Category: Economy

As both John Menadue and Ian McAuley have argued in recent posts there are good social reasons for governments to intervene to modify the outcomes from a purely capitalist economy. Right now rising inequality and taxation avoidance by companies and wealthy people are priority issues that should be addressed. It is also possible that the impact on the government budget from increasing inequality could have a negative impact on future economic growth.

I think, however, it is going a step too far to suggest that capitalism is leading to low wages which then result in a shortage of demand, and that this is the reason for the failure of business investment and economic growth to pick-up, especially in the US.

The fact is that currently – and indeed for decades – US domestic investment has been greater than US savings. The difference between the two is identically equal to the US current account deficit, which amounted to as much as 6 per cent of GDP immediately prior to the GFC, and is still running at around 2 ½ per cent of GDP notwithstanding generally sluggish domestic demand and a significant depreciation of the US dollar.  So the US is not short of demand in aggregate, although some might prefer a different pattern of that demand. Instead it is arguable the US needs to reduce its reliance on other people’s savings. Indeed with China holding around 40 per cent of US government debt, this is hardly the basis for an independent foreign policy and maintaining US supremacy in the Asia-Pacific region.

But what is required to restore a better balance between investment and savings in the US, and also in many other capitalist economies which are relying on the savings of foreigners?

One view, most prominently promulgated by Larry Summers, a former Secretary of the US Treasury, is that there is an excess supply of savings in the world.  Accordingly action needs to be taken to reduce the global savings rate, even if that is not true for many rich capitalist countries.

To the extent that excess global savings are a problem, the principal country responsible is China. Furthermore, China has been over-investing and many of its domestic investments are under-utilised. But if investment in China is more closely related to demand in future, potentially there could be even more flows of Chinese savings to the US and elsewhere.  Interestingly China agrees, to at least some extent, and its economic strategy envisages increasing consumption and lowering both investment and particularly savings. So effectively there is a measure of international agreement that the present global economic imbalances are not because capitalism has been paying wages that are too low, but rather because communism has been doing this.

The question then is what consequences would flow from a better global balance between savings and investment. In the US the reduction of the current account deficit would require some combination of a real exchange rate depreciation and increased savings. Both of these changes would reduce US consumption but this reduction could be more than offset by increased foreign demand and less reliance on imports, so that economic growth would be likely to pick up. But returning to our starting point, an increase in US wages and consumption is not the way to restore the health of the US economy.

For those of us who favour a more equal distribution of income an increase in minimum wages may well have a role in the US, where the minimum wage is very low, but only if it leads to an improvement in the relative wages of low paid people, and not an across-the-board increase in wages generally. A more lasting solution is to improve the skills of people on the margin of employment so that they can obtain the jobs of the future. It is in this respect that capitalism is too often at fault and risks being unsustainable unless it is prepared to make greater efforts to train people, and to train them not just for today’s jobs but also so that they can move easily to tomorrow’s jobs.

Michael Keating was formerly Secretary of the Department of Finance, and Secretary of the Department of Prime Minister and Cabinet.

In the SMH today (27 November 2014), Michael West has a very interesting story about the leaners and lifters in the business community and the unfairness of tax avoidance by some companies. It clearly works to the disadvantage of many Australian companies who are paying fair rates of taxation. For the link to this story, see below.  John Menadue

http://www.smh.com.au/business/comment-and-analysis/leadership-needed-on-tax-fairness-in-australia-20141126-11ukw2.html

In his challenging series last week on ‘Is capitalism redeemable’ Ian McAuley drew attention to how growing inequality is the cause not only of serious social concerns, but it is also presenting us with some quite serious economic problems.

There is not much doubt that in the US, the growing tax concessions for the wealthy and the obstacles placed in the path of low income and poor people to organise themselves through trade unions, has had serious economic as well as social consequences. With companies like Walmart paying poverty wages, low income people don’t have the money to buy goods and services that businesses would like to sell. And despite US companies and the wealthy being awash with money, particularly as reflected in the buoyant US stock market, business is not investing in new businesses and jobs for the chief reason that the demand is just not there. Inequality is a major economic problem.

The IMF has highlighted the economic damage that inequality is doing. A staff policy paper 2014 found that ‘our work built on the tentative consensus in the literature that inequality can undermine progress in health and education, cause investment-reducing political and economic instability, and undercut the social consensus required to adjust in the face of shocks and that it tends to reduce the pace and durability of [economic] growth.’

The managing director of the IMF has been even more explicit. She recently noted that the 85 richest people in the world control as much wealth as the poorest half of the global population – 3.5 billion people. She commented ‘With facts like these, it is no wonder that rising inequality has risen to the top of the agenda – not only among groups normally focused on social justice but also increasingly among politicians, central bankers and business leaders. … It is therefore not surprising that IMF research – which looked at 173 countries over the past 50 years – found that more unequal countries tended to have lower and less durable economic growth.’

