Markets, trade and human progress

Address to the Centre for Independent Studies

Sydney

Speech, check against delivery

10 March 2011

“We worked hard with you [the United States] during the global economic crisis to resist protectionist pressures. This only built on our decades working together to promote free trade in the world”.

Prime Minister Gillard
Address to the US Congress
9 March 2011

Open markets and human progress

A few short generations ago, the vast majority of our ancestors lived lives of struggle and subsistence. They fought hunger and disease daily — often losing — with their children confronting a bleak future.

Around the middle of the 18th Century, just a few lifetimes ago, life expectancy in England was less than 40 years and in France it was 35 years. Overall life expectancy was dragged down by staggering infant mortality rates: three-quarters of children born in London did not survive to their fifth birthday, most of them struck down by tuberculosis.

At Federation here in Australia, life expectancy was 55 years for males and 58 years for women. A century later it had climbed to 77 for men and 82 for women (though Indigenous Australians have not fared anywhere nearly as well).

What explains the astonishing improvements in human wellbeing in rich countries in such a short time? Greater economic and political freedom, advances in science and technology, and improved institutions and legal systems are all part of a great human success story. But so too is the acceptance of markets as the best way to allocate private resources and of trade between countries as a pathway to prosperity.

Improvements in legal institutions and in the functioning of markets, and the unimaginable progress in technology they have rewarded, can be expressed numerically in a single concept — productivity.

Ideas and inventions of the Enlightenment period, such as those of Isaac Newton, James Watt, David Hume and Adam Smith, powered the Industrial Revolution. Mechanisation and specialisation sharply lifted the average value of output of workers — their labour productivity.

Ideas and the productivity growth they have enabled have been the dominant source of improvements in material living standards over the last two and a half centuries.

While productivity boomed in Europe and North America during the 19th Century, it barely shifted in Asia and Africa, whose populations remained largely engaged in subsistence agriculture. Its superiority in labour productivity made the United States of America the world’s biggest economy during the 20th Century despite a population only a fraction of China’s and India’s.

But both China and India are now travelling along a productivity catch-up curve as they move towards reasserting a dominance of the world economy they enjoyed for many centuries before the Industrial Revolution in Europe and North America. If they were to succeed in catching up to the US productivity frontier, the economies of China and India would each be more than three times larger than that of the United States, owing to their vastly greater working-age populations.

Australia’s position in the global productivity race

Working Australians are 12th most productive in the world, ranking ahead of countries like Denmark, Canada, Switzerland, Japan and New Zealand, but behind others like the United States, France, Germany, Austria and Sweden. There was a time — quite recently — when Australia made great strides towards catching up with United States productivity levels (Figure 1).

Decades of starving the Australian economy of productivity-raising economic reform had led to Australian labour productivity falling by the late 1980s to less than 86 per cent of US productivity. But by the 1990s, the economic reform program initiated by the Hawke Government and built upon by the Keating Government began yielding its anticipated productivity dividends and by the late 1990s Australian labour productivity had reached almost 92 per cent of America’s. Australia was catching up fast.

But to sustain and build on this rapid improvement in such a short space of time a new economic reform program was needed. It didn’t happen. The Coalition Government claimed the fiscal benefits of a housing boom in the early 2000s and a mining boom from around 2004, but those booms masked a dangerous slide in productivity growth.

In 2005, Professor Ross Garnaut was compelled to describe the period from the turn of the century as one of a “Great Complacency,” a period during which the Government and the community, enjoying the wealth-creating effects of two temporary booms, no longer saw the need for ongoing economic reform.

At a conference organised by the Melbourne Institute and The Australian newspaper in 2006, I described the Howard era as a period of “squandered opportunity,” during which the two booms gave the Commonwealth ample revenue to invest in a new round of productivity growth but which, instead, was largely squandered on electorally-appealing handouts. Nowhere is this squandering of opportunity more starkly demonstrated than in Figure 1, which reveals that by 2008 all of the gains made by Australia during the 1990s in catching up to the US productivity frontier had been frittered away. Australia had slumped back to its worst relative performance since the early 1970s (Grattan Institute 2011, p. 17).

