CREDIT CODE RED Peter Brain’s doctoral degree, completed at the University of New South Wales, was a pioneering analysis of the National Accounts statistics then becoming available in time series In 1973, he was appointed to head the Econometric Forecasting Project at the Melbourne University Institute of Applied Economic and Social Research After graduation from the University of Melbourne, Ian Manning taught at one of the affiliated colleges of the University of Madras, India, specialising in the economics of banking He returned to the Australian National University to complete a doctorate on the economics of town planning, and then worked on social-security policy for the National Inquiry into Poverty In 1980, he joined the staff at the Melbourne Institute In 1984, Peter left Melbourne University to found the National Institute of Economic and Industry Research (now known as National Economics) Ian joined him a year later For the past thirty years and more, they have both collaborated and worked independently on projects covering all aspects of the Australian economy, its industries, its regions, and its people Scribe Publications 18–20 Edward St, Brunswick, Victoria 3056, Australia John St, Clerkenwell, London, WC1N 2ES, United Kingdom Published by Scribe 2017 Copyright © 2017 Peter Brain and Ian Manning 2017 All rights reserved Without limiting the rights under copyright reserved above, no part of this publication may be reproduced, stored in or introduced into a retrieval system, or transmitted, in any form or by any means (electronic, mechanical, photocopying, recording or otherwise) without the prior written permission of the publishers of this book The moral rights of the authors have been asserted 9781925322392 (Australian edition) 9781925548495 (e-book) A CiP entry for this title is available from the National Library of Australia scribepublications.com.au scribepublications.co.uk To Angela and Alice Contents Abbreviations Introduction Economic breakdown as a threat to prosperity Financial deregulation Financial deregulation and household debt Financial deregulation and overseas debt Australia under credit watch Crisis vulnerability over the next decade Neo-liberalism comes full circle Economic policy after neo-liberalism Appendix Acknowledgements: The role of financial deregulation in the accumulation of overseas debt Notes Abbreviations Australian Bureau of Statistics ABS European Commisssion EC European Union EU Gross Domestic Product GDP Global Financial Crisis GFC International Monetary Fund IMF Reserve Bank of Australia RBA Volatility Index VIX Introduction For more than thirty years, Australian governments have pursued and promoted free-market economic reforms They have trumpeted the virtues of profitability and competition; they have asserted that productivity is bound to increase when business is deregulated Their reforms have been guided by neo-liberal economics, the faith that ‘the free market, unimpeded by government intervention, will answer all human needs’ This faith claims a universal validity, and the Australian reforms were part of a surge of reform that originated in the United States and washed outwards from the Englishspeaking countries The reforms have now been in place for long enough, and in enough countries, to be associated with several adverse trends — notably, increases in the inequality of wealth and income, and increases in the incidence of severe economic crises Are the reforms responsible for these adverse trends? Our answer is a definite ‘Yes’ To prove the case that reform has increased inequality and vulnerability to crises, it is necessary to move beyond the neo-liberal economic theories on which the reforms were based These theories have nothing to say about inequality and crises; they simply assume them away When the neo-liberal theories came into fashion in Australia we were concerned that they would generate complacency We were not, perhaps, as concerned as we should have been about the promotion of inequality — Australia has a robust social-security system that has so far resisted the most outrageous reforms, though neo-liberal tolerance of high unemployment and failure to index benefit rates have raised the incidence of poverty Our particular concern was that governments would neglect the need for active policies to maintain stability and underpin future prosperity, and so would sleepwalk Australia into crisis Over more than three decades, we have maintained an unfashionablly broad approach to economics, unconstrained by neo-liberal assumptions This approach warns us that Australia is overindebted; its households have borrowed too much from its banks, and its banks have borrowed too much from overseas The neo-liberal reforms freed the banks to sell credit, and the resulting debt is becoming unmanageable Though it avoided the Global Financial Crisis of 2008, Australia is now drifting towards economic breakdown and Depression In this book, we hoist the Code Red signal; drastic action is required to extricate Australia from the pitfalls that neo-liberal policy has created When one encounters it in a first-year economics textbook, neo-liberal theory seems too esoteric to provide the foundation for a reform movement Expressed in mathematics and expounded in academic article after academic article, it buys its internal consistency at the cost of an almost endless list of assumptions These assumptions create an artificial world — a placid metaphysical world in which individual property-owners buy and sell their way to the common good Neo-liberal theory has been marketed as a sophisticated account of the complex interrelationships that comprise a capitalist economy, yet it simplifies these relationships by disregarding some of the most crucial interconnections and uncertainties within such an economy Herein lies its danger, when potential sources of economic breakdown are assumed away by those in charge of public policy The governments of Australia did not turn to neo-liberal theory through infatuation with its intellectual beauty Rather, they adopted it because it was heavily promoted by vested interests Though its basic theories were developed in nineteenth-century Europe to defend capitalism against Marx and other critics, their present incarnation owes much to a coterie of American billionaires, and their counterparts in Australia and the United Kingdom, who turned to neo-liberal economics in their search for arguments to defend their wealth against pesky taxes and environmental regulations Their fundamental contentions were that taxes, particularly those on high-income people, weaken incentives to produce and to innovate, and that regulations raise costs, with similar debilitating effects And, further, that production