The Governor of the Bank of England warned us only a few months ago that unless action was taken on inequality ‘capitalism would devour its children’.

The OECD in its June 2014 report said that ‘OECD data shows that well into the recovery from the global economic crisis, the distribution of pre-tax and transfer income remains significantly more unequal than it was before.’ In particular the OECD expressed concern about ‘anchored poverty’ particularly amongst the young.

Ian McAuley has pointed out that because of growing inequality and the unwillingness of corporations and individuals to fund new growth and new jobs, more and more people have to rely on government benefits to tide them over. That in turn results in increased budget problems. We all instinctively know that well-paid jobs in a strong economy are better for everyone than government benefits. We need to address this downward spiral by the poor who become increasingly dependent on welfare with severe personal and social consequences but also serious public finance problems.

One feature of modern capitalism particularly by global companies is tax avoidance. We are reading about it almost every day. It is not only unfair but has serious economic consequences. As Ian McAuley put it ‘The economist Joseph Stiglitz points out that well-crafted taxes can actually improve a country’s economic performance. Tax regimes which give a leg up to new ventures, which encourage retraining, or which shape depreciation provisions to encourage the uptake of new technologies, can all help improve a country’s economic adaptability. A carbon tax is an example not only of the payment for harm done to others, (negative externalities in the language of economists) but also of an incentive for industries to adjust and modernise their productive methods.’

But unfortunately Australia is going in the opposite direction with widespread tax avoidance. Companies such as Westfield paid an effective tax of only 8% over the last decade. News Corp tops the list with 146 subsidiaries in tax havens.

Companies like this are the real ‘leaners’ and not the welfare bludgers that Alan Jones and the Daily Telegraph talk about. But not content to avoid company tax on an enormous scale they have their corporations fund their private travel, private entertainment, and their private boats

In 2011-12 according to Peter Martin in the SMH on 13 May ’75 ultra-high earners had a taxable income of $1.10 each’.

Almost every day we have more and more information about tax avoidance and tax havens. What is becoming increasingly clear is that the benefits to the rich are damaging both our society and our economy.  Our four major international tax advisory firms are facilitating this large scale tax avoidance. They call it ‘aggressive tax planning’ or the means to overcome ‘unfair tax competition’, presumably by other tax avoiders in Australia and elsewhere.

The government is not making it easier to crack down on major tax avoidance by cutting back experienced and professional staff in the Australian Tax Office. The government and the ATO also need information on where profits are being made and taxes incurred by jurisdiction. The ATO needs new legislation to address profit shifting through transfer pricing, thin capitalisation and debt loadings. We hoped that the G20 in Brisbane would address this issue but it seems to have been overwhelmed by other matters.

The most consistent critic of inequality and concern for the poor is Pope Francis. A year ago he seemed a voice in the wilderness.  But he is now being joined by such people as the managing director of the IMF, the Bank of England and senior politicians.

We are finding that inequality breeds not only social problems but has serious economic consequences for the future of capitalism.

We get a laugh out of the Monty Python sketch of four Yorkshiremen competing with one another to tell stories of the hardship they endured when they were children, 30 years earlier – “you think you had it tough …”.

Without going into Pythonesque exaggeration, four older Australians could easily recount similar stories. If they grew up in a Brisbane middle-class suburb, their house probably had no indoor toilet: there would have been a bucket toilet in the backyard emptied by the “dunnyman” (the “sanitary collector” to use one common euphemism) . If they grew up any distance from a city they probably didn’t have electricity, and the idea of turning on a tap to get hot water was almost beyond imagination.

Like the Python characters, who all claimed they “were ‘appier back then”, they wouldn’t consider they had led deprived childhoods, because those were the standards of the time.

Those material standards now, however, would be considered deprivation. Even if our own material conditions don’t deteriorate, if everyone else’s conditions improve, we feel hard done by.

We have a natural concern for fairness, a concern not to be confused with envy. In our concern for fairness we want to see our own and others’ conditions brought up: envy is about wanting to see others brought down.

This may all seem to be no more than commonsense, but there is a strong economic philosophy captured in the slogan “a rising tide lifts all boats”, essentially saying that any outcome is a good outcome so long as no-one is made any worse off. Inequality doesn’t count in other words. This philosophy, based on the work of the Italian Fascist Vilfredo Pareto, made its way into schools of economics and into public policy in the latter part of last century and is a mainstream of economic thinking.

