Used by date: free trade

The recent closure of steel plants has brought a section of the trade union movement to publically criticise Australian trade policy. Another high profile example of attack upon trade policy is by retailers protesting over online shopping. Both groups have been given token support by Australian business. But to date nobody is seeking to mount the barricades and so the criticism of trade policy is fragmented, uncoordinated, and lacking credibility.

Railing against Free trade in isolation by one section of the trade union movement or business group is a pointless exercise. The real debate should be about the underlying economic philosophy and whether or not it is suited to a modern world.

Free trade ideology has been dominant in Australian politics since the formation of the Cairns Group of free trading nations in 1986. Labor Minister, John Dawkins, was the first Chairman of the Cairns Group that sought to raise the international profile of free trade in agriculture. By the time the Doha Round of trade talks arrived, the Cairns Group had lost standing in international trade forums. The arrival of the G 20 Group of nations had diluted the influence of the Cairns Group.

Free trade has been an integral part of classical and neoclassical economic philosophies since David Ricardo (1782-1823) first formulated his comparative advantage theory. It was primarily a labour theory of value and specialisation of production.

The neoclassics realised the unreality of Ricardo’s theory in a changed world. They sought to modernise the theory. Inherently, the model remained a labour theory of value, which distributed income between nations. But, it has no institutional structure to explain income between capital and labour. Income distribution is inherently contained within the assumption of full employment. The assumption of full employment is an important underlying assumption of both classical and neoclassical economics. The full employment assumption dates back to Say’s 1803 theory of supply and demand: Supply creates demand. The full employment assumption implicitly underwrites industry policy.

Theoretically, this assumption implies that a flexible labour market will adjust the wage rate so that the existing production base employs all those willing to work.  In a fully employed economy, efficiency and productivity have to rise to raise production and income. Any surplus is exported into open international markets thereby improving domestic and international welfare. If unemployment exists, it must be either voluntary unemployment, or, frictional unemployment. Voluntary unemployment occurs when workers voluntarily do not seek employment whilst frictional unemployment happens when workers move between jobs.

The philosophy does not recognise involuntary unemployment such as occurred during the Great Depression, 1970’s-1990’s, or, the GFC. Because the full employment assumption excludes involuntary unemployment, neoclassical theory cannot provide a solution when it occurs.  Chronic unemployment is explained as supply side bottlenecks impeding market forces.  Trade union power is a favourite target for neoclassical economists when labour markets become “sticky”. Market reform is recommended to reduce union power and make markets more flexible.

The modern political architect of contemporary economics was Margaret Thatcher. Reagan took it to America. Hawke/ Keating brought it to Australia. Lange took it to New Zealand. Gonzalez introduced it to Spain and Mitterand in France.

It could not have been introduced to Australia without the consent and active support of the trade union hierarchy. Paul Omerod in his book  “The Death of Economics,” describes social democrat governments that embraced this philosophy over the 1980’s and 1990’s as “notional“ social democrats. Ostensibly, regression to early nineteenth century economics was to solve the problem of stagflation post Bretton Woods collapse in 1971.

Post World War II, the international monetary system required economic management to focus upon full employment and balanced trade. When the Bretton woods system collapsed in 1971, a period of monetary uncertainty prevailed as the major players sought an alternative international monetary system. An “alternative system” was endorsed by 1976 when IMF member nations decided that countries could adopt whatever exchange rate system they preferred. International institutional endorsement of neoclassical economics and the push for free trade came from the alteration of IMF articles in 1976. By altering the charter of the IMF, the post War requirement for full employment and balanced trade was replaced by managing domestic price stability. Modern monetarism was internationally institutionalised.

Neoclassical economic philosophy in reality is a genre within which reside several separate schools of economics, some more austere than others. The particular school that received approval under the IMF was the Chicago School. Its leading scholar and advocate was Milton Friedman. As they are embedded in neoclassical philosophy, monetarists embrace the genre’s full employment assumption and belief in flexible markets. Competition drives markets both domestically and internationally.

The assault on industrial protectionism came from Reagan and his call for trade talks in the early to mid 1980’s. These talks dragged on until finalization at Uruguay in 1995. The Australian Cairns Group was very active in the push for winding back international protectionism whilst Hawke/ Keating set about withdrawing government involvement from Australian industry. Floating of the currency, microeconomic reform, and competition policy were euphemism coined to politically sell neoclassical reforms that deregulated markets. Howard and Costello formally confirmed monetarism when they gave independence to the Reserve bank in 1996. Australia’s back to the future modernisation had been completed.

The end result of the push to open up Australia to international competition can be traced through the structural change in sectoral employment.

Table 1 shows the decline in employment across agriculture and manufacturing.  Other employment, which includes retailing and services, has grown strongly.
                       

Table 1
           Employment by Sectoral Percentage
Year         Rural        Mining        Manufacturing        Other
1979-80    6.5%        1.3%            20.1%        72.1%
1982-83    6.6%        1.5%            18.4%        73.5%
1989-90    5.4%        1.35            14.7%        78.5%
1999-2000    4.9%        0.9%            12%        82.2%
2009-10    3.3%        1.6%            9.1%        86%
            Source ABARE Commodity Statistics 2010, p. 3

Much ado is made about the lack of skills particularly in the mining sector. Historic time series data shows that the two training sectors for tradesmen have been decimated by structural reform (rural and manufacturing sectors).

