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Stiffer doses of the same failed medicine?

By Frank Stilwell - posted Friday, 30 June 2000

The current economic conditions are the most troublesome since the start of the 1990s. Inflation is sure to surge with the introduction of the GST: the fine print in the Federal budget showed an expected impact double what the Treasurer had earlier forecast, while the latest survey of small-business intentions indicates an even bigger surge. The plunging value of the dollar has added further pressure because of the higher prices of imported goods. Interest rates have been pushed up, with the prospect of adverse impacts on the level of productive investment in housing and Australian industry.

This is a context in which a fundamental re-evaluation of economic policy is needed. The assumption of prosperity coming from continued economic growth generated by the private sector in an inflation-free environment is no longer tenable. Indeed, the spectre of recession is, or should be, becoming increasingly of concern.

Reliance on monetary policy is inappropriate in these circumstances. It is like trying to "fine tune" the economy with a heavy blunt instrument. Should interest rate policy be driven by booming economies like Sydney, currently experiencing the Olympics surge, or by depressed rural regions needing a lower cost of capital?


Deciding how to balance domestic economic considerations with international interest-rate trends is similarly perplexing. Proponents of higher interest rates argue that matching the movements in US rates is necessary to remain attractive, as a nation, for capital inflow. However, in the long term, this would likely lead to more outflows of dividends and interest payments, worsening the current account deficit. The major component in the current account deficit is not merchandise trade, but "income payable", mainly comprising the outflows of interest and dividends. This is the consequence of previous capital inflows, leading to the debt structure that causes most of the deficit on the current account. To the extent that the capital account drives the current account, and not vice versa, higher interest rates thereby increase the balance of payments problem in the longer term.

In any case, much of the capital inflow is of a speculative character, contributing little to the nation’s productivity. The more sensible strategy is to concentrate on the mobilisation of savings for productive investment in industry. The superannuation funds are an obvious target for any such national investment strategy but this requires a co-ordinated approach quite incompatible with the prevailing neo-liberal economic ideologies.

A coherent program for industry and regional development also needs to foster more economic diversification, reducing the dependence on imported goods and services. It is that dependence on imports that makes the inflation rate vulnerable to the falling value of the dollar. Meanwhile, the lower dollar value enhances some export sales, but long run export success depends more on the reputation of Australian goods in world markets. That requires a more coherent industry and trade strategy. Industry policy could be used, for example, to build the nation’s capacity and reputation for products geared towards ecologically sustainable development, drawing on the pioneering work done by our solar-energy scientists among others. That sort of strategic focus for industry policy would position the nation effectively for trade with countries starting to recognise the imperative of economic restructuring to meet environmental targets. But it won’t happen spontaneously on a "level playing field".

What is at issue here is fundamental differences of economic policy stance. The current approach leaves us vulnerable to the vicissitudes of international finance, with interest rate policy as the main response. But the use of that policy instrument can do more harm than good. Indeed, the prospect of it driving the economy into a stagflationary period cannot be discounted. Raised interest rates tend to fuel inflationary processes by increasing the cost of capital: they only work to dampen inflation to the extent that they undermine effective demand for goods and services. Let us be blunt about what that means - rising unemployment and falling incomes, except for money-lenders and speculators. It is an awesome prospect, showing the ultimate futility of the neo-liberal project.

The failure to embrace a more comprehensive strategy for industry, trade and regional development and, more generally, to develop an economic system that serves social needs, lies at the root of the problem. Interest rate policy can provide no solution. Its central place in the current policy process is symptomatic of the demise of economic intelligence.

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About the Author

Frank Stilwell is Professor of Political Economy at the University of Sydney. He is the coordinating editor of the Journal of Australian Political Economy. He is the author of eleven books and co-editor of four others. His new book, co-authored with Kirrily Jordan and just published by Cambridge Universty Press, is called Who Gets What? Analysing Economic Inequality in Australia.

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