It was influential not because academics and public servants had any attraction to fascism, but rather because it came in a neat “value free” mathematical package, absolving the academic or public servant from having to worry about fuzzy things necessitating moral judgements, such as equity.  And it provided an easy rationalisation for the economic philosophies of the Reagan and Thatcher administrations in the early 1980s, later to be taken up across the political spectrum.

Since the 1980s Australia has become more prosperous, but the benefits of that prosperity have gone disproportionately to those who are already most privileged. Research by Andrew Leigh and others shows that over the twentieth century Australia’s income distribution became more equal up to around 1980, but then started diverging once more. By now those gains have been lost: our income distribution is now roughly similar to what it was in 1900. Thomas Picketty’s research, which also takes in wealth, has similar findings for other ‘developed’ countries.

If that widening inequality were a result of choice it should not necessarily be a policy concern. There are people who choose to work hard and to take risks, while there are others who choose to join religious orders with vows of poverty or to seek low-paid but safe employment. Australians show no appetite for enforced social levelling.

But when inequality results from entrenched privilege, inheritance, “old boy” networks, exercise of political influence, denial of access to quality education and corruption, we are properly indignant. As a general point, we are less concerned with inequality in itself, than with the fairness or otherwise of the processes that lead to inequality. An almost uncontested political value in a country like Australia, transcending traditional “left’/”right” divisions, is a belief in equality of opportunity – a “fair go” in the vernacular.

While the fair go may be an aspiration, Australians don’t believe it holds in reality. In a recent survey by Essential Media respondents were asked “which has more to do with why a person is rich” – “because he or she has worked harder than others” or “because he or she had other advantages”. Hard work scored only 28 per cent while “other advantages” scored 56 per cent.

The capitalist economic system works when there is a strong connection between contribution and reward. That’s the very theoretical and practical basis of market economics.  That connection will never be perfect: even in the fairest system there is an element of luck. But when the connection between contribution and reward is badly severed the economic system itself loses its legitimacy. When legitimacy is lost people are inclined to reject the whole capitalist model, turning to superficially attractive but destructive alternatives. The plutocrats who show off their riches so vulgarly and the politicians who dismiss our concern with fairness don’t seem to realize that they’re threatening the very viability of the system that has supported them.

Even before reaching that self-destructive outcome, an economic system that results in inequality is one that is wasting many opportunities.  That’s the subject of the next article.

One of the world’s most useful social institutions is money, but it’s hard to think of it in its social context.

To understand the social value of money, think of a world without money, or a country where, through recklessness the currency has been debased, as happened in the hyperinflation in the Weimar Republic in the 1920s.

Barter served us well when few articles were traded – grinding stones, pituri and ochre in the Australian outback – but not in Germany in the 1920s and certainly not now. Complex trades require some agreed currency, not necessarily having any utility in itself, but with an agreed value in exchange. It’s that need for agreement, and for trust in those who control the currency, be it obsidian, rare shells, gold, or US Treasury Notes, that gives money that social context.

Besides facilitating exchange, money also allows those with a temporary surplus to lend to those with temporary deficits – the wealthy individual funding someone else’s startup business, the older generation lending to the younger generation to buy houses. Such deals involve a huge range of instruments – loans, mortgages, equity and so on – but what they have in common is the need for some level of trust. Trust that the debtor intends to repay, trust that the terms of the deal are protected by some external authority, trust by the creditor that the debt will not be whittled away by inflation.

Apart from times when we are caught short of cash – when the taxi fare is blown on the last race at Randwick – individuals don’t go around lending and borrowing. We do so through financial intermediaries, such as banks and stockbrokers. When we make deposits in these institutions we must be able to trust that they will act responsibly (in line with normal risk/return tradeoffs). That is, they will assess the quality of the way they invest that money on the depositor’s behalf and act as responsible trustees.

That’s the way money serves the economy – by facilitating trade and investment. Thanks to what is known as “fractional reserve banking”, money isn’t some fixed entity: if there is trust and confidence money expands. When I borrow to buy a house or to set up a business I use that money to pay a builder or to hire workers, who, in turn use some of that money to lend to others through their bank deposits.

These arrangements serve us well, until we lose sight of this practical, mundane function of money. They start to fall apart when we start to think that money itself is something real, as wealth, rather than as a means of denoting wealth.

It’s hard to put a date on this confusion of money with wealth. The Biblical warning about “love of money” suggests it goes back a long way. On the other hand, older Australians can remember when bankers were respectably dull people who drove Holdens, wore Fletcher Jones suits, and ate roast lamb with three veg on Sundays.

Something was changing when we started to hear life insurance salesmen (they were men) and bankers re-brand themselves as financial planners, and when they later re-branded themselves as “wealth managers”, when the Holden was replaced by a BMW and the Fletcher Jones suit by a Hugo Boss.

