Lowy Institute

Thomas Piketty might be the rock-star of the income-inequality debate, but Angus Deaton has won the Nobel Prize for economics, and deservedly so. 

Perhaps you first heard about his impending fame here on The Interpreter: his book, The Great Escape, was my book of the year in 2014 and I thought he got the better of the income inequality debate with Piketty. The Nobel, however, demonstrates that his contributions go back a long way, and cover much wider ground. You can read the short version of his contributions here and the long version here.

Most of his early work at the World Bank is quite technical, setting up the means for measuring and comparing income across disparate countries and over time, solving difficult issues of income aggregations and comparison. This analysis provided the bedrock data to support his various arguments. He provided a bridge between the arm-waving debate on poverty and the rigour of the academic world.

Tyler Cohen describes Deaton's contribution in more practical terms: 'understanding what economic progress really means'. 

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While Piketty was largely focused on rising inequality in mature economies, Deaton was telling a parallel story of a billion people in emerging economies (notably China and India) shifted out of poverty, dramatically reducing income disparities between rich and poor countries. Hong Kong, Singapore, South Korea and Taiwan demonstrated what a couple of decades of fast growth can do to raise living standards. China, India, Indonesia and a raft of others followed.

Instead of making comparisons of income, Deaton focused on the specifics of consumption measured in intuitively understandable terms: the spectacular general improvements in health and education:

The world is a healthier place now than at almost any time in the past. People live longer, they are taller and stronger, and their children are less likely to be sick or to die. Better health...allows us to do more with our lives, to work more effectively, to earn more, to spend more time learning, and to spend more time with our families and friends.

Not every country is succeeding, and inequality within the success stories is typically getting worse. Deaton captures this diversity with the image of a crowd running forward, holding national flags. Some advance faster than others. Some country groups start behind others. Within each country group the fastest runners are getting well ahead of their compatriots and steadily catching up to those who started in front. The overall result: fewer left behind in abject poverty but many still quite poor; a huge increase in the world's middle class; and a rapid expansion in that small group of the super-rich, holding an assortment of country flags.

Deaton accepts 'the deep conflict between incentives and inequality', but he reminds us that there is more to a better life than just income. Technology, dissemination of knowledge and improved social structures have dramatically raised living standards and life expectancy, making us healthier (and thus probably happier). In the past half-century, the poor have largely caught up with the longer life expectancy that the rich have enjoyed for more than two centuries. Life expectancy in India is now the same as it was in the UK in 1850, when UK income was far higher than India's today.

The foreign-aid industry may have mixed feelings about this award. Deaton was sceptical that foreign aid does much good. Particularly in Africa, fiscal dependence on aid flows has undermined the development of domestic tax administration and institutions.

While Piketty caught the zeitgeist of increasing concern about growing income inequality in mature countries, Deaton added a more cheerful and perhaps more important message: that opportunity – particularly opportunity for education and health – are hugely important to a well-functioning and equitable society. We can take heart from the upbeat opening line of The Great Escape: 'Life is better now than at almost any time in history.'


Ben Bernanke was a member of the US Federal Reserve Board in the tumultuous period from 2002 until 2014 and Chairman from 2006 to 2014. His version of this period is told in The Courage to Act, his 600-page meeting-by-meeting account. This degree of detail would overload a reader who just wanted to know what the lessons were, and where we are now. This is Bernanke writing for history, and he spells out the detail of how, on each of the many decisions, he got it pretty much right.

He joined the Federal Board with the right background for the times ahead: he is an expert on the 1930s Great Depression. This gave him a head-start over most central bankers, whose mindsets were formed (and perhaps scarred) by the 'stagflation' of the 1970s. While their focus was on inflation, Bernanke had the deflationary experience of the 1930s on his mind.

Does his dovish bias explain what many would see as the Federal Reserve's initial mistake – keeping interest rates too low in 2001-2006, encouraging the housing bubble that initiated the crisis? Not really. While 'Maestro' Alan Greenspan chaired the Fed, his views dominated. He had faith that the market would sort things out. In any case the Federal Reserve could not identify bubbles beforehand and could clean up after the bubble burst. Bernanke did not differ.

Bernanke's chairmanship covers two connected but separable phases. First, the unravelling of financial stability as the knock-on effects of the bursting of the housing bubble spread. Then the aftermath, as the US (and most mature economies) struggled to recover.

The excitement starts in 2007, when the collapse of the housing bubble sets off a slow-motion chain reaction. The beginning was hardly noticed: Bear Stearns bailed-out two of its subsidiary funds in 2007, which put it on the path to failure in May the year after. One by one the pins tottered and some fell, culminating in the bankruptcy of Lehman Brothers in September 2008 and the rescue of AIG the following week. 

