Can Australia make the most of the Asian Century?
The following speech was delivered by NAB Chairman, Dr Ken Henry at the Australian Institute of International Affairs in NSW on 30 August 2016. (Check against delivery).
A generation’s worth of unbroken economic growth. That is Australia’s boast.
There may be people here today who have never experienced a recession. People who have never had to confront the awful prospect of falling out of work and never having the opportunity of earning anther dollar in their lives. That is something to be celebrated. But has past success set us up for future failure? Has it made us complacent?
Do we understand the reasons for past success? Do we have any memory of the policy effort that was required to build an economy capable of generating 25 years of unbroken growth? Have we retained the capability to identify national challenges and opportunities, and to develop strategies to make the most of them? Do we even care?
If we were to judge by the quality of what we tolerate in policy debate in Australia today, we would have to answer these questions in the negative.
The recent global financial crisis should have served as a national wake-up call, but instead it appears to have encouraged an attitude of Australian invincibility. It should have reminded all Australians of the fragility of our financial linkages to the rest of the world – linkages that have been critical to Australian prosperity.
We take these linkages for granted, even as we observe continuing financial fragility and growing protectionist sentiment almost everywhere we look. Three things, in particular, provide compelling evidence that we have learned the wrong lesson from the crisis:
First, an inability to repair the fiscal position of the Commonwealth, putting at risk the AAA credit rating that underwrote much of what we were able to do in 2008 to protect the Australian economy.
Second, an increasingly fearful attitude to various foreign investment proposals, which is putting at risk our ability to join regional partnerships.
And third, a populist infatuation with the profitability of the larger domestic banks, putting at risk the robustness of the very institutions we rely on to provide dependable channels to global debt markets – funding that provides reliable financial support for homeowners, investors and businesses.
A country bogged in these populist quagmires cannot possibly have a sufficient understanding of the reasons for past success. It can’t possibly have any memory of the policy efforts of the 1980s and 1990s that underwrote 25 years of economic growth. And it can’t possibly be capable of developing strategies that would make the most of contemporary challenges and opportunities.
We are not invincible. To the contrary, our economic prosperity is at greater risk now than at any time in my working life.
HOW DID WE GET HERE?
A couple of months ago, a majority of those who turned out to vote in a UK plebiscite determined that it would be better if their country were no longer a member of the European Union.
According to various political commentators, the vote reflected a protest from ageing conservatives, who resent being told by foreigners – in this case, people in Brussels – what they can and cannot do, and a protest vote by others who feel that they have been taken for granted or simply ignored by their politicians.
Similar frustrations might explain Donald Trump’s emergence as the US Republican Party’s presidential nominee. And they might also explain, at least to some extent, why a significant proportion of the Australian population voted for minor parties in our recent election.
There are serious issues here. Globalisation has not been of equal benefit to all. And not everybody has the same political voice. As political debate has decayed to populism, most Australians would have good reason to believe they have been treated cynically.
Perhaps more importantly, virtually all industrialised countries have experienced significantly slower aggregate income growth in the last decade relative to the decade that preceded it. And there is an emerging consensus that this lower growth has been shared much less equally, with most of the gains accruing to the wealthiest citizens.
We should not be surprised that the vast majority, having been disappointed by economic outcomes, in a world that they observe to be globalising at an unprecedented pace, might conclude that globalisation is the problem.
And yet, the lesson of history is that a retreat from globalisation would be far more damaging to living standards, especially those of the less well-off, than anything that might properly be ascribed to post war internationalising forces. Thus, while I have read numerous reports that blame globalisation for the recent global financial crisis, that crisis, like the Great Depression 80 years earlier, provides a graphic illustration of what happens when globalisation shifts into reverse gear.
The global financial crisis was a consequence of an extreme retreat to nationalism, with financial intermediaries and regulators unprepared to trust anybody beyond their sovereign borders. What caused the lack of trust was not globalisation either. Rather, it was a set of domestic policy failures in several systemically important developed economies in the northern hemisphere.
The global financial crisis illustrates what can go wrong when national policy makers and regulators fail to meet the rigorous demands of globalisation. The importance of matching policy and regulation to the demands of globalisation is something we learned in the 1980s. And this is the thing that we seem now to have forgotten.
WHERE DO WE NEED TO BE?
Throughout its history, Australia has benefited greatly from its generally internationalist orientation, across economic, financial, social and inter-governmental dimensions.