The situation worsened as traders bought and sold financial instruments, sometimes not even knowing what acronyms such as “CDOs” stood for, let alone knowing about any connection these instruments may have had to any physical reality. Hence the GFC.

The GFC is most easily understood as a loss of trust, as a loss of the social capital that allows borrowers and lenders to deal with one another.

It meant that money literally disappeared. That doesn’t mean people’s or businesses’  bank accounts suddenly shrank, but it meant that many debts were never repaid, that some investments went belly-up, that investments in pension funds went backwards, and that people and businesses became reluctant to lend and invest. Governments tried to stimulate their economies with low interest rates and “quantitative easing” (i.e. printing money), but as fast as they injected money into the economy people took it out again, often re-investing in the safety of government bonds – the equivalent of putting banknotes under the bed. They no longer trusted the financial system, and trust, once lost, is very hard to restore.

That has been the main consequence of the GFC – a crisis that could have been avoided had governments not been so gung-ho about deregulating the financial sector in the 1980s.  As is so often the case, rather than replacing obsolete regulations with more appropriate ones, they went down the path of deregulation.

The other cost to the economy has been manifest since well before the GFC, and that has been the distortion of incentives in the economy. The message in the financial boom was that doing anything useful in the real economy was a mug’s game: playing with money was where the big returns were to be found. The finance sector took in some of the world’s most mathematically talented graduates, who could have been contributing to the real economy in engineering or science.

In so doing it worsened economic inequality, damaging the already tenuous links between contribution and reward. Inequality, its causes and consequences, is the subject of the next two contributions.

The link to The Conversation below, provides a useful summary of the G20 and its member economies, e.g.

The G20 economies represent 65% of the world’s population, 79% of world trade, 84% of the world economy and 77% of world carbon emissions.

Australia rates number 3 in GDP per capita based on purchasing power parity.

As a percentage of GDP, Australia has a relatively low level of debt compared to other G20 economies.

Along with Canada,UK and Germany, we are the only G20 economies with a AAA credit rating.

Australia and Canada have the lowest corruption rating amongst the G20 countries.

John Menadue.

http://theconversation.com/the-g20-economies-explained-in-12-charts-33887

Luxembourg (more properly the Grand Duchy of Luxembourg) is one of Europe’s smallest sovereign nations, both in population (about the same as Tasmania’s) and area (about one thirtieth of Tasmania’s).  Many Australians might have driven right through it, not realizing that in a half hour or so they had crossed a whole nation.

If corporate accounts are to be believed, however, it is a major centre of economic activity. Ikea, Fedex and Amazon – all firms with global distribution functions – realize a large proportion of their profits in Luxembourg, even though it is landlocked.

But if you linger in Luxembourg you won’t find any Amazon depot, and not even an Ikea retail outlet. Nor will you find an Australian bar for employees of AMP, the Macquarie Group, Lend Lease and the Goodman Group, companies which also report a significant presence in that country.

Luxembourg is in the Australian news because those firms and many others, using various techniques of transfer pricing, declare part of their profits there, taking advantage of its low corporate tax rate.  In other words, they are engaged in tax minimisation, at the expense of our own public revenue.

Whether such schemes are legal is a question for the courts. But by any reasonable criteria we are entitled to feel that there is something morally wrong about such corporate behaviour.

The common corporate rationalization for such behaviour is that everyone else does it. It’s an excuse we probably tried as children, and learned that it didn’t have much traction. But before we jump in and condemn the corporations, let’s look at that rationalization in two situations we may encounter when we’re in a stadium watching a football game or the races.

The first situation is where we may be tempted to shove our trash under the seat, observing that many others do likewise.

The second is when we stand up during an exciting part of the event, presenting the person behind us with the choice of looking at our backside or standing up herself. Our rationalization is that the person in front of us stood up.

Both decisions – discarding trash under the seat and standing up – incur costs on others. But in the case of the trash the personal cost of finding a bin is trivial. In the case of standing up, the personal cost of staying seated is significant. (Those who have studied game theory will recognize the latter as a “prisoners’ dilemma” situation.)

To generalise the issue, there are many situations where we do the wrong thing because we are penalised for doing the right thing. These are morally difficult situations where reasonable people feel they have no choice but to act unreasonably.

Those situations are often faced by corporations in competitive markets. The firm that doesn’t minimize tax, that doesn’t misrepresent the quality of its products, that doesn’t ruthlessly exploit its workforce, that doesn’t pollute the environment when its competitors are doing all these things may be sending itself out of business, or paving the way for an even more ruthless raider to take it over.

In competitive situations it is not feasible or fair to leave sole responsibility for good behaviour with the corporations. The moral responsibility is a collective one, involving a recognized higher authority. Returning to the stadium situation, if there were an enforceable rule requiring us to stay seated in the stadium, we would all be better-off.