foregone due to taxes and regulations is a loss to the nation as a whole, not just to its rich minority Neo-liberal economic theory can easily be tweaked to support these arguments, but for it to be of any political use in defending the billionaires’ interests it had to be established that the theory describes an attainable reality It proved hard to establish the theory as realistic — its assumptions were just too restrictive — but its protagonists had considerable success with their assertion that free markets are associated with freedom from authoritarian government It helped, too, that the seeming sophistication of the theory attracted intellectuals to the think tanks and academic posts that were founded to promote the reform program, and that journalists could readily be found to carry the message into the media Once academics, politicians, and the elite in general were drawn into a mental world in which neo-liberal perfection was considered attainable, economic policy became a simple matter of reforming economic institutions to make them look more like those assumed in the theory — in general, by promoting competitive markets It was argued that such reforms would guarantee increases not only in in productivity but also in incomes As neo-liberal theory permeated into Australian universities, we developed our critique of it, which at base was that the theory was too abstract to be reliable as a guide to policy We were especially concerned that reform was extended to an area where the underlying theory was particularly contentious: the extension from free trade in markets for goods and services to free trade in money In Australia, as elsewhere, financial deregulation was intended to increase the efficiency of the allocation of funds, but instead it has tempted banks and other financial institutions into the reckless misallocation of funds to finance consumption, and the reckless raising of funds by overseas borrowing By taking into account a much broader range of behaviours than those specified in neo-liberal theory, and by allowing for a wider range of interconnections between economic actors, we were able to foresee the disasters that would follow from the neo-liberal reforms We were not thanked, of course, for predicting the financial crises that punctuated the past three decades: the Australian 1990 recession, the Asian financial crisis of 1998, and the Global Financial Crisis of 2008 Happily, one of our predictions failed to eventuate — contrary to our expectations, Australia survived the Global Financial Crisis This happened partly because the Australian government took timely action, but chiefly because the Chinese government did so, and generated a mining boom that allowed the Australian finance sector to postpone the consequences of its over-exposure to overseas borrowing But one happy escape does not guarantee permanent immunity In this book, we trace the evolution of Australian economic reform in the neo-liberal era and show how it has increased Australia’s vulnerability to economic breakdown, mainly due to excessive overseas borrowing by the banks We also show how similar reforms in other countries (notably the United States) are increasing the danger that Australia’s credit rating will tumble due to events over which Australia has no control, maybe to the point where its banks’ overseas borrowings can no longer be serviced At this point, the Australian economy will collapse We chronicle, too, how the Australian financial sector has captured to 10 per cent of Australian national income, more or less double the proportion it attracted during the post-war era of economic growth, and again more or less double the proportion it attracts in continental European countries today This is not productivity: it is the cost of excessive intermediation; the cost of an insupportable burden of debt; and the cost of too much credit imprudently sold, resulting in debt that is all too likely to go bad Australia is a leaky ship in rough seas We have no alternative but to hoist the danger flag and declare that, on current policies, Australia will shortly enter the Credit Code Red zone We raise the alarm, not only because we fear the costs of economic breakdown — the unemployment and the loss of income — but because we fear half-baked responses to the breakdown, based all too probably on misunderstood neo-liberal theories that fail to address the weaknesses which caused the breakdown We also fear responses that go too far, and that fail to recognise the crucial role that an efficient and prudent financial system can play in maintaining prosperity and, dare we say it, in the transition to a sustainable economic system, including rational responses to climate change This is why we devote so much space to the history and mechanics of what has gone wrong Even so, our suggestions as to what should be done are but tentative additions to a burgeoning literature By what authority we warn that Australia’s credit code is turning red? We claim, first, authority that arises from the history of economics In particular, though the political mayhem of the 1930s is beyond living memory, the influence of the Great Depression lingers in economics Those were the days of unemployment and moonlight flits and of bad names, including those of Hitler and Stalin Yet there were also good names Among contemporaries who attempted to understand the maelstrom of the times, one good name stands out — that of John Maynard Keynes The economists of the time, the progenitors of today’s neo-liberals, practised as they were in the defence of idealised free markets against the vituperations of socialists and communists, were nonplussed by the Depression In their theoretical world, such disasters simply couldn’t happen Keynes offered an alternative vision in which free markets, while essential to the working of productive economies, provided no guarantee of full employment In a flurry of intellectual activity, previously puzzled scholars and practitioners developed, corrected, and elaborated his insights Professors of economics continued to ask the same questions on their exam papers, but diametrically changed the answers ... government and finance sectors are so central is that economic breakdown arises from bad debts Borrowing and lending are central to the capitalist system, and, thanks to the uncertainty of economic. .. governments are understandably reluctant to precipitate precautionary recessions, and are therefore inclined to trust to luck and continue with business as usual, even if a Code Red alert is imminent To. .. in the neo-liberal era and show how it has increased Australia s vulnerability to economic breakdown, mainly due to excessive overseas borrowing by the banks We also show how similar reforms in