Figure 1: Labour productivity: Australia as a proportion of United States 1980-2010

And it wasn’t that the United States was doing well and Australia was doing a little less well; it was that Australia was doing poorly (and the US was doing a little less poorly). Australia’s labour productivity growth averaged 2.1 per cent per annum during the 1990s but fell to only 1.4 per cent per annum during the decade just passed. And multifactor productivity growth, which picks up the effects of technological change, began sliding from around 2000 and has actually been negative since 2006.

These are very disturbing trends, especially since productivity growth accounted for 80 per cent of the growth in the income of Australians over the last 40 years and will have to do most of the heavy lifting over the next 40 years in an ageing population if further increases in living standards are to be achieved. Reserve Bank Governor, Glenn Stevens, has observed that productivity growth remains “the only real basis for optimism about future income” (Stevens 2009, p. 13).

When in government, the Coalition dismissed Australia’s deteriorating productivity performance as the product of a series of one-off factors such as drought, the entry into the workforce of less productive workers as the economy approached full employment, declining oil fields and the impact of mining investments that had not yet yielded increases in mine production. But an analysis conducted by the Grattan Institute confirms that Australia’s productivity slump is widespread and concludes that:

“... it may be dangerously complacent to assume that the decline in productivity growth over the past decade will be ‘automatically’ reversed during the coming decade” (Grattan Institute 2011, p. 22).

Opening Australia’s markets as a cause of productivity growth

It is no coincidence that Australia’s productivity growth was slow during most of the long period of high trade barriers to the late 1980s. Assured by governments of ongoing protection, and higher protective walls if they needed them, Australian businesses did not need to restrain costs or innovate to remain profitable. It was only when the Hawke Government began dismantling those protective walls, opening up the economy to international competition, that cost restraint and innovation became imperatives.

Exposing businesses to global competition is at once both good trade policy and sound domestic economic policy. Openness to trade drives economic reform as Australia’s competitors find new ways of reducing their costs and improving the quality of their offerings by innovating — which obliges Australian companies to match and better them.

Open markets allow international specialisation and gains for countries from producing and exporting goods and services in which they have a comparative advantage. And open markets cause businesses, employees and governments to increase labour productivity — not by working harder but by working smarter. Open markets therefore offer a double dividend for Australians: jobs, income and lower consumer prices from trading, and income-generating productivity growth.

The Productivity Commission has concluded that “the reforms of the latter part of the 1980s and the 1990s” were the “prime candidate” for the “most likely causes of the surge in productivity during the 1990s” (Productivity Commission 2010, p. 62). This conclusion has been supported by the International Monetary Fund, which estimates that the policy of opening up the economy to competition had lifted Australia’s productivity growth rate in the 1990s by 0.5-0.9 of a percentage point (International Monetary Fund 2000, p. 3). Similarly, the OECD has concluded that “increased exposure to international trade ... and product market liberalisation ... contributed to an impressive surge in productivity in the 1990s ...” (OECD 2010, p. 14).

The great Labor program of reshaping the Australian economy from a highly-protected, inward-looking one to an open, competitive economy laid the foundation for the 1990s productivity boom and two decades of sustained economic growth. But as the Coalition Government’s reform effort ebbed away, so did productivity growth.

Open trade is driving a new domestic reform program

While exposure to competition provides strong incentives for businesses to innovate and reduce costs, it also obliges governments to remove unnecessary impediments to business success.
During the period of high Australian trade barriers, heavily-protected Australian businesses sold their products not into a single Australian market but into a set of small, fragmented markets. As governments have gradually lowered protective barriers the Australian economy should have been making the transition to a single national market — a seamless national economy. Yet the Business Council of Australia in 2007 lamented:

“The creeping re-regulation of business and the introduction of policies that are inconsistent and overlapping across jurisdictions are ... examples of how the benefits of past reform can be quietly eroded over time” (Business Council of Australia 2007, p 5).

Business concerns about re-regulation of the economy were well founded: Australia’s ranking by the OECD’s integrated product market regulation indicator slipped from 5th in 2003 to a lowly 13th in 2008, owing to “the rate of reform, relative to comparator countries, having slowed in recent years” (Australian Treasury 2010, p. 4-32).

The Labor Government has responded to business calls to create a seamless national economy by removing unnecessary state business regulation and streamlining unwarranted differences among the states in their regulatory systems. Of the 27 areas of business regulation identified by the Council of Australian Governments (COAG), the reform process has been completed for 13. At its most recent meeting in February 2011, COAG agreed to bring forward the completion date for the entire reform program by six months.