In relation to corporate behaviour that authority is the government, which is where the prime responsibility lies. We elect governments to protect the weak against the strong, to protect the public interest against the sectional interest.

Politicians, in defence of weak regulatory effort, may claim that in an interconnected world individual nation states are powerless, but there are vehicles of multilateral cooperative action, such as the World Trade Organization attending to the rules of trade. The hurdles to cooperation on taxation, labour standards, product safety and environmental protection (particularly the urgent issue of global warming) are not insurmountable.

That doesn’t get corporations off the hook: they have political influence.  In that regard it was disappointing to hear a spokesperson for the Business Council of Australia suggesting that governments should not pursue international tax reform too vigorously.

While the Australian travelling through Luxembourg may not see much sign of corporate activity, he will see excellent publicly-funded public transport, roads, schools and a health care system.

The traveller, having been driving on French or German roads, may notice that Luxembourg has low gasoline taxes. Will he yield to the temptation and top up his rented car, or will he wait till he is over border and chip in to pay for the roads he has been using?

One article of faith in the corporate sector is that low taxes are good for the economy – not only low corporate taxes but also low taxes in general.

Echoing this sentiment, Treasurer Hockey and other spokespeople for the Government repeatedly promise to cut taxes. Even suggestions that the GST should be increased are set in the context of a tradeoff against income taxes, rather than any net increase in tax.

For a start, let’s get one myth out of the way. Although repeated surveys reveal that most people believe Australia is a high-tax country, the reality is that among high-income OECD countries, Australia’s taxes (as a percentage of GDP) are very low: only the USA has lower taxes, and they have achieved this by running much higher budget deficits than in Australia.

Another myth is that high taxes are bad for the economy.  Again, looking at high-income OECD countries, there is no evidence to support this proposition. There is no relationship between the level of taxes and economic growth or competitiveness. What does seem to be the important factor is not the size of government (as measured by taxes or spending), but the purposes to which public revenue those taxes are put. A competent “big government” contributes to economic performance in ways that an incompetent or corrupt “small government” does not.

Also, research on competitiveness suggests that some countries try to entice investment with the offer of low taxes to compensate for deficiencies in other conditions, such as poor infrastructure, corruption, or an inadequately educated workforce.

Businesses need publicly-funded services. They obviously need the networks of transport and telecommunications infrastructure. They need an educated and healthy workforce. They need a publicly-funded but independent legal system.

Less obvious, but no less valid, is the way business benefits from safety nets, such as social security payments. If people are to take risks, such as investing in start-ups, or developing specialist skills, they need a safety net to fall back on when these investments fail.

The economist Joseph Stiglitz points out that well-crafted taxes can actually improve a country’s economic performance. Tax regimes which give a leg-up to new ventures, which encourage re-training, or which shape depreciation provisions to encourage the uptake of new technologies, can all help improve a country’s economic adaptability. A carbon tax is an example not only of a payment for harm done to others (“negative externalities” in the language of economists), but also of an incentive for industries to adjust and modernise their production methods.

Of course, established businesses have a voice in various industry associations, such as the Business Council of Australia and the Australian Chamber of Commerce and Industry, as well as numerous industry-specific lobbies. These organizations, quite understandably, represent the interests of established firms (just as trade unions tend to represent the interests of already-employed workers). These are the firms that have established their place in the market, have benefited from past investments in public goods, and which don’t necessarily welcome the entry of new firms into their industries. They certainly don’t welcome disruptions such as carbon pricing – disruptions which may force them to lift their game or to go out of business as new and more nimble competitors grab opportunities.

Also when these lobby groups speak on tax matters, particularly personal income taxes, it is questionable whether they have in mind the interests of corporations (inanimate constructs with no interests other than those of their stakeholders) or the interests of generously-paid corporate managers.

In recent times we have heard pathetic rationalisations as to why Australian companies should be able to use Luxembourg as a tax haven, and why any right-minded business executive should feel affronted by the suggestion his or firm should pay their share of taxes. Perhaps the “small government” line is just a conditioned, rather than a considered, response.

In the next article we’ll look at the ethics of tax avoidance – it’s not as straightforward as it looks at first sight.

Karl Marx was the intellectual father of communism, grandson of a rabbi. Henry Ford was the quintessential American industrialist, anti-union and anti-Semitic.

They shared one insight, however. They both knew that capitalism could destroy its own markets. A plentiful supply of workers would keep wages low, to the benefit of industrialists. But those same industrialists needed markets for their products, and an underpaid workforce wasn’t going to be able to afford the products coming off the industrialists’ assembly lines.

