Living with the market cycle

When he was treasurer Paul Keating famously called the recession of the early 1990s “the recession we had to have” - and he had a point.

Recessions or economic downturns can be unpleasant but they can also serve as a way of getting rid of a lot of bad businesses kept afloat in boom times so that, eventually, the capital and resources used by those businesses can be used elsewhere in the economy to better effect. When Keating made that statement, Australia had a lot of bad businesses resulting from careless lending and capital raising during a major stock market and property boom, and all those bad decisions had to be discharged from the system.

Australian did not deserve this latest, very severe downturn, but unlike the recession of the early 90s this downturn has been used as an excuse to peddle some odd theories about the markets. Commentators on On Line Opinion and elsewhere have blandly asserted that since markets or the free market system have failed, it is time to replace them with something else. One newspaper commentary on the health of former British Prime Minister Margaret Thatcher even asserted that the free markets she championed were “now in ruins”.

With the dust from the initial crash settling, those hopeful pronouncements over the death of markets or capitalism can seen for what they are - nonsense. Markets have to be strongly regulated - the present economic mess is due to the American government’s failure to properly regulate its own financial markets - but as a means of allocating capital and resources they cannot be beaten. The occasional bust is the penalty of working with market systems. A glance at world and recent Australian history shows that markets are not lightly ignored.

Leaving aside the various attempts to make socialist or command economies work satisfactorily, one country which has tried to ignore the markets by using different criteria to make business decisions, is Japan. In the late 1980s Japan was lauded as a financial manager and as a brilliant exporter. Then, just as everyone decided that the Japanese had the key to success, the country’s financial system all but collapsed, a collapse from which it has yet to recover nearly 20 years later.

Economists took another look and realised that the Japanese companies, notably the car companies, exported because they had to. Instead of buying goods Japanese consumers habitually saved their money, because there were no aged pensions at the time or any social safety net. This meant major corporations had to look offshore for customers, and get those customers or go out of business. (This same effect can be seen in Australian companies during the crisis, with recent surveys indicating that businesses reacted to poor local conditions by looking for revenue offshore.)

Outside certain sections of the manufacturing industry, and even in parts of the manufacturing sector, the Japanese economy was and remains grossly inefficient by Western standards. Department stores hired platoons of people whose sole job was to greet customers as they came in the door, decades after doormen had vanished from Australian department stores. Western visitors to Japanese offices were astounded at the number of office workers in companies. This inefficiency was supported by long standing business customs. Certain companies would dominate, say, the fish wholesale trade and share the industry between them, with government departments actively preventing any attempts to upset the status quo.

The vast pool of cheap capital available from frugal Japanese consumers, who at the time were virtually forced to put them in post office accounts with almost no return, also encouraged poor lending practices. Loans were made on the basis of relationships between companies and banks, rather than for commercial reasons. The situation got to the point where most of the exporting which so impressed the West was done for very little profit. The exporters needed the cash to cover the increasing mountain of non-performing loans. Japanese banks start failing at the beginning of the 1990s, and had to be bailed out by the government. But rather than force the banks to write off all the bad loans in one, very painful recession, the government permitted them to keep the loans on the books in the hope that the borrowing business would eventually recover. There were few new loans and a whole generation of stagnation.

Japan has a degree of social cohesion and discipline notably lacking in Australia. Government departments cannot simply pass the word and expect companies to pay any attention, as happens in Japan. So we have been spared some of the egregious nonsense that has plagued the Japanese economy. But Australian governments did have a big hand in the economy, they just did it very differently.

Up until the election of the Hawke-Keating Labor administration in the early 1980s, markets were not permitted to operate in significant portions of the Australian economy. Those who think they have a better alternative to the markets would do well to study the period. The government, business and unions, for example, would routinely collude on what they called sweetheart deals. The unions in, say, the textile industries, would ask for a pay rise and the businesses concerned would say they could not afford it unless they could jack up prices, but they could not do that unless the government agreed to a tariff increase. Rather than face big job losses the government would usually do this, and consumers would pay the bill. This system got to the point where tariffs on imported textile products routinely more than doubled the product’s price.

These heavily protected industries could also be involved in economy-wide webs of cartel operations. Over the years this writer has seen allegations concerning cartels involving recorded music, cardboard boxes and retail ice (the stuff put in bathtubs at parties), to name a few. Then there were innumerable price fixing arrangements where distributors would dictate prices to their retailers. With a few exceptions that form of setting prices is illegal under the Trade Practices Act, and those who want to mess with the markets should ask themselves why it is illegal.

The list goes on. There use to be innumerable state and federal marketing boards fixing the prices of commodities like milk and eggs; as well as state and federal owed enterprises with no competition, a peculiar system of semi-centralised wage fixing and different regulations in each state that inhibited trade. Freight trucks in each state, for example, were subject to quite different regulations which plagued interstate trucking companies.

All of these arrangements resulted in higher prices for the consumers and a great deal of it has been dismantled in the past few decades - a process for which both Labor and Conservative governments can take credit - although some parts remains, such as a form of price control on books. The one market system is even being extended, in part, to New Zealand.

On top of all that the Federal government has now largely abandoned attempts to wring certain results from the markets by offering subsidies and tax concessions. It was found that those efforts mostly did not work or had results quite different from those intended. Tax concessions for Australian films of some years back, for example, achieved little more than the creation of a host of forgotten films, and to permit the already very rich to avoid tax. Concessions for spending on research and development also did little more than generate tax savings for the rich. Again, anyone who wants to seriously advocate different arrangements for getting business done should study those failed efforts.

Further, most of these changes were affected with barely a backward glance or a sigh. The dairy industry grumbled over losing cosy marketing arrangements but adjusted; the retail industry accommodated to the sweeping changes in regulations on trading hours; most of industry switched to enterprise based agreements with considerable grumbling but the old arrangements are now almost forgotten; unions have long abandoned advocating high tariffs.

Australia has in fact shifted wholesale towards free markets, and all of that house cleaning, plus much more effective controls for companies and the financial markets put in place after the recession we had to have, seems to have stood us in very good stead. This economic downturn was not of our making, but it has usefully exposed some weaknesses. With those weaknesses tidied up there is every indication that our economy will brush aside this enormous external shock and keep marching on - albeit with a distinct pause this year - unlike many other Western nations.

One potential issue with the Australian economy is its apparently poor export performance, but perhaps this is much less serious than generally perceived. Look at the example of Japan cited above, and consider China. Poor export performance can be a sign of a successful economy - where success is defined as the economy being geared to the needs of its citizens - rather than a black mark. If the export and import markets are left to themselves they will find their own level. That is the beauty of markets.

After all those decades of labour stripping out all the weeds that were choking the Australian economy, the commentators who are seriously suggesting that we should do something different should make concrete suggestions backed by solid reasons. Better yet, they should get into a time machine and go back to the 1970s, where people might listen.