TRADE: by Colin TeeseNews Weekly
'Benign neglect' no answer to debt crisis
, July 2, 2005
The Howard Government prefers to cling to discredited economic theories rather than take action to tackle Australia's worsening external indebtedness, writes Colin Teese, former deputy secretary of the Department of Trade.In a discussion about management theory, someone once said that many management practitioners apparently preferred to be guided by discredited theory rather than revise their opinions. It seems that the same is true of many of those advising us on the problems Australia is experiencing with the blow-out of our deficits on both the trading and current accounts.
The trading account describes, year by year, the balance between our outlays on imports of goods and services what we earn from our exports. The current account goes further. It balances total outlays against the nation's total external earnings.
The current account is the final reconciliation of our financial transactions with the rest of the world. It includes, for example, any earnings and outgoings we accumulate on overseas lendings and borrowings.
As things currently stand, the situation with the trading account does not look good. If we continue trading in the same manner for the rest of the year, our deficit on the trade in goods and services will amount to about 3 per cent of what our nation is able to generate through economic activity - i.e., the gross domestic product (GDP).
Bad though that is, it does not tell the full story. Obviously, our unsatisfactory trade performance flows into the current account. As a result, our total indebtedness for the year 2004/05 is likely to come in at about 8 per cent of GDP. Now if this were a "one-off" situation, we might conclude that the imbalance could be explained away by special circumstances, and need not be of particular concern.
There are, however, no special circumstances. In fact, the trading account has been in persistent deficit. It has gone into surplus in only three of the last 15 years - and each time for relatively small amounts. Furthermore, since the beginning of the new century, the deficit on the trading account has steadily increased, year on year, until it has leveled off at around 3 per cent of GDP. In all probability we might have expected worse, had it not been for the increases in the prices for our mineral exports in the last year or so.
In other words, our poor performance on exports is driving the nation further into debt each year. More will be said about why this is so later.
This article has quite deliberately refrained from loading the reader's minds with the various scores and hundreds of billions of dollars associated with the problems of our trading and current accounts. Non-experts understandably find it difficult to make sense of such huge amounts.
But it is possible - and worthwhile - to put the extent and implications of our indebtedness into better and more easily manageable perspective. Fortunately, an economist from the Hong Kong and Shanghai Banking Corporation, Mr John Edwards, has done that for us (Australian Financial Review
, June 16, 2005).
Over the past year, he tells us, $32 billion has left Australia to pay interest on our foreign debt. And, remember, that does nothing to reduce the level of the debt. As a result, Mr Edwards goes on to remind us that, for every $3 the economy generates in income, $2 is owed in foreign debt.
Our economy is said to be growing healthily, and in some ways it is. But the fact is that our overseas indebtedness is growing faster than our economy, and will continue to do so unless we can significantly increase our exports.
Mr Edwards correctly anticipates that this is unlikely. Certainly, it has not happened for more than 30 years. And although Mr Edwards did not say so, we should note that the last big trade surpluses were achieved in the years immediately preceding the onset of economic rationalism.
That we are facing a problem with foreign debt would appear to be beyond question: but if we were to rely for information from media and academic circles, we would never know. Most of those commentators confidently insist that normal market corrections will take care of the debt problem. Nothing else needs to be done.
In large measure, the Reserve Bank governor, Ian Macfarlane, agrees with them. More generally, Mr Macfarlane's comments are truly breathtaking.
The good news, he tells us, apparently without a blush, is that the expanding current account deficit does not go on forever. Market adjustments will expunge it. Industrial output, he assures us will increase. Exports will begin to rise. Everything will be fixed.
Really? The current account deficit, he surely knows, can be traced to the beginnings of market deregulation, and has been with us since the Hawke/Keating days. After Keating's departure, it has continued unabated. Indeed, our indebtedness has doubled over the life of the Howard Government.
Worse still, during a parliamentary inquiry, Federal Opposition spokesman Lindsay Tanner reminded the Reserve Bank governor that industrial output in Australia is actually falling. Manufacturing will not be in any position to boost our export income.
