Free trade or greater protectionism?

What should the Rudd Labor Government do to address Australia’s future policy needs? Is deficit public spending the solution? Should higher levels of public spending be promoted immediately, given that major problems may lie ahead with Australian businesses and banks possibly needing vast funds to bail them out if Australia does experience a severe recession?

In all probability, the Australian government (like all Western or capable governments) has little choice (in the short term) but to spend much more to offset the declining role of the private sector as recession sets in; although one hopes that debate between Australia’s political parties, interest groups and public opinion is extensive enough to ensure that spending is directed to the most productive areas and distributed fairly.

With China’s economy growing by 6.8 per cent in the fourth quarter of 2008, its slowest pace in seven years, it will be a long time yet before it alone can fuel international economic growth given that its economy in 2008 represented just over 5 per cent of world GDP compared to 36 per cent for the US, Japan, Germany, France and Britain alone (CIA World Factbook). Preliminary estimates already indicate that GDP in the OECD fell by 1.5 per cent in the fourth quarter of 2008, the largest fall since OECD records began in 1960.

With Labor sticking to a belief that declining tax revenue will be a temporary problem, and ruling out tax increases to pay for upcoming budget deficits (Philip Dorling, Canberra Times, February 16, 2009), this may be wishful thinking. Tougher access to credit may slow international economic growth for years with most developed economies already having high levels of per capita debt (private and public), thus complicating future spending and consumption possibilities.

It is worth noting that Australia’s net debt (total private and public) is already at about 60 per cent of GDP (or $658 billion) after being 38 per cent in 1996. This is despite the Howard government eliminating Commonwealth debt after public sector borrowing increased by an average 5 per cent of GDP a year from 1974-75 to 1986-87.

To a large degree, the policy options available to Western nations cannot be explained without reference to international considerations. While Western nations have been prepared to lose some global share of GDP in recent decades, this willingness will be tested in the future if rising developing nations do not play by the same rules, especially if social welfare expenditures in Western nations come under much greater pressure.

It may well be that China and India will play a greater role in future years (reflecting the growing size of their economies). This may include making important contributions to various international organisations with greater pressure placed on them to adhere to certain international agreements (perhaps even in relation to the environment).

China may also succumb to greater pressure to allow its currency to fluctuate, promote domestic economic activity rather than having such a high reliance on exports, and increasingly accept the demands of a growing middle class and public consciousness that will expect that government does much more to meet social welfare and environmental needs. China may also need to accept the boom and bust that accompanies economic cycles despite recent concern about the stability of its $US1.95 trillion foreign reserves, which includes $US682 billion holdings of US government debt (Belinda Cao & Judy Chen, Bloomberg, February 11, 2009).

But even if a relatively peaceful transition of power arrangements occurs and general support for freer trade remains - which is preferable to any return to full-blown protectionism - greater pressure will emerge on Australian governments to adopt extensive reform.

In a sense, we are returning to debates that were evident in the late 1980s, as noted by Ross Gittins when he expressed concern that “national investment exceeded national savings by 4.5 per cent of GDP, roughly the size of the current account deficit” (Sydney Morning Herald, May 1, 1989). The current account deficit had previously averaged about 2.5 per cent during the 1960s and 1970s.

While a higher current account deficit is not always bad, as domestic firms do have greater access to foreign savings which help funds infrastructure, company expansion and new enterprises, things can go wrong especially when world growth slows. If Australia’s level of debt is increasingly viewed as unsustainable, this may lead to a large withdrawal of capital and a shortfall in Australia’s savings. And if demand for Australian exports falls but import levels remain similar, this will lead to higher debt repayments in order to fund the current account deficit.

Quite simply, all developed nations (including Australia) are in trouble despite recent attempts to balance compassion and competitiveness as seen by most OECD nations increasing social welfare expenditure as a proportion of GDP between 1990 and 2005 with Australia’s level rising from 13.6 to 17.1 per cent of GDP compared to the OECD average level rising from 18.1 to 20.5 per cent (OECD.StatExtracts).