Marx saw this as the root of capitalism’s undoing. Ford saw it as a challenge.

In 1914 Ford doubled workers’ pay, an act based not on generosity, but on well-calculated self-interest. He wanted a loyal and productive workforce, with a stake in the success of the enterprise.

His move was a rejection of the nineteenth century idea that capitalism needed a pool of workers with nothing to offer but their brawn, facing starvation if they did not accept the industrialists’ meagre offerings. He realised that his assembly-line model of mass-production required a mass market of well-paid workers, and that it was in his interests if other industrialists did likewise. Unemployed workers, or workers working for miserable wages, weren’t going to be able buy T-Model Fords.

That notion of production and consumption, where wages come back to the industrialists as demand for their products, became a central tenet of economics. A well-paid workforce is a basis for capitalism’s success.

That understanding was built into the Australian understanding of capitalism from early on, codified in the 1907 Harvester Judgement, establishing the idea of a basic wage. Tariff protection was the mechanism which would allow for a recognition of the shared interests of industrialists and workers. The journalist Paul Kelly was to call it the “Australian Settlement”.

So strong was the idea of the Australian economy depending on a well-paid workforce that in the 1950s and 1960s the Country Party, which one would expect to favour free trade, supported tariff protection. Jack McEwen, the Party’s leader, realised that farmers’ most reliable markets were prosperous Australian households.

Tariff protection is well past its use-by date, but the idea that a fully-employed and well-paid workforce underpins a successful economy is no less valid now than it was in 1907 or 1914. Also, as Ford understood, when labour is cheap workers are not properly valued. A reasonably high minimum wage helps see that workers are employed productively. (Australians visiting the United States, where in some states minimum wages are as low as $5 an hour, are often surprised to find people in low-productivity jobs, pumping gasoline or walking the streets wearing sandwich-boards advertising local businesses.) Former US Labor Secretary Robert Reich, in his work Outrage, clearly attributes America’s recession and sluggish recovery, in large part, to its low-wage economic structure.

In 2008, when the Global Financial Crisis hit Australia, the Rudd Government, acting on sound advice from Treasury, understood the urgency of maintaining domestic demand and stopping unemployment from rising too high. The cost was a rise in government debt to a modest level – modest both by Australian historical and by contemporary world standards. Those who misrepresent this cautious intervention as causing a “budget emergency” never mention the cost of inaction which would have seen much higher unemployment – people doing nothing instead of building school classrooms and halls, insulating houses and constructing highways, and maintaining their connection to the workforce. Nor do they mention the IMF’s praise for Australia’s policy response, and its more recent criticism of those countries that pursued austerity in response to the GFC. It’s a callous attitude, oblivious not only to the economic cost of unemployment, but also to the misery suffered by people excluded from participating in productive activity.

Perhaps those same people who criticize the Rudd Government’s GFC response are locked into a nineteenth-century model of capitalism. Rather than striving for an economic structure  that can support a well-paid workforce, they envisage a future based on low wages. The present Government has taken a lead by reducing real wages for those on the public payroll, and its proposals on pensions, Newstart allowances and foreign workers are all designed to keep downward pressure on wages.

It’s an agenda that meets with the approval of business lobbies, who, like Marx, still see the world through the lens of class conflict. They don’t seem to realize that they are undermining the capitalist system they claim to support.

And they still see “low taxes” and “small government” as the path to private sector prosperity – the subject of the next contribution.

Republican victories in the US midterm elections have given conservatives a psychological boost, just days before the twenty-fifth anniversary of the fall of the Berlin Wall. (For the record, the 1989 collapse of European communism was a victory for those Germans, Hungarians and others who risked all to stand up against tyranny, but it has been appropriated by American conservatives as a triumph of unfettered markets over government.)

Those celebrating the midterm results may be overlooking other recent developments, such as the resounding defeat of the Swedish centre-right coalition which had tried to privatize health and education. Even the midterms were less than a decisive endorsement of the Republicans’ free market agenda: several states voted to lift minimum wages, and by a quirk in the US electoral system there was a concentration of central and southern states going to the polls. These are the poorer states where the agenda is far more complex than traditional “left/right” conflicts.

Perhaps people have forgotten the Global Financial Crisis, or as it has come to be known, the Great Recession, when cowboy behaviour in financial markets would have crippled the world economy had governments not bailed them out.

And in celebrating the fall of the Berlin Wall it is easy to overlook communism’s contribution to capitalism. In its role as a rival ideological suitor it kept capitalism on its best behaviour. As the Marxist historian Eric Hobsbawm wrote in his reflection on the twentieth century:

It is one of the ironies of this strange century that the most lasting results of the October revolution, whose object was the global overthrow of capitalism, was to save its antagonist, both in war and peace – that is to say, by providing it with the incentive, fear, to reform itself after the Second World War, and, by establishing the popularity of economic planning, furnishing it with some of the procedures for its reform.

