Introduction

For more than thirty years, Australian governments have pursued and promoted free-market economic reforms. They have trumpeted the virtues of profitability and competition; they have asserted that productivity is bound to increase when business is deregulated. Their reforms have been guided by neo-liberal economics, the faith that ‘the free market, unimpeded by government intervention, will answer all human needs’.1 This faith claims a universal validity, and the Australian reforms were part of a surge of reform that originated in the United States and washed outwards from the English-speaking countries.

The reforms have now been in place for long enough, and in enough countries, to be associated with several adverse trends — notably, increases in the inequality of wealth and income, and increases in the incidence of severe economic crises. Are the reforms responsible for these adverse trends? Our answer is a definite ‘Yes’.

To prove the case that reform has increased inequality and vulnerability to crises, it is necessary to move beyond the neo-liberal economic theories on which the reforms were based. These theories have nothing to say about inequality and crises; they simply assume them away.

When the neo-liberal theories came into fashion in Australia we were concerned that they would generate complacency. We were not, perhaps, as concerned as we should have been about the promotion of inequality — Australia has a robust social-security system that has so far resisted the most outrageous reforms, though neo-liberal tolerance of high unemployment and failure to index benefit rates have raised the incidence of poverty. Our particular concern was that governments would neglect the need for active policies to maintain stability and underpin future prosperity, and so would sleepwalk Australia into crisis.

Over more than three decades, we have maintained an unfashionablly broad approach to economics, unconstrained by neo-liberal assumptions. This approach warns us that Australia is over-indebted; its households have borrowed too much from its banks, and its banks have borrowed too much from overseas. The neo-liberal reforms freed the banks to sell credit, and the resulting debt is becoming unmanageable. Though it avoided the Global Financial Crisis of 2008, Australia is now drifting towards economic breakdown and Depression. In this book, we hoist the Code Red signal; drastic action is required to extricate Australia from the pitfalls that neo-liberal policy has created.

When one encounters it in a first-year economics textbook, neo-liberal theory seems too esoteric to provide the foundation for a reform movement. Expressed in mathematics and expounded in academic article after academic article, it buys its internal consistency at the cost of an almost endless list of assumptions. These assumptions create an artificial world — a placid metaphysical world in which individual property-owners buy and sell their way to the common good. Neo-liberal theory has been marketed as a sophisticated account of the complex interrelationships that comprise a capitalist economy, yet it simplifies these relationships by disregarding some of the most crucial interconnections and uncertainties within such an economy. Herein lies its danger, when potential sources of economic breakdown are assumed away by those in charge of public policy.

The governments of Australia did not turn to neo-liberal theory through infatuation with its intellectual beauty. Rather, they adopted it because it was heavily promoted by vested interests. Though its basic theories were developed in nineteenth-century Europe to defend capitalism against Marx and other critics, their present incarnation owes much to a coterie of American billionaires, and their counterparts in Australia and the United Kingdom, who turned to neo-liberal economics in their search for arguments to defend their wealth against pesky taxes and environmental regulations. Their fundamental contentions were that taxes, particularly those on high-income people, weaken incentives to produce and to innovate, and that regulations raise costs, with similar debilitating effects. And, further, that production foregone due to taxes and regulations is a loss to the nation as a whole, not just to its rich minority.

Neo-liberal economic theory can easily be tweaked to support these arguments, but for it to be of any political use in defending the billionaires’ interests it had to be established that the theory describes an attainable reality. It proved hard to establish the theory as realistic — its assumptions were just too restrictive — but its protagonists had considerable success with their assertion that free markets are associated with freedom from authoritarian government. It helped, too, that the seeming sophistication of the theory attracted intellectuals to the think tanks and academic posts that were founded to promote the reform program, and that journalists could readily be found to carry the message into the media.

Once academics, politicians, and the elite in general were drawn into a mental world in which neo-liberal perfection was considered attainable, economic policy became a simple matter of reforming economic institutions to make them look more like those assumed in the theory — in general, by promoting competitive markets. It was argued that such reforms would guarantee increases not only in in productivity but also in incomes.

As neo-liberal theory permeated into Australian universities, we developed our critique of it, which at base was that the theory was too abstract to be reliable as a guide to policy. We were especially concerned that reform was extended to an area where the underlying theory was particularly contentious: the extension from free trade in markets for goods and services to free trade in money. In Australia, as elsewhere, financial deregulation was intended to increase the efficiency of the allocation of funds, but instead it has tempted banks and other financial institutions into the reckless misallocation of funds to finance consumption, and the reckless raising of funds by overseas borrowing.

By taking into account a much broader range of behaviours than those specified in neo-liberal theory, and by allowing for a wider range of interconnections between economic actors, we were able to foresee the disasters that would follow from the neo-liberal reforms. We were not thanked, of course, for predicting the financial crises that punctuated the past three decades: the Australian 1990 recession, the Asian financial crisis of 1998, and the Global Financial Crisis of 2008.

