August 10th 2019


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Articles from this issue:

COVER STORY Boris Johnson and the EU: Crash through or just crash

EDITORIAL When will Morrison stamp his authority on his mandate?

CANBERRA OBSERVED A quick peek into the security shadows

ENVIRONMENT When apex predators hit the turbines, think of the clean energy

HUMAN RIGHTS Unalienable rights can be recognised, not made up

SECURITY Australian Signals Directorate comes out of the shadows

RURAL AFFAIRS Distress, economic and societal, pervades Australia

GENDER POLITICS I was America's first non-binary person: It was all a sham

FICTION Mick and the Little Man

HUMOUR Japan G20: Donny meets Jenny

MUSIC Dire tonics: Departure from harmony has proved a flop

CINEMA The Lion King: Remake takes a deeper look

BOOK REVIEW Public enemy No. 1 and his twin, No. 2

BOOK REVIEW In the market with the Angelic Doctor

POETRY

ZEG'S PLACE

NSW ABORTION BILL Clear and present danger to women's health

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RURAL AFFAIRS
Distress, economic and societal, pervades Australia


by Dr Mark McGovern

News Weekly, August 10, 2019

In Prosperity and Distress in Australia’s Cities and Regions, Scott Baum, William Mitchell and Michael Flanagan have mapped a Prosperity and Distress Index (PDI) for federal electorates. While the level of stress is uneven within electorates, the city-country divide is stark. (See map below)

Prosperity and Distress in Australian Localities 2016

The map shows prosperity is concentrated in the major centres.
Elsewhere, distress reflects the loss of many “value adding”
manufacturing enterprises and the decline in profitability of the rural sector.

Source: Prosperity and Distress in Australia’s Cities and Regions,
Scott Baum, William Mitchell and Michael Flanagan

 

Such is the result of over four decades of the same policy mindset. Unsustainable competition, market liberalism, public retreat, financial liberalisation and like policies favour only some. Embracing these policies uncritically has left our nation divided.

“Inequality is a choice,” wrote the renowned economist, Joseph Stiglitz, and inequalities build when you keep the same set of policies in play for many years without corrective actions.

Resources become depleted when any gains are less than the costs imposed. As key contributors to production become stressed, our ability to profitably produce falls. For too long this has been the situation for most rural regions, and indeed many urban areas.

The underlying reason

Beyond select suburbs and population centres, Australians are living in areas experiencing comprehensive run-down of important economic capitals.

Returns to all manner of Australian economic capitals used in the production of many types of product have been inadequate for decades. Yet we still persist with clearly inadequate options. It seems no one wants to ask, “why?”

By definition, failures across Australia to retain and build economic capital arise as a result of routinely repeated investment mistakes. Mistakes may rest in organisational inadequacies, ignored uncertainties, systemic failures and, underlying all this, a persistent failure in evaluation.

How do failures not only persist but spread without even attempts at correction? Mindset and power are convenient answers.

Lawrence E. Mitchell wrote in Financialism: A (Very) Brief History: “While capitalism still characterizes a portion of the American economy, it has become subordinated to a new economic order. This economic system is one in which the financial markets exist primarily to serve themselves.

“In this system, capital is raised for the purpose of creating, selling, and trading securities and derivative securities that do not finance industry but rather trade within markets that exist as an economy unto themselves. At the same time, those markets have profound and adverse effects on the real economy. This new economic system is Financialism”.

The run-down in the capital base of “the real economy”, which produces our goods and services, mirrors the rise of financialism with its opportunistic detached behaviours.

Investment and capitalism

Capitalism supposedly favours prosperity viaits more effective development of the real economy. Indeed, this was the case in the decades after the Great Depression of the 1930s with “democratic capitalism” structured to balance all capital interests. This favoured all manner of well-considered capital developments aided by fit-for-purpose finance. Rising prosperity followed as gains realised from investments were aptly distributed to sustain and develop all key capital types.

