John Howard's bottom line

On January 13, 2005, "in welcoming the latest job figures as further proof of economic vitality," the Australian Prime Minister said:

We had strong growth in the late 1960s, but at that time our economy was very heavily protected. It wasn't much of an advertisement for a market economy. But if you fast-forward to the early part of the 21st century, you find that so much of that has changed. We have a floating exchange rate, we have negligible levels of tariff protection, we have reformed our taxation system, we have a far more open industrial relations system, and I hope that in a few months' time we will have an even more open industrial relations system.

This is a fascinating statement in so far as it provides evidence of the superficiality with which our political masters - not only in Australia but elsewhere - treat our economic situation and interpret our history. There is a great deal that is political spin - to demonstrate what a great job the current government is doing. However, there is, above all, a great deal of ignorance of the past and of the dynamics of the current economy.

The prime minister is correct in saying that Australia "had strong growth in the late 1960s". Indeed, that growth was so remarkable as to be unprecedented. The unemployment rate was not much more than one per cent - and sometimes less. The savings rate was comfortably able to sustain a high level of real, fixed-capital investment from domestic sources. In those years, we supplied upwards of 90 per cent of our own capital needs with about 10 per cent coming from overseas; debt was tiny to non-existent. Consumer debt was, in any quantity, yet to come. The inflation rate ranged between one and under three per cent, until the government, from 1969 onwards, began raising interest rates and applying fiscal policies to "slow the economy".

During the decade of the 1960s, if real private investment was high, so also was public investment, especially from 1965 onwards. Investment in education, health, transport and communications and virtually every other form of public spending doubled and then began to double again, all in the space of three or four years.

Prime Minister Howard says, "It wasn't much of an advertisement for a market economy". In some ways, that is indeed true, but in the sense opposite to that which Howard intended. Rather was the economy so strong that it provides solid evidence justifying a return from today's "market economy" to the "mixed economy" that we had in the 1960s.

In that mixed economy, the government acknowledged and lived up to its economic and social responsibilities. It did not abdicate its responsibilities to "the market". It participated actively in the economy through government-owned banks, transport systems and the like, and it attended to the economy's infrastructure requirements in ways that were wise and far-sighted. That it was a market economy was undoubted: but it did not allow the market wholly to dominate the society; it did not confer unmitigated authority on "the bottom line"; and it did not encourage massive speculation through bubbles in real estate, on the stock exchange or, most particularly, through free-floating currencies.

Mr Howard appears to take pride in the fact that now, "We have a floating exchange rate, we have negligible levels of tariff protection".

We must wonder whether he has the faintest idea of the dynamics of trade and the ways in which "free-floating exchange rates" and "tariff protection" are related. In the 1960s, Australia did tend to have higher tariffs than we have now. Mainstream economists tend to assume that tariffs both protect domestic industry and make domestic industry uncompetitive in world markets.

However, there is a curious contradiction of this theory in Australia's export performance in 1965 on the one hand and 2005 on the other. In 1965, we were exporting substantial numbers of Australian-made Holden cars and vans to, for example, South-East Asia and Nigeria. In 1966, the Nigerian government made changes to their tariffs on cars, based on engine capacity. The Holdens would have incurred higher import duties so, as high commissioner, I was instructed to make representations to ensure that we retained what was a useful market. My representations were successful and we continued to export Holdens to West Africa - until, by our own policies, we destroyed our market in so many things in so many places.

Holdens weren't the only Australian item of manufacture that we exported to West Africa then. The Kingsway Stores and other retail outlets offered a whole range of Australian clothes and textiles, confectionery, pharmaceutical products, patent medicines, and so on.

All of that stopped long ago, and the more we lowered our tariffs, the more rapidly our markets were lost. If we gained in competitive strength, it was not reflected in the size and diversity of our export markets. That is a part of the history of our export trade, of which our present prime minister seems completely unaware.