With their supposed rival discredited, capitalism’s champions have been pushing boundaries aside. In some countries – the English-speaking countries in particular – it is becoming beyond question that the best government is small government, and that markets should be left to their own devices.

The Bank of England Governor Mark Carney at a conference on “inclusive capitalism” earlier this year warned about such thoughtless exuberance:

All ideologies are prone to extremes. Capitalism loses its sense of moderation when the belief in the power of the market enters the realm of faith.

Seventy years ago, when economists and politicians were considering the postwar order, the Hungarian economist and philosopher Karl Polanyi warned about a coming “great transformation”, when the market would be unleashed from its previous constraints.

Since markets had first emerged, Polanyi pointed out, they had been subject to society’s norms and moral codes, and generally limited in space (the market place) and time (market days and fairs). They had been constrained by notions of a “fair price” and rules against usury. He foresaw the postwar order, however, as one in which people would live in a “market society”, and the organising principles of society would be the those of the market.

As it happened, the immediate postwar order saw a tamed version of capitalism. The Great Depression was fresh in people’s memories, and communism still had followers. (Menzies won the 1961 election on Communist Party preferences directed away from Labor.)

But from the early 1980s, with the election of Thatcher and Reagan in in the USA, capitalism became more triumphant and more aggressive, and by now Polanyi’s prophecy has largely come to pass. We have let the market take over more of our physical and metaphorical space. With commercial television and the internet even our homes are subsumed into market space. Our roads are turned over to private companies to operate as tollways, and to make sure we can’t escape the market, public space is becoming cluttered with billboards. And, most seriously, we are increasingly allowing the profit motive to intrude into health and education – areas we once considered to be subject to the rules of social obligation.

The Harvard philosopher Michael Sandel in his book What Money Can’t Buy: The Moral Limits of Markets points out some of the extensions of the idea that everything is on the market: some Californian prisoners can buy a cell upgrade; $500 000 will buy you a visa to migrate to the United States; you can sell space on your exposed skin for tattoos carrying advertising; a lobbyist can hire you to stand in a queue to meet a congressman. He goes on with a list that makes prostitution look positively respectable by comparison.

Possibly because this transformation has been gradual, we have tended to underestimate its extent. And possibly because some of the earlier restrictions on markets were dysfunctional (such as the closure of all shops, even garages, for 45 hours from noon on Saturday), we have assumed that the alternative to poor regulation is no regulation.

We have let the profit-driven private health insurance industry into health financing, using clumsy, expensive and ineffective mechanisms, such as “community rating” to try to restore some equity. We have let for-profit corporations enter what we now call the “market” for education. We talk about the “labour market”, as if people are tradeable commodities like iron ore or soy beans.

The pushback, where it has occurred, has been insipid. Politicians, even those supposedly on the “left”, talk about policies “balancing” economic and social objectives, and businesspeople talk about “triple bottom line” reporting, as if there is some tradeoff between economic and social outcomes.

But, Polanyi would ask, what is the point of economic activity if it does not contribute to social outcomes? We laugh at the apocryphal story of the officer who said during the Vietnam War “we had to destroy the village in order to save it”, but we let pass the equally silly idea that we must somehow compromise social objectives to achieve economic objectives.

The market must be restored to its place, not above or beside society, but contained within society, subject to its norms.  The mixed economy, where markets, civil society and governments all do what they do best, has served us well in the past, but the fashionable “small government” ideology is leading us down a destructive path.

Markets are capable of bringing great prosperity, but when left to their own devices can be destructive. Like an obese patient eating himself to death, capitalism needs to be protected from its own excesses.

In following articles I will touch on capitalism’s self-destructive forces, and on what we must do, through the governments we elect, to protect it from those forces, because there is a danger that in response to its failures we will reject it altogether. The alternatives to properly-regulated capitalism are rather unattractive.

The Economics Editor of the Guardian, Larry Elliott, describes how capitalism is facing an increasing crisis. He says that after the fall of the Berlin wall, we have seen the dark side of the post-Cold War model. Instead of trickle-down, there has been a trickle-up. Instead of the triumph of democracy there has been the triumph of the elites. We are seeing this in so many ways – the avarice of bankers, growing inequality, executive salaries and greed. This article suggests that the Vatican may be right that markets must be underpinned by morality. For this interesting and challenging account, see the link below.  John Menadue.

http://www.theguardian.com/business/economics-blog/2014/nov/02/post-cold-war-capitalism-moral-roots-ancient-places

Taxation Reform and Vertical Fiscal Imbalance

Another third and final reason for national government pre-eminence over the States in our federal system is of course the national government’s domination of taxation, widely described as ‘vertical fiscal imbalance’ or VFI. Paul Keating called VFI the glue that holds our nation together, but for the States and the champions of States’ Rights, VFI is regularly trotted out as the root cause of centralism.