Beginning in 2007, the Fed and the Treasury were busy putting their fingers in the many leaking dykes. The Fed added liquidity (base money) to the financial sector, guaranteed the money-market funds, allowed investment banks such as Goldman Sachs to change their status so that they were protected by government guarantees, facilitated mergers of failing banks and saved Citibank with guarantees and capital injection. Critical to financial stability overseas, the Fed made US$600 billion of loans to foreign central banks to allow them to on-lend to dollar-short foreign commercial banks.

Ingenuity prevailed, with many late-night and weekend sessions cobbling together solutions.

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The result was a mish-mash of ad hocery, with consistency taking second place to force majeure. The Fed lends to some insolvent banks while others are taken over; Lehmans goes under but AIG is saved. If you want the minute-by-minute version of these dramtic events, read this book. You will sense the lack of preparedness and the unnoticed vulnerabilities that had evolved over the previous decade as profit-hungry financial firms pushed the risk frontier outwards. You will also hear Bernanke condemn the dysfunctional nature of the US political system.

The financial system had become inextricably interconnected and complex. The bursting of the housing bubble – not in itself catastrophic – triggered contagion, reaching to the whole globe. Each of these interconnections was fragile because everyone had borrowed up to the hilt. It was all held together by confidence that the sun would go on shining. When confidence was lost, depositors and lenders wanted their money back; risk perceptions swung from mindless optimism to deep pessimism overnight. The credit rating agencies, always assessing risk by looking in the rear-vision mirror, belatedly downgraded tottering institutions, ensuring they would topple.

Meanwhile, the US supervisory system was so compartmentalised that coordination was lacking. The huge risks on AIG's balance sheet were supervised by an obscure and understaffed regulator. Much of the shadow banking system was under the oversight of the corporate regulator. Deposit insurance was not in the hands of the Fed but a different agency with different priorities. 

Whenever the problem interfaced with the political system, ideology (in particular, free market non-interventionism) dominated. Congress was uncooperative, hobbling and delaying necessary action. The public was stunned and angry that the richly rewarded 'masters of the universe' in the financial sector turned out to be inadequate for the task. 

The second phase of the Bernanke period began in 2009, when the financial sector had regained some composure. The crisis had left a legacy of over-leveraged home borrowers and chastened banks, pushing the economy into recession followed by a feeble recovery. 

The shift of interest rates as the crisis unfolded was dramatic, with the policy rate taken almost to zero. Bernanke was ready to do more. In his 2002 speeches, he had recalled Milton Friedman's idea of 'helicopter money': the authorities could give the public extra money to spend, financed by the central bank. In fact Bernanke did not implement 'helicopter drops'. Instead, quantitative easing (QE) was deployed, which the Japanese had tried earlier in the decade to little effect. The Fed flooded the banking system with reserve money to encourage banks to lend and to push down the longer end of the yield curve.

A Friedmanite helicopter drop would have provided a powerful fiscal stimulus (similar to the Australian 'cash splash' in 2009). QE, however, is a much weaker instrument. Instead of directly providing the public with additional spending power, its aim is to lower the longer-term bond rate in the hope that this will encourage spending. It also provides a psychological message which weakens the exchange rate and pushes up equity prices, both helpful for a frail economy.

Whatever the effectiveness of QE, it is a poor substitute for adequate fiscal stimulus. This was made worse by Congress' threats to impose a debt limit on government spending. Bernanke was left to face a problem which monetary policy alone was not powerful enough to solve.

A reader might come away with the feeling that these serious deficiencies have been resolved. That would be too sanguine. Perhaps the new laws, higher capital requirements and rescue techniques pioneered in this period could do the job when needed. Macro-prudential measures are the new panacea, as yet untested. Much is made of the Fed's greater transparency, without much acknowledgment of its inability, so far, to give a clear message to financial markets, whose instinct was always to panic first and think later.

Bernanke and his colleagues can take credit for preventing an even more serious financial melt-down and recession, but the narrative of the crisis and its lackluster recovery needs a more critical vantage-point, more ready to contemplate the possibility that mistakes were made. More important still, the structure of the financial sector needs a more fundamental re-think, without pressures from Wall Street to get back to business as usual.


I'm only too ready to leave it up to strategic experts such as Rear Admiral Peter Briggs to sort out how many submarines we need. I'll stick to the economics. We shouldn't let the number be determined by a perceived need to provide work-continuity for ASC in South Australia. And we should acknowledge that this is a decision about 'guns or butter': spending more on submarines by building them at home means less of something else.