The great post-Depression economist, John Maynard Keynes, argued that it is was essential to euthanase the “unearned returns” of “opportunistic capitalists” such as those who created the 1920s financial bubble that burst in 1929 with the subsequent Great Depression.

Pivotal for Keynes was “the marginal efficiency of capital” (MEC). This is technically defined as “the rate of discount which would make the present value of the series of annuities [repayments] given by the returns expected from the capital asset during its life just equal its costs”. (J.M. Keynes, The General Theory of Employment, Interest and Money).

A well-set MEC means no unearned returns. If debt financing is used, the MEC needs to exceed interest rates charged. In a nutshell, MEC is designed so that returns match investment costs over the lifetime of the investment given expectations of inflation and interest rates.

Next comes the confidence to actually decide to invest. Confidence reflects what Keynes termed investor “animal spirits”. It centres on how parties to an investment, each and all, hope to see themselves better situated in the future from taking on the risks of investment now. Investment links capital contributors via uncertain times in a joint journey to build a better future.

For further reflection, you might consider this thought [with annotations] from Keynes: “If I am right in supposing it to be comparatively easy to make capital goods [as with modern technology] so abundant that the marginal efficiency of capital is zero [and the loan rate lower?], this may be the most sensible way of gradually getting rid of many of the objectionable features of capitalism [such as unearned returns].”

Exploring Financialism

Being an American Professor of Law, Lawrence Mitchell is well placed to explore the legislative path that brokered the return of opportunistic capitalism in the United States. Australia has had its own accommodative pathway since John Gorton stepped down from the prime ministership.

Mitchell wrote: “Financialism is grounded principally in two dangerous ideas, ideas not dangerous in themselves but dangerous in practice. These ideas have helped to provide intellectual support for the shift from capitalism to financialism and lie at financialism’s foundation.”

Mitchell associates the first danger with the shift from actions “grounded in the behaviour of the self-interested, but nonetheless morally sensitive, economic man” of Adam Smith, to the abstraction and celebration of morally insensitive “individual pursuit” in whatever context.

The second change followed the implementation of a new statistical capital asset pricing model (CAPM), “further detaching any human element of concern for the real economy while at the same time profoundly affecting real economic behaviour by affecting the underlying stock prices that drive managerial incentives”. Financial anal­ysis became detached.

In the absence of effective countervailing influences, financialism, with its preferencing of returns to well-placed financial elements and detachment from investment realities, has seen the return of opportunistic capitalism. Financialism perverts the application of finance, including through poorly designed and exploitive investment products.

Incentivised financial parties embraced this culture. “Winners are grinners, and others don’t count” became the shared ethos, even after the financial sector began to devour itself.

Despite then already clear warning signs, in July 2007 Citigroup chief executive “Chuck” Prince told the Financial Times that “global liquidity was enormous and only a significant disruptive event could create difficulty in the leveraged buyout market. ‘As long as the music is playing, you’ve got to get up and dance. We’re still dancing.’ ”

Unrecognised and unchecked, the “significant disruptive event” already under way even then continued its growth. Lehman Brothers and other investment banks failed during 2008, so falling interbank trust slowly froze “the music” of easy movement of monies. Subsequent reforms and initiatives failed to rectify problems. Just thawing the musicians and redistributing problems was never going to work.

Today, the same music still plays, despite over a decade of needlessly ruined investments and miserable income growth for most. Debts are markedly higher today than in 2007, especially in Australia and China.

Some points

Unlike most nations, Australia still has the opportunity sensibly to arrest the downward spirals that characterise financial crises. However, policy solutions have been piecemeal and show “shoot first and ask questions later” inspiration. This must be changed.

Consider the situation too often evident across Australia.

