Macroeconomic Policymaking since Federation – David Vines

Macroeconomic Policymaking since Federation: Its Implications for the Australian Settlement

David Vines, University of Oxford – 4 January 2017

This blog develops the ideas in the 2016 Harcourt Lecture, called “Institutions, Individuals, and Ideas: Macroeconomic Policymaking in Australia from Federation to 2020”, which Professor Vines delivered at the University of Adelaide on 29 September, 2016.

It was Paul Kelly who introduced the term “Australian Settlement” in his book The End of Certainty, first published in 1992. Kelly used his phrase to capture both the political economy of how Australia is managed as a nation, and the implications of that political-economy for the stability of the Australian political system. In my Harcourt Lecture, which I delivered on 29 September 2016, I argued that the growing competence with which macroeconomic policy has been made within Australia, ever since World War II, has had significant implications for this Australian Settlement: it has made it much less fragile than Kelly believed.

When Kelly coined his phrase he meant five things: protectionism, centralised wage-fixing, high migration (managed by means of the White Australia Policy), imperial benevolence, and state ­paternalism. These five features had all been emphasised by Keith Hancock in his remarkable early book, Australia, published in 1930. The last feature was crucial – state-led growth was necessary if infrastructure was to be provided in in this vast new country.

Kelly was concerned to argue that the Hawke-Keating reforms of the 1980s pulled the rug from underneath the Australian Settlement, since Hawke and Keating together abandoned the first two fundamental elements of that settlement: protectionism and centralised wage fixing. Although a policy of high immigration remained in place, imperial benevolence was gone, and had been gone ever since the fall of Singapore in 1942. Furthermore, state-led growth seemed vulnerable to Kelly at the time. As a result, his argument was that Australia faced great uncertainty, since almost nothing of the original settlement remained in place. Hence the title of his book. The country needed a new direction and, to Kelly, it was not clear what this direction would be.

But Kelly’s description of the Australian settlement makes no mention of macroeconomic management. That is because, in the early days of Federation, there was just the Gold Standard. In my lecture, I argued that the birth of Keynesian macroeconomic management during World War II radically strengthened the Australian Settlement. And this happened in a very distinctive way: Australia’s open-economy Keynesianism grew out of a very clear understanding of Australia’s position as a small open economy. The story of how this policy-making system was established, and of how it strengthened the Australian Settlement, is a fascinating one.

At the beginning of World War II, a group of Australia’s first economists, led by Lyndhurst Giblin, established a Financial and Economic Committee in Canberra. Their task was to provide Prime Minster Robert Menzies with advice on the kind of economic policy necessitated by the war. Giblin was guided in this work by John Maynard Keynes, in a detailed correspondence which the two men carried out, on how to pay for the war. The outcome, in Australia, was a policy framework which cast aside the balanced-budget conservatism that had accompanied the gold standard.

Because of Australia’s international vulnerability, the form of Keynesianism adopted by Australia’s economists was, from the very beginning, of an open-economy kind. In the run-up to the Bretton Woods conference in 1944, Australia’s economists contributed significantly to the discussions, in London and Washington, about how to reform the international monetary system. They were determined that, after the war, the world would not return to the deflation which had characterised the gold-standard world of the 1930s. They insisted that the new International Monetary Fund be charged with ensuring that countries carry out a full employment policy after the war.

And when it came to devising domestic macroeconomic policy within Australia, these economists recognised the need to achieve not just ‘internal balance’ — full employment of resources without inflation — but also ‘external balance’, meaning a satisfactory balance of trade. An open-economy policy framework of this kind made possible a period of unprecedented growth for Australia, lasting right through until the breakdown of the Bretton Woods system in 1971. Things then turned rather bad during the first half of the 1970s, which was a difficult time throughout the world. In Australia, rapid growth gave way to an era of class conflict and high inflation.

But a remarkable thing about the Australian macroeconomic policymaking system was that it was strong enough, and flexible enough, to remake itself. As a result, Australia’s macroeconomic policymaking system evolved very significantly. Five important things happened.