The Senate inquiry on the future of naval shipbuilding in Australia is a 'must read' for anyone interested in the decision-making process. It's an example of Australia's own version of Eisenhower's 'military-industrial complex' in operation. Even though this was the Senate Economics Reference Committee, the list of contributors is almost exclusively construction-industry representatives, regional lobbyist, trade-unionists and former services personnel. The taxpayers were under-represented. 

Reading the testimony, you might get the impression that the Collins saga had been a brilliant success and that building a new fleet of submarines in Australia would be no dearer than building overseas, an assertion consistently refuted by actual domestic ship-building experience (See ASPI's 'Four ships for the price of six').

Members of the Committee would have been courageous (in the 'Yes Minister' sense) to have been critical or sceptical, as all political parties covet those South Australian votes. Even so, the report was not, as Admiral Briggs stated, unanimous. There was in fact a substantial dissenting report issued by the Government members of the Committee, which (inter alia) specifically addressed the issues I raised in my initial post on this issue.

In response to the recommendation that Admiral Briggs quotes, the dissenting report says:

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Response to recommendation 3. The draft report calls for an Australian build at all costs. This could give rise to national security outcomes being compromised by a prioritisation of industry policy over defence policy and it could force the taxpayer to underwrite an economically uncompetitive project. While we want to see the Future Submarine contract awarded to Australian shipbuilders, it must also be the result of a competitive tender process and it must be awarded on merit. This will ensure that Navy receives a fit for purpose product of the highest standard while Australian tax payers receive the best possible value for money.

. . .Recommendation 3 effectively relegates national security policy to second place behind industry policy.

I couldn't have said it any better.

The substantive difference between Peter Briggs and me relates to the impact of spending on submarines on the economy. It is standard practice for consultants-for-hire to make their lobbying case on the basis that spending on the target industry will boost the economy, not just by the amount of the actual expenditure, but by a multiple of this because of successive rounds of spending. This is akin to the familiar textbook multiplier process. You can go one step further (as the 'eloquent' testimony of Professor Goran Roos does) and double-count the contribution of sub-contractors. If you want to get a good reception where 'jobs and growth' are the paramount political concern, this is the way to go.

It is only in rare circumstances, however, that this makes any economic sense. The multiplier logic relies on squeezing more than a pint out of a pint pot. The implicit assumption here is that there is unused capacity in the economy – capital, managerial talent and unemployed workers – all ready and waiting to respond to this extra demand to build submarines, adding to GDP in the process. Not only are these resources assumed to be unemployed now, the assumption is that they would have remained so over the life of the project.

Of course Australia has unemployment – currently 6.2% of the workforce. But this is close to the lowest level of unemployment Australia has had for the past quarter-century. It would be nice to get back to the lower level we had at the height of the resources investment boom, but this kind of fine tuning is not feasible.

The proper way to analyse how the submarines might affect GDP is to think in terms of opportunity cost: if these resources – capital, managerial talent and labour – were not building submarines, they would be doing something else which society also values. The productivity challenge is not to attempt to conjure productive capacity out of thin air, but to shift the economy's given resource endowment into uses which have a higher social value.

Government industry policy (subsidies, 'picking winners' and so on) may play a part in that process. Economists are not all free-market ideologues. Some of us accept that governments can sometimes use their considerable expenditure to steer resources into areas which will catalyse higher-value output and have longer-term benefits even when the expenditure ends. But economists also look back on the history of infant industries which never grew up, and on politically driven white elephants. Who wants another Darwin-Alice Springs railway? 

Where does domestic submarine construction fit in such a framework?

Will this foster a viable industry which suits our comparative advantage? Will it form the nucleus of a cluster of highly productive firms with a self-sustaining future when the submarine work is finished? Will it link into international supply chains, thus compensating for our lack of manufacturing scale? Will it be disciplined by international competition, or link us more firmly into the rising demands of East Asia?

The Collins-class experience suggests that constructing bespoke submarines is a dead end, a mendicant industry whose survival depends on government subsidies.

Does it make any difference that domestic construction avoids importing? In a globalised world with flexible exchange rates, this 'exports good, imports bad' argument, common though it is, has to be dismissed. The flexible exchange rate looks after the need to keep imports and exports in equilibrium with the available funding from capital flows.

The dissenting report of the Senate inquiry was a brave attempt to put some limits on the size of the hand-out, through giving the rival bidders some flexibility on the domestic content of construction. The competitive evaluation process seems the last opportunity to impose some economics on this politics-driven project.