With the right domestic policy choices, we will continue to benefit from being an open economy. Right now, the challenges is to make the most of the opportunities presented by the Asian century. The potential benefits for Australians are enormous, across an extensive set of commercial, social and cultural activity.
But in respect of domestic policy capability, we are some distance from the place we need to be. In that place, political activity would be predictable, with policy based on sound theory and robust evidence. It would, therefore, be a place in which government policy avoided short-termism and had no taste for protecting vested interest; a place in which government had the intellectual capacity and political courage to articulate a compelling vision of what could be, the challenges and opportunities confronting us, the strategies that would best meet those challenges and opportunities, and the investments in capabilities, systems and processes required to ensure successful implementation of those strategies.
HOW DO WE BRIDGE THE GAP?
History tells us that there is no substitute for political leadership. And the most important attribute of political leadership is communication that provides positive motivation. The world’s politicians understand this, of course, but they don’t seem to be able to put this understanding into practice. Political discourse, in many countries is, instead, constructed on platforms of fear and anger. But that is the antithesis of what is required. What we need is political leadership capable of constructing a compelling narrative that contains a realistic assessment of present circumstances, articulates an attractive vision of what could be, and explains the strategies that will best secure that vision.
Australia has no such narrative today. But there was a time when it did. And it’s not that long ago.
REFORM SUCCESS OF THE 1980S AND 1990S
Australia’s modern economic reform program was motivated by a particular set of challenges confronting it as it emerged from the deep recession of the early 1980s.
Late in 1983, the Australian dollar was floated and capital controls were abolished. By the middle of 1985, the currency had depreciated nearly 20 per cent in trade-weighted terms. Over the following years it continued to depreciate, losing in three years more than a quarter of its value.
A lower Australian dollar should have provided a boost to Australia’s international competitiveness, yet this was eroded by increases in nominal unit labour costs of about 10 per cent a year.
To ensure nominal currency depreciations became real depreciations, our centralised wage system (characterised by wage indexation) needed to be abolished and Australia’s product markets be made more competitive.
At the core of the reform narrative of the early 1980s was the proposition that workers would be made better off, in due course, if they accepted the short-term sacrifice of lower real wages and large-scale structural adjustment.
It was in their interests to have real wages fall. It was in their interests that labour productivity improve substantially.
It was in their interests that tariffs were reduced, and that they get ‘match-fit’ for international competition.
And it was in Australia’s interests that we recognised we were part of the Asian region, not a country on its periphery.
While the reforms of the 1980s and 1990s were focused on economic objectives, their articulation formed part of a much broader narrative about where and how Australia might find its place in the world.
Other countries were asking similar questions at the same time, together riding a wave of globalisation.
Crucially, the 1980s reform narrative was developed by a government that insisted on taking ownership of the nation’s challenges. It is also important that the core internationalising elements of the narrative were embraced by its successor; as were the core pieces of the economic policy architecture, including an independent central bank with a clear mandate, a credible medium-term fiscal strategy to balance the budget over the economic cycle, strong competition policy, effective corporate regulation and so on. And in some dimensions, it was a narrative that built on courageous decisions of other Australian governments, at earlier times in the post-war period.
Nearly 60 years ago, the tenacity of Sir John McEwen and others saw the conclusion of the landmark Commerce Agreement with Japan.
Reflecting in 1997 on the 40th Anniversary of the Agreement, Minister for Trade in the Howard Government, Tim Fischer, said: “Those who negotiated and supported it recognised that the long term national interests of Australia and Japan were moving closer together…. It was a formal recognition that our future was tied to our region.”
Visiting Australia soon after the agreement was concluded, then Japanese Prime Minister Kishi, who had been a member of Cabinet during World War II, described it as the first sign that “Australia had awakened its Asia-mindedness”.
In fact, the economic dimensions of Australia’s internationalisation have long had a strong Asian element. This has been less true of the social and cultural dimensions, though that too is changing.
The transformation of Asia this century is comparable to what occurred in Japan during the extraordinary periods of growth in the 1950s and 60s.
Only this time it isn’t just happening in one country, it’s happening across an entire region.
And its pace and scale is truly staggering.
Consider this: during the Industrial Revolution, it took Britain 50 years to double its per capita income.
China and India – like Japan, South Korea and Singapore before – both doubled their per capita income within a decade. And have then gone on to repeat that doubling several times over.