When the United States ended the dollar's connection with gold and the IMF collapsed as a regulator of stable exchange rates in 1971, we entered upon the era of what the prime minister calls "free-floating exchange rates". It was a momentous step.

In December 1972, the brand-new Whitlam Government appreciated the Australian dollar to near parity with the US dollar. It has been a bumpy ride since.

This is not the place to describe all the ups and downs of the Australian dollar against a variety of the world's major currencies. However, it can fairly be said that there have not been many periods of any great length that have seen "stability" in the value of the Australian or most other currencies.

Against the US dollar, the Australian dollar has experienced a low of just US$0.50 - even a little below for a while. In what the prime minister calls "the early part of the 21st century", it has recovered to a large extent against the American currency - at one time to US$0.80 and at the present moment, to around US$0.76. Those are formidable swings.

Against European currencies, the volatility has been even greater. To take the fairly typical example of the Austrian schilling, the Australian dollar was at one time, in the 1970s and 1980s, worth about 25 schillings. Later, over the years, it slipped way down to below 7 schillings and, against the Euro, its value was not a great deal higher. However, just in the last few weeks, the Australian dollar has moved up in value from €0.59 to more than €0.63 and is likely to go still higher. That is an appreciation of around 7 per cent, with probably more to come.

These large and frequent, indeed never-ending changes in exchange rates cannot fail to have an impact on trade flows and, even more important, on speculative capital flows. Indeed, the latter are not really capital flows at all, but simply waves of cash changing its identity as it seeks a more profitable and very temporary haven. These days almost all money is "hot." The days when "hot" was a rare exception to "cold" money have long since gone.

During the last several months especially, there has been a keen international debate about the value of the Chinese yuan-renminbi and its peg to the US dollar. Some other Asian currencies are also believed, with substantial justification, to be undervalued. The thinking is of course that a revaluation upwards of the Chinese and several other Asian currencies will improve the balance of trade by protecting domestic industry in the United States and elsewhere and improving the deficit countries' competitive position in export markets.

The extent to which this will happen, given especially the destruction of the manufacturing sector, is uncertain; but what is certain is that the protection - or not - provided by currency movements actually or potentially dwarfs that customarily conferred by tariff barriers.

It is in this context that we must view the WTO. In relatively stable growth situations, with relatively stable exchange rates, tariffs will provide all that is needed to manage a modest regulation of trade. However, when currencies fluctuate wildly, under free-floating currency arrangements, tariffs lose much of their relevance.

The lively and persistent volatility of exchange rates over recent years has inevitably led to financial speculation on a massive scale. That has meant that exchange rates and, to an important extent, interest rates are determined more by financial speculation than by the underlying strength or weakness of individual, real national economies.

The Australian prime minister applauds the changes that have taken place; but there are dangers in what is inherently an unstable, highly speculative world economy. The bursting of any of a whole array of bubbles could set off a world financial and economic crisis of unprecedented dimensions.

Mr Howard says, "We have reformed our taxation system, we have a far more open industrial relations system", but even these features of our current society carry risks. The taxation system now bears relatively much more heavily on the poorer and middle classes and much less on the wealthier and higher-income groups. The financial rewards going to the latter are now too frequently obscene and those groups make too small a contribution to the society from which they derive their income and wealth.

In addition, the "far more open industrial relations system" has severely diminished the strength and authority of the trade unions and of others, including political institutions that have traditionally given comfort to the "lower orders". An argument can be adduced that the trade unions, despite their propensity to err, were a built-in insurance for peaceful change by steady evolution in the Anglo-Saxon and some other countries, rather than through violence and revolution. That was the case until the later decades of the 20th century.

With the decline of the unions and other support institutions for the lower-income and less privileged, the society is likely to be less secure and much less predictable, when - rather than if - a major collapse of the financial system and with it the general economy occurs.

Australian Prime Minister John Howard shows no awareness of any such "bottom line". He sees only blue skies above as far as his complacent vision can see.