Photo courtesy of Australian Defence Image Library.


The economic debate in Australia is dominated by the impact of the unwinding of the commodities 'super-cycle'. Australia is having to adjust to substantially worse terms-of-trade (the price of what we export compared with the price of our imports), the slowing of the spectacular resources investment boom and reduced fiscal revenues from resources.

Australia is not, however, the only country which has to undergo this adjustment. In fact, our fiscal dependence on resources is quite low by global standards. It's hard to see on this crowded graph, but Australia is eighth from the right, with less than 5% of budget revenue coming from resources during 2000-2011, according to these IMF figures.

This analysis was delivered at a conference in Jakarta, where Indonesia is fumbling to sort out the mess of its mining legislation. The focus was on our neighbours, with regional data presented in this more legible graph:

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The extreme cases here (Brunei and East Timor) have such huge oil revenue that the current lower prices won't affect budgetary expenditure much in the near future. Timor is accumulating substantial oil revenue in its sovereign wealth fund, rather than spending it all in the budget. But for the other five, the fall in revenue will be painful and immediate.

Indonesia, for example, improved its budget position by cutting petroleum subsidies last year. But lower commodity prices are offsetting much of this improvement. Indonesia also has some self-inflicted challenges. Current Indonesian legislation requires mineral exporters to process ore domestically, which is discouraging investment. The objective sounds reasonable enough: to shift from a simple focus on resource revenues towards a new objective of boosting the wider economy. But this is an illusion. The better way to think about this issue is to see the processing requirement as an imposition, like a tax: if Indonesia didn't impose this obligation, it would be able to collect more mining revenue. This lost revenue is being directed into what are probably low-return investments in ore processing, rather than being available for higher priority budget expenditures, such as infrastructure.

For Australia, there are other elements in this painful adjustment: adaptation to the ending of the investment boom and the lower terms-of-trade. The lower resource revenue requires a policy response, and the IMF argues that a resources-rent tax should be a key element of tax strategy. This is not only a matter of equity: a tax which varies with the commodity cycle would greatly assist macro-economic management.

The resources-rent tax proposed by Kevin Rudd was so complex and confusing that the mining industry pulled off the greatest public-relations coup of all times (combined with political ineptitude of a high order), with super-rich miners winning the debate. The proposed tax was reduced by Julia Gillard and even this tiny vestige was abolished by the Abbott Government. That's not the only reason why Australians now find themselves with an inadequate tax take, but abolishing a tax, no matter how rhetorically attractive, has to be made up by other taxes sooner or later.

There is talk that all elements of taxation will be on the table under Australia's new leadership. Is this one included? Low commodity prices provide the best environment to introduce a super-profits resource-rent tax, because profits are not super in this phase of the cycle, and resistance may not be so fierce. Once in place, the tax is ready to help manage the next upswing, whenever it comes.


The pace of decision-making on Australian submarines is quickening, with the core of the current debate driven exclusively by South Australian politics. But the insistent voices of regional and industry lobbyist need to be balanced by reminders of the price the rest of Australia will pay for make-work projects creating permanent mendicant industries.

The proponents should be obliged to make the economic case, not just threaten to pull the political plug. In a world where the nation is trying to become more productive and internationally competitive, economics should enter this key decision in a more substantial way. For example, ASPI's most recent examination of the project is feather-light on economics.

Where economic arguments are put forward, they are often fallacious: see this demolition of the South Australian lobbyists' advocacy. 

As a small nation in an uncertain world, our best chance is to be highly efficient and productive in what we do, and this means avoiding frittering away our resources on white-elephant projects. We need to correct the false economics in the current arguments over the future of the project and introduce the concept of opportunity cost.

There is a widespread sentimental view about the importance of manufacturing: because manufacturing provided many well-paid jobs in the past, the argument goes that we need to get back to 'making things'. But manufacturing provided well-paid jobs thanks to huge subsidies, mainly in the form of tariff protection, which raised prices for consumers and lowered national living standards. After many decades of tariffs and direct subsidies for automobile production (with South Australia a large beneficiary), we are finally wrenching ourselves free. Consumers now have the benefit of cheaper cars, and the burden on the budget is being lifted.

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Manufacturing is now 6.5% of GDP, less than half of what it was four decades ago. The economy has adjusted successfully to the reality that Australia does not have the scale or cost-base to be a major integrated manufacturer. Manufacturing will find its place as part of a global supply chain, in specialised niches, and in offset projects working with foreigner producers. The Government should be ready to help fund the adjustment process, but we don't want to adjust from one unviable manufacturing model to another.