First of all, as Kelly noted, in the 1980s and 1990s Prime ministers Bob Hawke and Paul Keating overturned two key aspects of Australia’s post-Federation political economy: protectionism and centralised wage fixing. These two policies had been connected, since protectionism had sheltered the wage-fixing process from the pressures of international competition. Gradually in the years since then, centralised wage-fixing has given way to a decentralised system of enterprise-level bargaining about wage levels. Yet Australian political economy, in the years after the Hawke/Keating era, has retained a powerful and distinctive concern for the fairness, and a determination to moderate income inequality. This is a legacy of the era of centralised wage-fixing. And there remains a sense that government will ensure that opportunities continue to grow for all Australians, including for those who have been negatively affected by the removal of protectionism and by a move to a more competitive labour market.

Second, through the 1980s and into the 1990s, there was a move towards an inflation-targeting regime. In this new regime, interest-rate setting, rather than centralised wage fixing, became the means of stabilising inflation.

Third, in 1983, Australia finally cast aside its continuing adherence to quasi-pegged exchange rates and moved to a floating exchange rate regime. In this regime, as interest rates are moved, the exchange rate responds, in a way which plays a hugely important role in helping to stabilise the economy.

Fourth, there has been a gradual establishment of fiscal discipline in Australia. The country’s stock of public debt is small by international standards. And Australia has a much better-than-average private pension system and a growing young population. Care of the elderly is thus not likely to become an unmanageable burden on public finances as is likely to happen in many other countries.

Finally, Australia has developed a form of financial regulation as good as that in Canada, or indeed as anywhere else in the world. This was in part a response to Australia’s own history: memories of the financial fallout from the house-price collapse in the early 1990s engendered a sense of caution both by banks and by regulators. The effect of this regulatory caution was to clearly dampen the effects of the global financial crisis in Australia in 2008.

These five changes have given rise to a macroeconomic policymaking system in Australia that has steered the country through the last four decades in a remarkably effective manner. During this period the Australian economy experienced four major shocks: the worsening of the terms of trade in the mid-1980s; the Asian financial crisis in 1997–98; the global financial crisis of 2008; and the commodity price collapse in 2014–15. The outcomes following these shocks have, in each case, been remarkably successful.

Movements in the nominal exchange rate have played a major role in defending the country against the effects of each these shocks; each time the exchange rate of the Australian dollar has fallen in the way required to sustain growth by means of increased exports and reduced imports. But these movements in the exchange rate have only achieved such an outcome because they formed part of a coherent macroeconomic policy system: currency falls have not – as elsewhere – caused threats to the control of inflation or endangered the sustainability of the government’s fiscal position. The reforms that have made this possible were hard won and politically challenging. But once in place, they have enabled Australia to achieve a superior level of macroeconomic performance. As I write, the economy continues to grow. And unemployment is more or less back to its pre-crisis level.

In a nutshell, I believe that the addition of competent macroeconomic management to the Australian Settlement, something which happened during World War II, made that settlement much more robust. My view is that, when two powerful elements of the settlement – protectionism and centralised wage fixing – were kicked away by Hawke and Keating, what remained was both more powerful and more distinctive than what Kelly had suggested. A concern for equality remains crucial in Australia; this is a legacy of the wage fixing era. A concern for growth and an understanding of the need to be welcoming to immigrants is still present. And a concern that this growth be state-led is still a widely-held belief. These three things mean that that there is a sense that the state will ensure that opportunities continue to grow, and grow for all those present in Australia. Central to this belief is a confidence that the economy will be well-managed, enabling the growth process to continue without disruption. That confidence has been based on the capacity for competent macroeconomic management which was created during World War II and which has been developed and adapted ever since.

David Vines is a Professor of Economics, and a Fellow of Balliol College, at the University of Oxford. He has recently been a Visiting Fellow at the Crawford School of Government at The Australian National University.

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