation in theory, but so often flouted it in the most intimate of our personal transactions.  Fortunately, as the author's well-stocked references establish, most children do grow up adequately, provided that they are not forced to accept from their mentors, moral and social banalities which are quite grossly at odds with emotional and spiritual growth.

Finally, Wilson gives some space to gender and moral response.  It is true that men rend to construe moral conduct in terms of gestures, whereas women tend to embody this more in their basic attitudes.  As spouses, mothers and latterly as civil functionaries women so often Furnish the environment in which male moral activity can be advanced.  But each is an ethical agent to himself or herself and gender roles can widely vary or overlap.  In the Orient, businessmen often have a "feminine" sensibility in which the politesse of the encounter must receive equal recognition to the urgency of the transaction -- a useful trait which Australia's men might acquire.  Often the truer morality is not in winning, hut in worthily taking part.  Meanwhile this book provides a cornucopia of material for reflection and should be in the library of everyone involved in matters of public policy.