Happily, one of our predictions failed to eventuate — contrary to our expectations, Australia survived the Global Financial Crisis. This happened partly because the Australian government took timely action, but chiefly because the Chinese government did so, and generated a mining boom that allowed the Australian finance sector to postpone the consequences of its over-exposure to overseas borrowing.

But one happy escape does not guarantee permanent immunity. In this book, we trace the evolution of Australian economic reform in the neo-liberal era and show how it has increased Australia’s vulnerability to economic breakdown, mainly due to excessive overseas borrowing by the banks. We also show how similar reforms in other countries (notably the United States) are increasing the danger that Australia’s credit rating will tumble due to events over which Australia has no control, maybe to the point where its banks’ overseas borrowings can no longer be serviced. At this point, the Australian economy will collapse.

We chronicle, too, how the Australian financial sector has captured 9 to 10 per cent of Australian national income, more or less double the proportion it attracted during the post-war era of economic growth, and again more or less double the proportion it attracts in continental European countries today. This is not productivity: it is the cost of excessive intermediation; the cost of an insupportable burden of debt; and the cost of too much credit imprudently sold, resulting in debt that is all too likely to go bad.

Australia is a leaky ship in rough seas. We have no alternative but to hoist the danger flag and declare that, on current policies, Australia will shortly enter the Credit Code Red zone.

We raise the alarm, not only because we fear the costs of economic breakdown — the unemployment and the loss of income — but because we fear half-baked responses to the breakdown, based all too probably on misunderstood neo-liberal theories that fail to address the weaknesses which caused the breakdown. We also fear responses that go too far, and that fail to recognise the crucial role that an efficient and prudent financial system can play in maintaining prosperity and, dare we say it, in the transition to a sustainable economic system, including rational responses to climate change. This is why we devote so much space to the history and mechanics of what has gone wrong. Even so, our suggestions as to what should be done are but tentative additions to a burgeoning literature.

By what authority do we warn that Australia’s credit code is turning red? We claim, first, authority that arises from the history of economics. In particular, though the political mayhem of the 1930s is beyond living memory, the influence of the Great Depression lingers in economics. Those were the days of unemployment and moonlight flits and of bad names, including those of Hitler and Stalin. Yet there were also good names. Among contemporaries who attempted to understand the maelstrom of the times, one good name stands out — that of John Maynard Keynes.

The economists of the time, the progenitors of today’s neo-liberals, practised as they were in the defence of idealised free markets against the vituperations of socialists and communists, were nonplussed by the Depression. In their theoretical world, such disasters simply couldn’t happen. Keynes offered an alternative vision in which free markets, while essential to the working of productive economies, provided no guarantee of full employment. In a flurry of intellectual activity, previously puzzled scholars and practitioners developed, corrected, and elaborated his insights. Professors of economics continued to ask the same questions on their exam papers, but diametrically changed the answers.

We were too young to participate in this burst of creative thinking; that was the privilege of our teachers and mentors. However, we lived through the challenge that a revived free-market economics, now termed neo-liberal, posed to the simplified policy-Keynesianism of the 1960s. We contributed, as well as we could, to the Australian Keynesian response to this challenge. Here lies our second claim to authority.

We took the criticisms of the neo-liberals seriously, adjusted our Keynesian framework to take them into account, and tested the results by preparing economic forecasts. As time passed, we were able to check our short-term forecasts — and, in due course, our medium-term forecasts as well — against what actually happened. We learned from the successes and failures of our predictions, and updated the Keynesian framework so that it not only provided accurate forecasts but also generated the best policy answers of the day.2 At the heart of this updated policy framework is a recognition of the need for active and, in some cases, big government.

Contra to the neo-liberal paradigm, we believe that Australian governments should use all the policy instruments at their disposal to maintain control over the finance sector, constraining its size and hence the level of debt, and aim for moderate current-account surpluses to avoid balance-of-payments crises and defaults on foreign obligations. They should aim for a stable or slowly evolving exchange rate between the Australian dollar and overseas currencies so as not to undermine industry competitiveness, and should use a range of industry-assistance instruments to ensure that the structure of the economy is compatible with sustainable long-run prosperity. They should also recognise that sustainable prosperity requires the maintenance of reasonable equality in the distribution of income via appropriate wage, tax, and social-security policies.

Our predictions from the 1970s onwards proved accurate, made as they were on the basis that governments would ignore the activist policy framework that we recommended, and would remain stuck in the neo-liberal rut. We saw in the mid-1970s that the oil-price shocks would lower the long-term Gross Domestic Product (GDP )growth rate to well below previous trend levels; we predicted in 1984 that within five years there would be a recession as a consequence of financial deregulation and indifference towards the current-account deficit; we predicted the Asian economic crises of 1998 from the indicators available in 1994; and we predicted the Global Financial Crisis of 2008 from trends developing nearly ten years before. In 1999, we clearly saw that the continued adherence of the Anglosphere countries to the neo-liberal model which they had adopted in the 1980s would result in economic instability and difficulties in adapting to the rise of knowledge-based industries, and the economic, social, and political pressures that this would create:

The increasing inequalities both between and within economies will make it clear that things have to change. Change will come after 2006. The only question is whether it will be forced by depression and the seizure of power by anti-democratic radical alternatives with similar violent consequences as in the 1930s or whether change can be planned and managed to spread opportunities for growth more evenly throughout the world.3

However, accurate prediction by us and others has made no difference. Neo-liberalism had closed the minds of the policy establishment. Despite its hegemonic status in the decades following the Second World War, Keynesian economics never completely supplanted its predecessor. For some, chiefly academics, the Keynesian approach called into question too much of the intellectual capital that had been built up over the preceding century; they concentrated on reconciling Keynes with the classics, and in the process relinquished most of Keynes’s distinctive insights.

