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).

Even the US, ranked first according to the World Economic Forum’s 2008-09 Global Competitiveness Report, has increasingly relied on debt (even allowing for inadequate regulation).

So if we are to accept freer trade as the best concept for promoting peace and prosperity, we will have to be honest about policy limitations. Thus, we may have to accept tougher times ahead given that it was the developed nations, aided initially by high levels of industry protection or other measures, that have continued to benefit most from much higher levels of per capita wealth, an important advantage in any world committed to common institutions. We cannot expect to promote democracy in developing nations by just hoping that they merely prop up Western societies through the purchase of bonds, as evident most in the US.

So let us look at the policy decisions needed to balance both national and international considerations without abandoning general adherence to freer trade.

First, unless Western nations (including Australia) are prepared to accept budget deficits for some time yet, as growth is unlikely to increase substantially in the near future, then severe cuts to government spending will be needed.

Yet, this does not mean that Australia will ever adhere to some theoretical or philosophical model. Rather, pragmatic policy making will rule the day (as it always has) regarding the promotion of freer trade. Reform will have to occur in a way acceptable to the electorate, as suggested by government intervention in the Australian economy still being 34.5 per cent of GDP in 2006 after being 37.7 per cent in 1991: a reality in line with a slight decline in the OECD average from 41.3 to 40.2 per cent (OECD.StatExtracts).

But with ongoing pressure for Australia to remain attractive to investment, further reform will be needed. In the end, Australia’s ability to meet many economic, social and environmental policy needs will be determined by its ability to promote economic activity and maintain revenue in an increasingly competitive (yet fairer) world.

Of course, this task may be complicated by the ongoing need for taxation reform to enhance investment, although Australian governments have done their best to keep taxation receipts as high as possible, despite the need to remain competitive in international terms in line with Australia’s circumstances. This is why both Labor and Coalition governments adopted appropriate reform to ensure that taxation revenue remained similar as a proportion of GDP as evident by lower income and company taxation rates being accompanied by the introduction of the fringe benefits tax, capital gains tax, and the GST.

Sure there is a possibility that taxation rates can be lowered further by targeting tax deductions associated with company and family trusts which enables split incomes between family members, negative gearing benefits for those who purchase investment properties or shares, salary packages, putting wages in names of low-income earning spouses, or deferring tax from capital gains held longer than a year.

But any reform must not merely favour the wealthy who have benefited most from reform in recent decades. If we are to have across the board tax cuts, given the need to attract investment, reform should be offset by appropriate measures in other policy areas. For instance, while removing taxation from all superannuation payouts makes some sense to boost savings, should the rich be completely excluded from some tax given that someone with a payout of $650,000 in 2006 gained about $200 a week whereas those with an average payout (about $168,000) gained little given that the first $130,000 was already tax-free.

And if deficit spending is to be used to offset the decline of the private sector (as is occurring now), it must also address the productive capacity of the nation rather than merely boosting consumption with temporary handouts. The faster that significant resources are directed to important infrastructure needs, such as transport and water, the faster will be Australia’s ability to potentially benefit from a growing international economy which will long need mineral and agricultural products. Infrastructure spending may also include greater public transport spending, including a fast train between Sydney and Melbourne, which happens to be one of the busiest airline corridors in the world.

Any desire for free trade deals must also pay adequate attention to the Australian interest, as hopefully will be upheld by the Rudd Labor Government’s response to China’s current bid to own Australian mining operations. As indicated by 2005 efforts by the Howard government, there is need for measures to protect Australian firms from being obliterated by cheap Chinese imports including tough “anti-dumping” rules (Steve Lewis, The Australian, February 14, 2005), and a need for agriculture to be included in free trade deal with China (Katharine Murphy, The Australian, March 8, 2005).

And in regards to manufacturing, some assistance will always be necessary. Quite simply, Australia and other Western nations will never be able to compete in any type of manufacturing should China and India or other developing nations be given full access to Western markets. With wages always a factor, it is worth noting that the average profit margin for Chinese domestic LCD TV makers was as low as 2.3 per cent in 2007, compared with the electronic industry's overall profit of 3.5 per cent (Shanghai Daily, October 8, 2007).

Australia’s social welfare system, which increased under the Howard government from $56 billion in 1994-95 to $82 billion in 2004-05 (Steve Lewis, Herald Sun, November 14, 2008), may also need to be modified through tougher means-testing if lower budgetary revenue becomes the norm. For instance, the Medicare safety net introduced by the Howard government in 2005 clearly favoured rich areas given that such families have the resources to throw at such services: 9 of the top 10 benefiting electorates were blue-ribbon Liberal seats (Patricia Karvelas, The Australian, March 10, 2006).

In the end, the demands of the international economy will probably mean tougher times ahead, a reality that may well complicate the ability of any nation to meet all of its economic, social and environmental needs, although I hope that Western nations (including Australia) will lead the way with sophisticated policy mixes despite present economic concerns.

I have offered a perspective that is hopeful, but one which recognises that the struggle to balance compassion and competitiveness is inevitably linked to freer trade which still does offer the best potential for nations to address both national and international economic considerations, although I will never dare to suggest that such a concept is perfect. Time will tell if freer trade or greater protectionism wins the day in coming years as Western governments (including Australia) continue their struggle for a pragmatic policy mix.