In the past the national government has passed payroll tax back to the States, and more recently the States now receive all the proceeds of the GST. It would, however, require very big further changes to taxation arrangements for the States ever to achieve full financial self-sufficiency.  While broadening the GST and/or increasing the rate would offer material assistance to the States, the revenue from the GST would need to increase by around 90 per cent in order to replace completely the revenue that the States presently receive from the Australian government though various specific purpose payments. Clearly such a 90 per cent increase in the GST is most unlikely. Indeed the scale of the change and its implications for the balance between indirect taxation and income taxes would have major implications for equity.

Consequently, in order for the States to become completely financially independent they would need to raise a substantial amount in their own names by way of the income tax. In principle this might be possible if the States and the Australian Government were able to agree an arrangement for the States to share in the proceeds of the national income tax. But do the States want to do this and would the Australian Government agree?

In fact in the past the Fraser Government offered the States the chance to levy a surcharge on top of the Commonwealth income tax, but none of them took up the opportunity. Apparently the States preferred to continue the arrangement whereby the Australian Government took the blame for the level of taxation, while they spent the proceeds, and were then able to cry poor and blame the Commonwealth whenever their service provision was considered deficient.

Equally for the Australian Government to exercise its responsibilities for national economic management and performance it would need to control the share of the income tax proceeds that the States received. This would need to be a fixed share, and not allowed to vary from year to year according to the preferences of the States; otherwise such variations could play havoc with the Australian Government’s macro-economic policy. But in that case it is questionable how much independence the States would really gain. Indeed the stage could then be set for a return to the traditional argy-bargy about how much general purpose funding the Commonwealth should make available. While at the same time the Australian Government would have lost any financial influence over the national objectives that specific purpose programs are presently meant to achieve.

Conclusion

While there is a case for broadening the GST and increasing the rate, with the proceeds to flow to the States, this in itself is unlikely to change significantly the nature of our federal-state financial relations. Instead substantial VFI will most likely remain, in which case we cannot really expect much change in the incentives and consequently the behaviour of either the Australian Government or the States.

Furthermore, the biggest problem facing all levels of Australian governments in recent years has not been so much the balance of revenue between the Australian Government and the States, but rather finding sufficient revenue to fund the services that Australians are demanding without recourse to continued borrowing. Thus in the last full year of the previous Labor Government (2012-13) the Australian general government sector payments represented 24.1 per cent of GDP; in fact a bit less than their long term average over the previous twelve years since 2000-01 of 24.5 per cent. While by comparison government revenue represented only 23.1 per cent of GDP in 2012-13 – quite a bit less than the average of 24.3 per cent over the previous twelve years. So it is reasonable to conclude that we have a revenue problem rather than an expenditure problem right now. Furthermore, this need for additional revenue may well increase further over the next decade or more because of the ageing of the population and increasing expectations such as have led to the demands for additional funding for the National Disability Insurance Scheme.

The reality is that tax reform inevitably uses up scarce political capital. In these circumstances the priority must be to restore the Australian Government’s access to revenue; for example by reducing and even removing many of the expensive tax concessions and plugging present loopholes. Restoring the integrity of the tax system in this way is much more important than a futile pursuit of a non-existent ‘big-bang’ solution to improve the operation of our federal system. Such an approach is almost certainly impractical and could never gain the necessary consensus. Instead incremental progress is much more likely and in practical terms probably the best way forward to an improved federal system for Australia.  This incremental approach will need to be based on a continuation of case-by-case discussions for the various programs and regulatory areas leading to the rationalisation of the respective roles and responsibilities of each level of government.

Although this approach to reform sometimes seems slow and tedious, past experience shows that it can achieve results. And the pace of reform can be speeded up by a Prime Minister who is prepared to make reform of the federation a priority and provide the necessary leadership, as was demonstrated by the cooperation achieved at the time of the Keating Government.

Finally we need to remember that, as Abbott himself concedes ‘The federation we have – with all its flaws – has spawned a vibrant democracy, a strong economy and a cohesive society that millions of migrants have chosen to join’. Not only is there no real possibility of radical change in our federal system, neither is there any need for it.

There has been much comment about Gough Whitlam’s performance as an economic manager. Ian Verrender, the Economics Editor at the ABC, presents an alternative view.  See link below.  John Menadue

http://www.abc.net.au/news/2014-10-27/verrender-think-whitlam-ruined-our-economy-think-again/5842866