Part of this sentimental attachment to manufacturing has been a nebulous security argument: in the event of war, we need to be self-sufficient. But self-sufficiency in modern defence technology for a small country like Australia is a pipe-dream. Even if the submarines are built here, large key components are going to have to come from overseas. In the event of hostilities, we'll inevitably be dependent on overseas suppliers to keep our submarines operational (same for our military aircraft). 

Those who put forward the canard of defence self-sufficiency should recall the World War II experience of sending home-made Boomerangs up against Japanese Zeros. This did not turn out well. We need state-of-the-art subs, not compromises to boost domestic content.

The current proposals involve reconstituting the domestic submarine industry, which cost us so dearly and produced an imperfect product with the Collins class. It is more than a decade since the last of these was built, so the specialised skills brought together have dispersed. There is no hope that anyone else will buy our bespoke subs, leaving the construction component as a dead-end industry.

Australia is a federation, and the need to support South Australia (and others) is part of the federation deal. But the question is: how much? Federation shouldn't be a license for political blackmail.

Tony Abbott offered South Australia a substantial medium-term economic future building surface ships, and the prospect of doing the ongoing maintenance of the new submarine fleet. Now, with the South Australian defence lobby feeling the wind in its sails, the stakes (and the subsidies) are rising. One of their arguments rejects the idea of partial (hybrid) construction on technical grounds: modern sub-building has to be done in one place. This argument is put forward in the confident belief that this place has to be Australia. A variant is Senator Nick Xenophon's specification that 70% of the total value of the submarines should be Australian-made. Is there no technical limit to the make-work arguments?

Here are some considerations:

  • The competitive evaluation process should be rigorously enforced to limit the intrinsic 'open cheque-book' nature of the project. Construction promises should wait until this process takes place.
  • Let's not preempt the competitive evaluation process by specifying the local content in advance. Let's see what the bidders offer, each of them knowing that domestic content has a favourable weight in the assessment.
  • Out of this evaluation process should come a well-based figure of the extra cost the nation will have to pay for home-made subs. This can be weighed against our obligations as a federation.
  • The number of subs to be built shouldn't be set by the need to provide continuous work in South Australia, but by a realistic evaluation of our security needs and capacity.
  • Past performance (in this case the lamentable Collins experience) can't predict the future but, as usual, it's a good place to start. Objective assessment, not industry assertion, is needed to evaluate domestic capability.
  • The Department of Defence should articulate the reality of opportunity cost. If submarines cost more to make here, that should mean less defence spending elsewhere: fewer subs or fewer guns. It shouldn't mean upping the demands on the general budget ('more guns, less butter').
  • Given the political reality that some manufacturing subsidies are inevitable and that adjustment support is desirable, is this the best option? What alternative manufacturing industries might offer a realistic prospect of creating a viable internationally competitive industry? 

The cost of the subs puts the project on a par with the National Broadband Network, which was endlessly debated in public. In contrast, home-made subs might become a fait accompli without ever passing any serious economic scrutiny.

Photo courtesy of Australian Defence Image Library.


Global financial markets are on tenterhooks waiting for the US Federal Reserve to decide when to start raising the Fed funds rate – the short-term interest rate which sets the datum for many other interest rates. The media have reported this in portentous tones, exploring every possible downside risk including a repeat of the 1997-98 Asian financial crisis.

But exactly when the Fed makes its first tiny move in the tightening sequence is not very important, and should have little or no effect on the real economy, in the US or elsewhere.

The current interest rates in almost all mature economies are at extraordinary lows, with the policy rate effectively zero in many countries and even negative in some. Most accept that, with the US recovery underway, interest rates will soon begin returning to more normal levels.

But the exact timing doesn’t matter much. Janet Yellen, the Chair of the US Federal Reserve, has said again and again that the Fed will move when the time is right, and that the sequence will be gradual. Yellen has emphasised that the policy moves will be ‘data dependent’; in other words the Fed will move sooner and with more follow-up increases if the economy is seen to be expanding fast, and more gradually if the expansion is weaker. 

There can't be many investment projects whose viability hangs on the exact timing of this first decision. Nor should the decision have much impact on financial markets. If the Fed goes earlier and the sequence is faster, it means the economy is stronger, thus equity prices face offsetting factors. Current expectations about the sequence of future tightenings have already been built into longer-term yields, and the Fed’s first move won’t add much to what the market already knows about subsequent tightenings.