Mr Howard's position is no less curious. At the time when he was seeking to wrest the prime ministership from Mr Keating, he considered our then level of indebtedness to be a disgrace. In 1995 - not long before the Federal Election which saw Howard come to power - the Coalition campaigned with a "debt truck", warning that Australia's foreign debt had reached the dangerous level of $170 billion - something which Howard and his new government were determined to fix.
As we all know, foreign debt is now two-and-a-half times the size it was when Mr Howard took office. Not much of a record you might conclude, but what does the Prime Minister say about the debt now? It does not matter, he is reported as saying, because it is all private debt.
What exactly is Mr Howard trying to tell us? That somehow a debt at less than half its present level was bad when Labor was in office, but is okay now? Presumably not.
And what about the idea that the debt is "private" and need not be a concern for the nation? Well, leaving aside that the same was essentially true under Labor, what is Mr Howard's point? That default by private borrowers will carry no implications for Australia as a nation?
Taking into account what happened in the wake of the Asian financial crisis of the late 1990s, that surely cannot be true, given that most of the Asian debt was private.Government responsibility
The International Monetary Fund made it very clear to the indebted Asian countries that governments were responsible for the repayment of the debt and must introduce savings measures which would make possible the creation of schedules for repayment of the debt, regardless of their effect on economic growth.
As it happened, the IMF prescription was exactly the opposite of what was needed, and actually made things worse. The one country which ignored the IMF and introduced its own corrective measures, Malaysia, was the country which recovered most quickly.
In light of what happened in Asia, it would be unwise to expect, in the case of a crisis with Australia, more sympathetic treatment solely on the basis that the debt was private.
Understandably, politicians will be reluctant to tackle the problem of debt. After all, the fairly fragile economic prosperity we currently enjoy relies fundamentally on consumer spending funded by foreign debt. What politician - on either side of politics - would want to risk being blamed for interventions which might disturb the present basis for economic prosperity?
Better to leave it well alone, and hope that the problem of the deficit might simply disappear, or that some miraculous process, perhaps engineered by the Reserve Bank, will deliver salvation. This would make political sense if, indeed, benign neglect was a realistic and risk-free policy.
But it is not. And if the Government declines to take the initiative and deal with the issue in a way which allows it to keep control, while that opportunity still remains, then circumstances (or possibly the IMF) might intervene and impose on the economy - and the Government - a much more unpalatable solution.
"Benign neglect" strategy is no option while we are ever amassing foreign debt faster than the growth in the nation's income.
True, our interest rates are high and tempting, relative to the rest of the world, because of our foreign debt levels. But do we believe that lenders will keep funding our import bill on the basis of healthy interest rates alone?
Besides, there are two sides to the equation. What about the consumers? Surely, they won't be able to go on borrowing to gorge themselves on cheap imports forever. Will not their own personal "debt trucks" eventually be filled to overflowing and be unable to support further debt? Those are the kind of inevitabilities the Government must face.
So what are the options available to it? Ultimately, there is only one. Bring export income and outlays on imports into closer balance.Industry policy
This involves increasing exports of manufactures and/or decreasing imports. Increasing exports is impossible without an industry policy - which the Government has not got and, apparently, does not want.
Although the Reserve Bank governor refuses to believe it, the Australian Bureau of Statistics confirms that industrial output is in decline - which is hardly surprising. Our manufacturing sector contributed 20 per cent of GDP a couple of decades ago; it is now about 11 per cent.
And our manufacturing has declined principally because, under our free-trade policies, it cannot match import competition in the Australian market, much less in export markets.
If we cannot, or will not, contemplate revitalising our manufacturing sector, then the alternative is to curtail the flow of imports. Given the way our economy is now structured, that could not be done without significant impact on our economic growth and standard of living. But then doing nothing will probably lead to essentially the same result.
So it is over to the Government to bring about whatever policy changes will most effectively control and contain our foreign debt.
The options are challenging, and none can be achieved without some discomfort. The aim must be to devise correctional policies which will re-focus the economy in the right direction, with the least possible disruption.