In the past 30 years, China’s GDP per capita has grown about 20-fold. In the past 20 years, China and India have almost tripled their share of the global economy.
Today, around 40 per cent of global economic activity is occurring in Asia and world growth continues to be led by Asia, despite recent slowing in China.
These are staggering achievements, and not only in economic terms.
They have lifted tens of millions of people out of poverty.
By the end of the first decade of this 21st century, there were already 500 million middle class people in Asia. By the end of this decade, that’s expected to rise to 1.7 billion people, and by the end of the next to more than 3 billion.
Billions more people with a better quality of life. With higher incomes, improved education and health care and, for the most part, more choices about the direction their lives take.
Asia’s emergence has been driven by internationalising changes to its own policy frameworks, just as the relative decline of many Asian economies through to the middle of the 20th century was a result of insular policies.
The steel intensity of Chinese development has had a profound impact on the Australian economy. I don’t need to spend any time today detailing the dimensions of that impact. But I will say this. If we consider how far the Asian giants of China and India have come, and how much further they will have to travel in order to attain developed world income levels, it would be reasonable to conclude that the shocks we have experienced to date will, in due course, be seen as relatively small. Even today, Chinese GDP per capita is only about one-fifth of that of the United States; India an even smaller fraction. Perhaps these countries will never reach developed world status. Perhaps they will find themselves caught in a middle-income trap. Perhaps. But it would be foolish to base our strategic thinking on that assumption.
This is what motivated the development, a few years ago, of the White Paper on Australia in the Asian century. That document will be familiar to this audience, despite it having been deemed politically incorrect. I won’t repeat its findings. Instead, I will offer some remarks about three matters that featured strongly then but which appear to confound policy making today: (1) supporting the development of Asia-relevant capabilities; (2) developing a rational, consistent attitude to foreign direct investment, especially from China; and (3) understanding Australia’s particular sources of international competitiveness in the Asian century.
- Developing Asia-relevant capabilities
In leading the extensive consultations that contributed to the development to the White Paper, I heard often the need for Australians to possess what we labelled ‘Asia-relevant capabilities’.
Things like understanding the way business is done in Asian countries, having the appropriate cultural understanding to operate in different nations and, not least, for a smaller set of people, the language skills that enable us to negotiate and develop personal relationships in languages other than English.
Asia-relevant capabilities is shorthand for the skills Australians will need now, and in the future, if we’re to prosper as economic power continues to shift to the Asian region.
In the years since the White Paper was launched, I have become even more convinced that securing prosperity in the Asian century demands an intense focus, by policy makers and business, on an important set of Australian capabilities.
- Foreign direct investment
In the past 200 years, we have benefited from several ‘waves’ of foreign investment, first from Europe, which helped build the Australian agricultural sector, then from the United States, and more recently from our neighbours in Asia. Every one of those ‘waves’ has been controversial.
I wonder how many of the people presently agitated about emergent Chinese foreign investment in Australia would be aware that the Foreign Investment Review Board was established in the mid-1970s as a result of concerns about investment from the United States.
How many would be aware that, even today, the United States remains our largest foreign investor, with the US and the UK, together, accounting for nearly half of the stock of foreign investments in Australia?
How many would be aware that China, by contrast, accounts for less than 2.5%?
Our reliance on foreign direct investment has a straightforward explanation. Australia has a high rate of investment; that is, investment in physical capital relative to output. In the decade to 2010, it averaged 27 per cent of GDP, peaking at 29.2% in June 2008. But our national saving rate (national saving as a proportion of output) has not been high enough to finance all of our investment. Thus, we are a current account deficit country, reliant upon funding from offshore.
That funding will generally come from countries unable to offer equally attractive investment opportunities; countries in which national saving exceeds national investment. Some of the funding will enter Australia as debt, some as portfolio equity and some as foreign direct investment.
Historically, foreign direct investment has supported a relatively high rate of economic growth, created employment opportunities, improved consumer choice and, in some cases, promoted healthy domestic competition.
Foreign direct investment has characteristics that distinguish it from portfolio equity and debt. It has the character of a ‘partnership in development’.
The question is whether Australia can make the most of the new partnership opportunity presented by China.
The commercial attraction of large and rapidly expanding Chinese markets for Australian producers is obvious; across multiple activities, including high value food and wine, tourism, education, logistics, infrastructure, natural resource management, banking and finance, professional services, science and technology.
But it is not reasonable to expect that Australian businesses will capture new Chinese markets without being supported by the personal relationships, commercial links, and especially the funding, that Chinese investment in Australia can provide.