For others, such as Friedrich Hayek and Milton Friedman, who were more politically engaged, the guidance that Keynesian economics gave to active government of the market raised the spectre of authoritarianism; they could not accept the Keynesian approach as a via media between ungoverned capitalism and over-governing socialism. This group expended great effort in modernising the traditional defence of free markets against socialism, and gave it sophisticated mathematical garb, in which dress it became known as neo-liberal economics. With considerable financial aid from American billionaires interested centrally in tax minimisation, this group became the pundits of neo-liberal reform, of a return to pre-Keynesian policies by implementing an economic-policy program that became known in due course as the Washington Consensus. They sold themselves as the champions of freedom, yet the policies they advocated have led to accumulations of debt that degrade freedom as surely as authoritarian government does — the difference being that the dictator is no longer home-grown, but a junta of overseas creditors.

We argued, to no avail, that active governance is a necessary but not sufficient condition for sustainable prosperity. Active governments should be guided by realistic theory based on accurate statistics and behavioural assumptions, and they should be honest — serving general, not sectional, interests. Instead, rather than recognising the need for informed yet disinterested government action, the neo-liberals constantly repeated the simplistic message that since some governments are incompetent, all governments should be cut back to the minimum. Many countries, but not all, heeded this message, and we are now in a position to compare and contrast the results.

The best example of a country where the government adopted an appropriate framework for high, sustainable growth is China, which refined the old Soviet comprehensive and rigid planning framework to concentrate its policy focus and resources on the 15 to 20 per cent of the economy that is essential for sustainable growth — namely the high-technology sectors, the sectors where large-scale capital resources are important for competitive success, the infrastructure-service sectors, and those sectors whose world trade share is going to grow relatively rapidly. The rest could be left to market responses. The Chinese learned from the Japanese, the Germans, and the Taiwanese that targeted control of market forces can be a highly efficient way of achieving national economic objectives.

The efficiency of the Chinese economy and of other countries that have learned the same lessons, and the ability of these countries to take advantage of growth opportunities, means that the Anglosphere economies cannot compete. The neo-liberal countries have a simple choice: they can either get with the strength by providing themselves with active, competent governments, or they can retain their current ideological commitments and retreat behind trade barriers.

Faced with this dilemma, the anti-Keynesians will argue that active government is incompatible with economic freedoms. They are wrong. Europe and East Asia both include countries that have combined democracy with active government. A particularly apposite exemplar for Australia is Norway, which over the past decade and more has shown that a democratic version of the Chinese model can manage a resources boom to permanently enrich its citizens — in complete contrast to the Australian case, where the recent mining boom resulted in excessive debt and rising prospects of economic catastrophe. Norway astutely retained ownership of its minerals until their final sale on world markets, employing multinational companies as contractors for the production process; by contrast, the Australian states sold their minerals in situ, in the ground, so that the multinational mining companies cornered nearly all of the final sales value of the minerals.

In this book, we draw on our Keynesian background and on recent developments in practical economics to critique Australian economic policies implemented over the past thirty years, and to present an admittedly gloomy view of the immediate future if current policies continue. Our gloom arises not from a lack of alternatives, but from the cramped mindset of the present political, academic, and media elite. It arises because this cramped mindset is so wilfully unaware of its limitations. We have been trying to point these out for decades.

How do we challenge the neo-liberal mindset? Not by denying the basics of demand and supply; traditional market analysis provides a very useful account of the interaction between highly motivated buyers and sellers.4 However, we insist that economic analysis cannot be abstracted from the march of time. Economies lurch through time; they are often the prisoners of their past, the playthings of technological change, the pawns of international circumstance. This contrasts with the ideal of timeless optimality embedded deeply in the neo-liberal account of market activity. We deny that this basic calculus adequately describes market behaviour; we eschew the concept of equilibrium. The particular resource endowments of regions and nations matter, as do the processes by which these endowments change and are managed and governed.

We try to constantly remind ourselves that economies are infinitely complex; that relationships which are important in some times and places are unimportant in others, and that this changes over time. No matter how many variables and relationships are programmed into the computer, economic analysis inevitably simplifies reality. The challenge is to extract from all the complexity a relevant, comprehensive, yet comprehensible account of each economic question: an account that gives due weight to the uncertainties which arise as we look into the future. The best that can be done is to try to learn from history, from other places, and from developments in all the fields of study that affect economic outcomes — which, in turn, become the inputs for the next round of history. Let the reader judge whether we succeed.