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What about the hand-wringing over the impact on emerging markets? The last panic about the Fed’s policy prospects was the notorious ‘taper tantrum’ in May 2013. Ben Bernanke, then Chair of the Federal Reserve, told the markets something that was already widespread knowledge: that at some stage quantitative easing (QE) would come to an end. In response to this non-news, exchange rates in a number of emerging economies fell quite sharply. When active QE did come to an end later that year, financial markets hardly noticed. 

Since then, the large capital flows that went to the emerging economies during the QE period (2009-2011) have reversed, and exchange rates in these countries have adjusted downward in response. The Indonesian rupiah, for example, is down about 10% this year and about 25-30% over the past few years. That’s about the same as the fall in the Aussie dollar. In neither country has this caused great trauma. It's part of the usual commodity-price adjustment process.

What market adjustments will be necessary when the Fed makes its move? All those with vulnerable portfolios have already adjusted – hence the capital outflows from emerging economies over the past year. Those with dollar-denominated debt are already dealing with the consequences. Longer-term interest rates have adjusted to the best guess of the future.

It’s true that the tightening phase in the past has sometimes been stressful. Commentators look for guidance from the 12 Fed adjustment cycles since 1955, and in particular the 1994 tightening which came as a surprise to the bond market. But there are no surprises in store this time.

It’s also worth noting that all the early tightenings in this history took place in a very different policy environment, where it was necessary to rein in an economy that was travelling too fast. With the crude policy tools of the time, this often caused a sharp downturn. Policy instruments are now more subtle and exchange rates are flexible. This tightening can be gentle because it's not responding to runaway demand.

Commentators also point to the mistakes which policy makers have made in past tightening phases, including two recent examples: Japan in 2000 and, notably, Sweden in 2010-11. But the very fact that Yellen quotes these earlier mistakes is insurance that the Fed won’t repeat them.

In any case, even if the Fed does make a mistake and tightens too early, we won’t know that it was a mistake for some time.

Nor will this first move tell us anything about future moves, or whether the Board of the Federal Reserve is dominated by hawks or doves. Yellen is by inclination on the dovish side, but she has talked about the impending increase so many times that the move, whenever it comes, cannot be interpreted as a victory for the hawks. 

Some are arguing that if the Fed moves while inflation is still so low, this will confirm that there has been a change in policy regime – the abandonment of the implicit 2% inflation target. This, too, seems an overwrought interpretation. The mature economies have experienced an unusual, perhaps unique, period of zero-interest rates. This has distorted saving and investment decisions and leaves economies vulnerable to asset mispricing. A move while inflation is still low will confirm what we already know: that central banks are uncomfortable with near-zero interest rates and anxious to get them up off the floor just as soon as they can safely do so. Getting inflation back to 2% will take longer, but the idea of using inflation as the key guidance for setting the stance of monetary policy hasn’t been abandoned.

To argue that the exact timing of the Fed’s first move is unimportant is not to deny that there are serious unresolved issues in macro-policy. There is no disputing that the normalisation of interest rates over coming years will traverse unknown territory. There are also real concerns about possible secular stagnation. Have the mature economies lost their mojo? The recovery in the mature economies in the seven years since the financial crisis has been pathetically slow, notably in Europe. How can growing income inequality be addressed? Can China maintain the 7% growth we have all come to depend on?

In this uncertain world, why have financial markets fixated on this trivially unimportant decision? One possibility is that much of the business of financial markets – forward contracts, futures, options and so on – is a form of gambling about events which in themselves don’t affect the real economy much. But the outcome of the gamble does have great import for the players themselves. Unfortunately there is collateral damage to innocent bystanders, adversely affected by the gloom and general uncertainty produced by this fixation. Perhaps this is why emerging-economy policy-makers are now urging the Fed to just get on with it and to put an end to the confidence-sapping agonising.

Photo courtesy of Flickr user International Monetary Fund.


In terms of the world's financial markets, China is the centre of attention. Last week I argued that concerns about stock markets and exchange rate devaluations were minor and ephemeral issues. Attention should instead be on the longer-term challenges that China faces in keeping its growth rate close to 7%.

How much does this matter to Australia?

Sometimes a table can tell the story better than a thousand words. The table below shows the share of each G20 country's exports going to China. Australia is at the top. This dependency has increased dramatically since 2007 – well over two-fold.

Exports form G20 member states to mainland China, as a share of the country's total exports, in percent (Peterson Institute)

Actually, Peterson Institute data suggests that there are 10 or so other countries (such as the special cases of Hong Kong and Mongolia, but mainly in Africa) which may be even more dependent on exports to China than Australia. But Australia tops the list of countries with data that is sufficiently reliable to draw a firm conclusion.