- Sources of Competitiveness in the Asian century
In the development of the White Paper, I heard many times that many of the skills and qualities Australians bring to the table are valued highly by our regional neighbours. Our creativity, independence and initiative are just some of the skills and qualities that are valued.
In the early 1990s, as Australian tariffs were being cut and the ‘Asian tigers’ to our north were developing rapidly, it was common to hear Australian business people say that their international competitiveness was being damaged by the costs to business of a set of Australian attributes developed over generations: A preoccupation with governance, incorruptibility and respect for the rule of law; the separation of powers; safe working conditions; and institutions that support social harmony, economic and social opportunity, and tolerance.
Today, every one of these attributes constitutes a potential source of competitive advantage, not disadvantage.
Understanding why that is the case requires some rethinking of the notion of competitiveness.
To succeed in the years ahead, we don’t need to compete by trading off our wages and working conditions, or by supplying lower quality products.
Ultimately, our international ‘competitiveness’ and the pattern of our economic integration with the Asian region, will be determined by our particular set of national endowments, natural and created.
Our natural assets include things like clean water, an abundance of mineral and energy resources, healthy ecosystems and productive soils. All of these are at risk because of unsustainable practices. That has to change. Our future depends on it.
While there are many reasons why we should protect our natural capital, here is one that should resonate. Our international produce brand, for our farmers, is tied to the quality of our natural assets.
Buyers want to know that their seafood was farmed in the cleanest of waters; that their berries were grown in Tasmania; or that their Wagyu beef came from South Australia. They want provenance and they will pay for quality.
That is international competitiveness in the Asian century.
Our people constitute a further source of competitive advantage. In 2015, the ABS estimated that 28.2% of the population (6.7 million people) were born overseas, an increase of nearly two million people compared to 2005.
In the past few years, there has been a significant shift in the source countries from which people are migrating permanently to Australia. Just a few years ago, China overtook the United Kingdom as the principal source country. The very next year, India took top place surpassing both China and the United Kingdom.
Where Italian and Greek were the second languages heard on suburban streets in the post-World War II era, Mandarin and Cantonese and, increasingly, Punjabi, are the second languages on Australian streets in the Asian century.
Migrants from Asia don’t just bring cultural and social diversity to Australia; though they certainly do that. Their knowledge of Asia, cultural and historical understanding, and language skills, also provide valuable skills for employers to harness in the Asian century.
And it is important also to understand the contribution to international competitiveness that has been made by foundational investments, over several generations, in strong legal and government institutions; public infrastructure such as our schools and hospitals; and the universities and business that support innovation and research.
TOWARDS A BETTER PLACE
I talked earlier of the need to bridge the gap between where we are now, bogged in the dysfunctional politics of fear and blame shifting, and the place we should aspire to be.
That would have Australia as the ideal place to do business, providing access to labour with the right skills, and to deep and liquid capital markets that are sophisticated and robust.
To those developing regional and global value chains, Australia would offer world-class partners, with a sophisticated understanding of Asian languages, cultures and institutions.
It would offer its people a high quality education, and rewarding jobs and careers.
It would encourage intellectual development and reward science, innovation and effort.
This vision has to be part of the contemporary narrative. Here is another bit of the narrative: If we want to make the most of the Asian century, we can’t think of ourselves as standing apart from Asia, selling product and services into it.
Rather, Australia will be most successful through deep and seamless integration with our neighbours; through collaboration, partnerships and seeking out ways of complementing one another’s strengths.
And here’s a third bit of the narrative. It is the most important. It concerns the need to focus on building capability in all citizens, so that all Australians have the opportunity to choose a life of value. This set of capabilities includes political voice; freedom from bigotry; a well resourced and respected public service; an accessible judicial system; independent, apolitical media; education systems that attract students to pathways to knowledge; affordable heath services and housing; programs that support structural adjustment; and science and innovation systems that support creativity and the commercialisation of ideas. And right now, it means also building in all Australians a set of Asia-relevant capabilities.
I want to emphasise that this focus on individual capability building is not a footnote to the narrative. It must be at its core.
In the 1980s we developed a highly successful Australian model of globalisation. It matched the removal of external barriers to trade and investment with domestic policy discipline and a determination to build capability in those who might otherwise have been disadvantaged by free markets.
This model has not been lost. But we do seem to have forgotten how to use it.