The retail sector gained from structural reform. Retailers enthusiastically imported cheap foreign goods, which ultimately destroyed any internationally uncompetitive manufacturing industry. Now retailers face international competition from online suppliers faced by agriculture and manufacturing over the past three decades.

As the mining sector demands skilled tradesmen, retail and services sectors cannot provide the wanted skills. Structural reform successfully removed workers out of training industries, but now cannot return them in the numbers demanded. Industrial policy has become the victim of the much vaunted modernisation of Australian industry. The only policy option is 457 visas. Trade unions have no one else but themselves to blame.

Farm viability depends upon farm gate output prices rising in line with prices in the wider community. Of particular concern to farmers and rural policy is the long-term decline in industry terms of trade (ratio of prices received to prices paid). In 1979/80 before structural reforms began, farmer terms of trade had an index value of 162.7. In 2009/10, the same index value was 91.5. Structural reform has overseen farm terms of trade decline by 43.8% or 1.9% compound annually.  

Real net value of farm production has declined from a peak index value of 278.7 in 1979/80 to a low of 105.4 in 2008/09. Prior to 1980’s structural reforms, farm debt was 34.3% of the gross value of farm production. By 2009/10, farm debt was 154% of the gross value of farm production. By any common sense measure, rural structural reform has been a failure and now threatens national food security.

Employment is another important measure of philosophical failure. We hear much about the performance of Australian fundamentals delivering full employment. However, when the IMF changed policy objectives the definition of full employment also changed.

IMF member nations moved away from the Post World War II commitment to provide employment for all those wanting work, to the monetarist definition of the natural rate of unemployment defining full employment. Conveniently, the natural rate of unemployment is around 5% unemployment which is very different to the 1963 Vernon Committee definition of full employment being a range between 1% – 1.5% unemployment.
The true efficiency measure of the Australian labour force is given by the underutilisation rate. The underutilisation rate draws into a composite figure both the unemployed and the underemployed seeking more employment than is available.

In August 2011, the underutilisation rate for Australia was 12.3%. The two worst states were Queensland 12.9% and Tasmania 14.9%. The national unemployment rate was 5.1%, Queensland 6.3% whilst Tasmania had the strange result of 5.2%. The strange Tasmanian statistic suggests political presentation of unemployment data rather than real world analysis of national unemployment data.

 
From ABS; Australian labour market Statistics 6105.0, 2009

It is interesting to compare the underutilisation and unemployment rates of 1983 and 2011. When Labor came to power in February 1983, the unemployment rate was 9.6% with an underutilisation rate read from the ABS graph around 12%. In March 2011, the comparative figures were unemployment 4.8% with an underutilisation rate of 12.8%. The real story of failed industry policy lies inherently within these comparative figures. But, where are the trade unions?

Once industry protection was removed in 1988 and again in 1991, balance of payments outcomes become an important measure of underlying philosophy and theories.
 
Compiled from:  ABARE Commodity Statistics 2010, Macroeconomic variables

Graphical analysis provides an evaluation of structural reform of Australian industry. Despite euphoria over the mineral boom and resource prices, Australia’s current account as a percentage of GDP remains a net drain on domestic production. This comes about from chronic current account deficits being funded by overseas borrowing.

Interest and other income payments are netted out to give a net income variable on the current account. Net Income is presented as a positive value to identify the comparative volume of GNP that is required to meet offshore debt payments relative to that which remains for domestic distribution as GDP.  

Chronic current account deficits such as Australia’s require the capital account to subsidise losses on the free trading current account. Prior to free trade being adopted, protective instruments and currency adjustment would have been used to support Australian industry and balance the current account.  

Net subsidisation of losses on the current account is paid for by ordinary Australian’s paying higher interest rates on the monies borrowed. Chronic deficits, such as experienced by Australia, indentify an overvalued exchange rate. Capital inflow is therefore required otherwise the currency value would collapse.

To successfully fund a chronic current account deficit, the RBA must hold Australian interest rates above other comparable official interest rates. A chronic overvalued currency supported by overseas borrowing, identifies monetary policy’s preoccupation with domestic price stability. The negative effect of such discretionary policy indirectly subsidises imports whilst imposing a tax effect upon exports.

An overvalued currency then is anti exports, anti-employment and anti-industry. Any industry debate that does not address monetary policy administered by an unelected and politically unaccountable institution is a debate without substance.

The GFC became the very public failure of neoclassical economics. It is poetic justice that six from the elite G7 Group of nations (UK, USA, Italy, France, Japan, Germany) that have been so influential in maintaining the philosophy post 1976 are now faced with severe domestic dislocation. Token protestations by isolated Australian trade union officials and retailers concerns will achieve little.

To change policy direction, public rejection of political parties must occur when they cannot or will not provide full employment, an equitable distribution of income, and rising living standards in modern economies. In the mean time, political instability is likely to become entrenched as growing numbers of the excluded wield increasing electoral power at the ballot box. It will be interesting to see if notional political protestations by some trade unions and business groups grow a backbone and strongly mount the argument that free trade has reached its used by date.