The graph below draws on the same data, but groups countries by region. China's imports have grown so quickly that every region has increased the share of its exports. Overall, China's share of global exports has grown from 6% in 2007 to 9% in 2013.

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These statistics are over a year old, and more recent information shows a sharp fall in the value of China's imports. This may be evidence of a significant slowing in China's growth rate. But there are other possibilities. It may instead reflect cheaper global commodity prices (a ton of iron ore or coal now costs a lot fewer US dollars). Or there may be reduced reliance on imported inputs into manufacturing production, as China develops capacity to make these requirements domestically. Or the larger volume of services now in China's output mix may have little or no import content. Whatever the reason, it seems unlikely that the spectacular growth of imports will resume.

Australia has a lot of adaptation ahead if we are to continue to be pulled along on the coattails of China's evolving economic expansion.

There is an often-heard concern that the export-led model that propelled China's growth in the two decades before 2007 cannot be maintained. But that model expired six years ago when China shifted away from using net exports to boost growth. Exports are still important, but have grown more slowly than imports (shown by the negative net exports in the most recent years in this graph).


Over the last few weeks, global financial markets have once again demonstrated their predilection for over-reacting to ephemeral news. For their part, the media are always happy to pad out the 24-hour news cycle with a breaking crisis. If it's transient, so much the better: you can report a fresh crisis tomorrow. Together, the drama-queens of the markets and the media might confuse us about the prospect of the global economy.

And recently China has been hogging the headlines. As Leon Berkelmans noted, we should keep calm and wait to see what develops. It's certainly true that China now has such heft in the global economy (both through the size of its GDP and its importance in international trade, particularly commodities) that its prospects matter to the rest of us. But the recent news has focused on two rather minor short-term issues: a reversal of the unsustainable equity euphoria and a minor adjustment to the exchange rate. The important underlying issues are much the same as they were a month or a year ago:

  1. The economy's rate of expansion. Is China still growing at somewhere around 7%? Scepticism about official data is an old story among China watchers, and in the past the sceptics have been confounded. Will this time be different? Maybe, but some of the best commentators remain to be convinced that China is far off its normal growth track.
  2. Can China make a smooth transition from investment-led growth to consumption-led? This path is tricky and probably not without some bumps, but the same data which gives rise to growth concerns also suggest that this transition is underway. The recent rapid growth of the service sector (larger than manufacturing and construction taken together) suggests a shift to consumption. Services expansion doesn't require big capital expenditures, but it does employ a lot of people, so this fits apparent anomalies in the current data.
  3. The 2010 stimulus not only boosted GDP growth, it also boosted debt levels. Thus, China's growth of debt remains a concern. It's an established norm that countries going through financial deregulation routinely suffer a financial crisis. Again, expect bumps along the path, but there is not much new to add to these old stories.
  4. Did the Chinese market intervention demonstrate that policymakers have lost their sure touch or that their policy approach is no longer appropriate? Not really. They are, by nature, policy activists. Free-market commentators will disparage such intervention, but the ongoing consequences of this misstep are minor. It says little about underlying policy competence.

So much for China. But closer to home, commentators can't resist drawing parallels between current events in Southeast Asia and the 1997 Asian financial crisis.

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Most egregious of these stretched comparisons is the observations that the Indonesian rupiah is now not far from its disastrous nadir during the worst days of 1998, with the implication that a repeat of the crisis is imminent.

True, the exchange rate is now 14,000 rupiah to the US dollar, compared with 16,000 on several occasions in 1998. But in 1998 this represented a drop of 80% within a few months. Those who had a loan denominated in dollars suddenly found their debt had gone up seven-fold in terms of rupiah. The current rate is down less than 10% so far this year and is around 25% below the average of recent years. This is not much different from the fall of the Australian dollar against the US dollar. The exchange rate of the rupiah against the Aussie remains around 10,000 – where it has been for the past few years. This is an unhappy outcome if you happened to have borrowed in US dollars, but it is not a national disaster.

It might even stir the authorities to focus more on economic policy, where there is much that could be done to demonstrate to financial markets that this is a routine commodity cycle, not a crisis.

What about the other emerging economies? The importance of these in global economic growth is illustrated in the chart below: it's not just China that has kept the world economy growing over the past decade, other emerging economies were important as well.

Here the news is rather mixed, as usual. Brazil has flopped back into its traditional disappointing under-performance. On the other hand, India might grow as fast as China. Around the rest of Asia, China's reduced import demand will be a dampener on growth, but once again this is a matter of degree, not crisis.