  • Australian farms are reported as having the highest production and income volatility in the world. Yet the standard farm loan is built upon regular repayments that assume steady income! The lending product is by design not fit for purpose.
  • Drought (or any other external event) is not the central problem. Rather, the inability to deal with imbalances in an uncertain environment is the problem. Foundational problems, not symptoms, need to be resolved. If the issue is variability, achievable adaptability to adversity and attendant capital stresses is the goal that should be set. The current “save for a dry day” proposals reflect inept considerations of optimal capital usage.
  • Liquidityas the reliable availability of funds for investment on sensible terms has long been missing for rural industries. By definition, asset prices are unsustainably high in a bubble because of inadequate income potential. Loans are issued that are not viable at issue. An asset bubble in rural Queensland beef lands was acknowledged before the Financial Services Royal Commission. Offering a loan without explicitly checking serviceability is irresponsible, or worse.
  • Income flowssupportnot just loan serviceability, but household survival and maintenance of key enterprise capitals. All these have to be prudently considered when lending. Financial agents and campaigns uncritically peddling regular, on-time loan repayment products do no one any favours, including the banks and their shareholders.
  • The problem of financial agents with loan-selling or management incentives has to be dealt with. Temptations build when real properties (such as farms or business premises) can be held as security to cover financier exposures. Under financialism, high-equity borrowers become particularly attractive for exploitation, since loan value is much less than security value. This can be especially so if the practice – as seen at the Financial Services Royal Commission – is that all enterprise assets can be liquidated in a fire sale.
  • Human, physical, financial, environmental and other forms of capital have been run down for a long time. Policy choices have discriminated against rural and remote areas, as particularly evident in the ongoing needless economic and wealth losses across agriculture. Apt renewal of all styles of capital is needed.
  • Poor use of ideas leads to policies malformed by design. Pop economics, dangerous strategies like asset inflation, naïve competition policies, denial of trade realities and theories, woeful regulation and polluting debts from unchecked Ponzi finance schemes were all part of a self-reinforcing destructive logic. They still are. Prudent private and public policies, well informed by relevant insights, sound understanding and competent evaluation, are needed.
  • Much can be done to restore financial/economic/societal viability. Continuing with the “quick fixes”, policies and thinking that led to today’s problems will solve nothing. Rather we need to build sensibly on what can deliver real results on the ground now and over the medium and long terms, and so rebuild enterprise, environmental and community vitality.
  • There are economic losses (and gains) at all times, but losses today are needlessly high. Key capacities have been seriously weakened. It is past time for adopting fresh thinking and relevant insights “to stop the rot”. To name a few such insights, we can draw from successful restructuring and development efforts; industry theory and production realities; and public Inquiries into finance, including the Financial Services Royal Commission. Untapped insightful research and extension activities can be found in many relevant areas. Comprehensive and complementary capabilities across communities can make goals realities.

An historically unprecedented crisis is under way. It will continue while the overreach of financialism stymies productive investment, inhibits employment in well-paid jobs and puts stress on needlessly all manner of capital-building enterprises.

The crises in rural areas most evident over the last decade are now also on their way to the cities. Perverse financial arrangements need reversing if we are not to live through further lost decades.

Restoring a positive direction for Australians

Avoiding needless destruction of capitals and key capacities is pivotal in stabilisation and any successful turn-around. Rectification via effective transitions with sound outcomes properly involve inclusively:

  • Recognising and remediating economic flaws in current policies.
  • Developing insightful approaches and efforts that underpin robustness in not just investment positions but also societal achievements.
  • Rebalancing and rebuilding capital returnsviaprudent investment practices.
  • Developing well-formed private and public policy responses capable of yielding desired results by constructively using apt information, relevant knowledge and productive dialogues with stakeholders.
  • Restoring viability and vitality to key economic sectors, such as agriculture, and their communities.

We might term these the “10 Rs” that we need to relearn if we are to revitalise our own situations and re-engage more effectively and equitably in building afresh our many capitals and common wealth, and those of the world.

For those still holding out for a market-correction, remember to tell your family, colleagues, and friends: “The market can remain irrational longer than you can remain solvent.” (attribu­ted to Keynes)

Dr Mark McGovern is an economist and is currently Visiting Fellow in Economics and Finance at Queensland University of Technology. As an active member of the 2015–16 Queensland Rural Debt and Drought Taskforce, he was able to extend his earlier research and identify apt policy responses to challenges otherwise little dealt with.




























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