If Australia is to move to a seamless national economy it will need a national school curriculum and a national industrial relations system. Both are being advanced, as is a national ports strategy and a national freight strategy. These are but a few components of the Gillard Government’s productivity-raising economic reform program.

Keeping trade open — resisting new protectionism

As Prime Minister Gillard observed during her address to Congress yesterday, we must continue to resist protectionism, building on decades of promoting free trade in the world.

During the period of market opening by the Hawke and Keating Governments business groups (most notably the predecessor to the Australian Chamber of Commerce and Industry) routinely warned of massive job losses and an inability of Australia to produce anything when confronted by “unfair” low-wage competition. Theirs was a prescription for continuing down the low road of low skills and low wages. The Hawke and Keating Governments rejected the low road and chartered a course for a high-skill, high-wage, open, competitive Australia.

It should be reassuring that business and interest groups nowadays routinely declare they accept the 30-year argument about tariff reductions has been settled. Yet calls on governments to embrace new forms of protectionism under far more respectable guises of protecting the environment are as vociferous as those for old-fashioned protection 30 years ago.

Environmental protectionists argue that rich countries like Australia must block or otherwise restrict imports from poor countries that degrade their environments. Never mind that Australia gained an ongoing competitive advantage over poor agricultural producing countries by wiping out native vegetation on one-third of the continent’s arable land (Beeton et al. 2006, p. 69), handed out water extraction licenses way in excess of ecologically sustainable levels and presided over the extinction of 56 species and the endangering of 181 more (EPBC Act 2011). And never mind that successive Australian national and state governments have subsidised non-native agricultural practices to operate well beyond the ecologically sustainable margins of cultivation.

Any poor country that similarly clears land of native vegetation, dams rivers or extracts water for agricultural purposes is fair game in the world of environmental protectionism. Repressing poor people who strive to break out of poverty is no prescription for a better environment or a better world. An extra 2.2 billion humans will inhabit the earth by 2050, on top of the existing population of 6.9 billion. They will want to be fed and to feed their children. They should not be prevented from doing so by protectionism.

Developed countries have a responsibility to support ecologically sustainable development at home and in the world’s poorest countries. Using rich-country trade restrictions to consign the poor to survival by cutting down trees for firewood and opening up subsistence agricultural plots destroys native forests, reduces carbon sinks and emits greenhouse gases.

But nor should the doctrinaire Right invoke free-trade principles to defend trade in illegally-harvested forest products and in endangered species. Being a free trader does not require the condoning of killing elephants for ivory or the capture and export of orang-utans. Australia should not be obliged to import illegally-harvested rainforest timbers just to prove its free-trade credentials, as argued by some in the doctrinaire Right (Wilson 2010). And free traders should accept that consumer preferences in rich countries can shift in favour of production processes in developing countries that do not rely on child labour or on preventing workers from joining trade unions.

It is perfectly reasonable for trade unions to argue for the inclusion of provisions in trade deals that support freedom of association. But any seeking of bans or restrictions on imports from countries that have lesser industrial relations protection and environmental standards than Australia would be tantamount to banning trade with most of Australia’s trading partners — a prescription for a long and deep Australian depression. It would also deny those very countries the opportunity to gain the wealth needed to rise above the struggle to survive and begin the struggle for the higher goals we can share, like political and economic freedoms and environmental protection. My discussions with the ACTU and leaders of individual unions indicate that in their desire to include labour clauses in trade agreements they are not seeking import bans or other trade restricting measures but a capacity to argue the case for freedom of association if this basic right is breached.

Now that the Australian Government has begun the process of putting a price on carbon, this has given rise to suggestions that tariffs be imposed on imports from countries that do not apply a similar price on carbon. The appropriate way of dealing with any disadvantage facing trade-exposed industries from the application of a carbon price is to use revenue raised from the issuing of permits to provide support for these industries to make the transition to a low-carbon future. Re-introducing tariffs to protect Australian manufacturing from import competition would increase costs for consumers and for all industries using protected manufactured products as inputs into their own production processes.

A practical problem with carbon tariffs (otherwise known as border tax adjustments) is the difficulty of correctly accounting for the various actions being taken around the world to combat climate change. Many countries are acting to reduce emissions — and in substantial ways — but not necessarily through an explicit carbon price. Ambitious mandatory renewable energy standards, enforced closures of coal-fired power assets and large scale government subsidies are just some of the policies being pursued by some of our neighbours. They all add to business costs and impose an effective price on carbon. In May 2011, the Productivity Commission will report on the effective carbon prices that operate in some of these economies. But to perform such an exercise for all our trading partners and for all traded products would be a prohibitively complex administrative task.

The huge administrative cost of assessing the carbon content of overseas production processes would likely mean any tariff would be set according to the level of carbon embedded in an equivalent Australian product, even assuming we could ignore non-price climate change policies overseas. Tariffs designed to ensure local producers are not disadvantaged by their exposure to a carbon price would actually discourage investment in cleaner technologies or production methods, which defeats the whole objective of pricing carbon.

The imposition of tariffs also fails to deal with the situation of exporters who are subject to a carbon price while their competitors overseas are not. Even if tariffs were imposed to ensure import-competing industries did not suffer unfair competition, a different mechanism would be needed for exporters.

There are better ways to ensure domestic industries do not suffer a competitive disadvantage from the imposition of a carbon price. The allocation of free permits to trade exposed industries is a clear example.

Free permits effectively insulate firms from the cost impost of a carbon price while retaining the incentive to reduce carbon emissions. Providing free permits changes the incentive to abate from a negative, cost-minimising one, to a positive profit-maximising one. A free permit is an asset on which the firm will want to maximise its return. If the cost of abatement is lower than the permit value, the firm will choose to abate and sell the permit, pocketing the difference. The allocation of free permits can be used to alleviate competitive disadvantage for exporters as well as for import-competing industries.

The use of tariffs for any purpose opens the door to their misuse. Once a reason for the imposition of tariffs has been legitimised, their abuse becomes a real and tempting possibility. This is especially true for those interests in any economy who see themselves as standing to benefit from reduced international competition. For this reason, legitimising the use of tariffs, especially to deal with a concern that can be better dealt with by other means, imposes an unnecessary and dangerous threat to the open global trading system which underpins our shared prosperity.

Building on the Hawke-Keating legacy

Open markets and trade have enabled the creation of Australia’s modern prosperity — two decades of recession-free economic growth and job creation. Modern Australia owes a great deal to the vision and courage of Bob Hawke and Paul Keating, who saw the enormous possibilities for our country from connecting Australia into the opportunities presented by this, the Asian region in the Asian Century.

An open, competitive economy in an open, competitive world is in the interests of working Australians and the poorest people on earth. As a nation we must not only stay the course set by Hawke and Keating we must press ahead with new economic reforms, putting an end to the “Great Complacency” that beset our country a decade ago and from whose grip we are only beginning to free ourselves.

References

  • Australian Treasury (2010), ‘Statement No. 4: Benefiting from our mineral resources: opportunities, challenges and policy settings’, Budget strategy and outlook, 2010-11 Budget Paper No. 1, Commonwealth of Australia, Canberra, May.
  • Beeton, RJS, KI Buckley, GJ Jones, D Morgan, RE Reichelt and D Trewin (2006), Australia state of the environment 2006, Independent report to the Australian Government Minister for the Environment and Heritage, Department of the Environment and Heritage, Canberra.
  • Business Council of Australia (2007), Policy that counts: reform standards for the 2007 federal election, Melbourne.
  • EPBC Act 2011 (Environment Protection and Biodiversity Conservation Act 1999, List of threatened species), available at: http://www.environment.gov.au/cgi-bin/sprat/public/publicthreatenedlist.pl?wanted=fauna (accessed on 7 March 2011).
  • Eslake, S and Walsh, M, (2011), Australia’s productivity challenge, Grattan Institute, Melbourne.
  • Organisation for Economic Cooperation and Development (2010), Towards a seamless national economy, OECD reviews of regulatory reform: Australia 2010, OECD Paris.
  • Productivity Commission (2010), Annual report 2009-10, Canberra.
  • Salgado, Ranil (2000), ‘Australia: productivity growth and structural reform’, in IMF, Australia — Selected issues and statistical appendix, Country Staff Report 00/24, Washington DC.
  • Stevens, Glenn (2009) ‘Challenges for economic policy’, Address to the Anika Foundation, 27 July.
  • United Nations (2009), World population prospects: the 2008 revision, Department of Economic and Social Affairs, Population Division, New York.
  • Wilson, T (2010), ‘Green protectionist racket incompatible with free trade’, The Australian, 4 October 2010.

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