The IMF's latest forecast was made in July, before the China excitement. In any case, bureaucratic constraints prevent the Fund from ever forecasting a crisis. That said, the Fund's outlook is for 'business as usual'. As I have noted before, the Fund's commentary over the past three years has emphasised slowing economic growth, but its figures – actual and forecast – have shown a steady expansion (measured in terms of purchasing power parity) over the long-term average: around 3.5% globally, with emerging economies growing around 4.5%.

It's hard to fill the headlines with routine news. It's hard to make profits from financial trading if the markets are stable. So expect more of this confected panic from the professional doomsayers.


A month ago, international trade was in the headlines. President Obama had just obtained Trade Promotion Authority for the Trans-Pacific Partnership (TPP), and in Australia, the China-Australia Free Trade Agreement (ChAFTA) was signed. But then all went quiet.

Trade Minister Andrew Robb.

The ministerial meeting in Hawaii that was supposed to finalise the details of TPP didn't reach full agreement. ChAFTA's passage through the Australian parliament is not without opposition. Both these initiatives, however, are still very much alive.

The TPP negotiations are being held behind closed doors, but there seem to be three problems:

  • Canada doesn't want to open up its milk market, while New Zealand (the world's biggest exporter of processed milk) sees this as an important issue.
  • In automobiles, the US wants better access to the Japanese market. Interaction between TPP and NAFTA rules are also complicating this trade.
  • The US pharmaceutical industry wants to keep its biologics testing results secret for 12 years, but Australia thinks five years would be enough.

There may be other issues as well (Australian sugar producers are still hoping to open up the US market), but these are the main stumbling blocks. None of them look insurmountable.  It's hard to see further protection for pharmaceuticals as a deal-breaker for Australia even though our trade minister has given assurances that the TPP will not undermine Australia's pharmaceutical benefits arrangements, a key component of social welfare.

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Nor will the deal be lost because of US-Japanese auto trade. Some observers would regard US manufacturers' hopes of shipping lots of cars to Japan as a conceit and a delusion. But even if there is substance in this trade-opening initiative, it's too small to stand in the way.

It seems just as unlikely that dairy trade will torpedo the agreement, although it might mean that Canada joins late (or New Zealand, as one of the initiators of the TPP, goes away very disappointed). It's just not substantive enough to stop the broad-reaching TPP from going forward.

Given Obama's high-profile commitment to the TPP and the need to put substance into the US rebalance to the Asia-Pacific, he is not going to lose this one without a very serious fight.

The wild card in all this is the US Congress. With the various delays, Congressional consideration is unlikely to take place until next year, while the presidential election is in full swing. There will be the usual Congressional histrionics in defence of local interests, and the vote could be lost, almost by accident. This is the main threat to the TPP. 

The pity of the current debate is that it largely misses the substance of the TPP. Most of this horse-trading has been old-fashioned guerrilla resistance to the longer-term inevitability of integrated global markets. The essence of the TPP is not in trade-opening measures (although they are present, of course), but rather in its effort to lay down a set of broad rules to cover general aspects of international trade, with intellectual property (IP) rights the most prominent. 

IP (and the other behind-the-border issues) are not the win-win issues which usually characterise reductions in global trade barriers. Instead, the rules around IP arbitrate the division of the benefits of innovation between owners and users – a zero-sum game. This should be settled not by an arm-wrestle between trade negotiators, but by a technical consideration of which rules offer the greatest incentives to ongoing innovation. Giving past inventors a monopoly may not be the best way to foster future innovation.

Australia's stand on pharmaceutical data secrecy is on the side of the angels. It's inefficient to keep testing data secret, because it ends up either lost to the wider community or duplicated by other researchers. But it's inconceivable that we would take our principled stance to the stage where we walked away from the negotiations. There is too much else at stake to want to infuriate the US over this issue.

If the TPP goes ahead, the outcome on these rule-setting issues (not just IP but also investor-state dispute settlement) will be a measure of how successful our negotiators have been. 

In the longer term, history may judge the most important issue to be the exclusion of China from the negotiations. Does this tactic allow a superior set of global trading rules to be put in place, with China coming to adopt these later, to everyone's benefit? Or will this turn out to be a missed opportunity to make China a responsible stakeholder in global economic infrastructure, helping to convince it that cooperation within such a framework is better than confrontation?

We don't know if Australia's negotiators ever explored this issue. But we now have the example of the Asian Infrastructure Investment Bank, which suggests that where China is blocked from full participation (as it has been in the IMF and World Bank), it seeks alternative arrangements where its role, for good or bad, will be exercised more individually.

Photo courtesy of Flickr user TPP Media Australia.


An underlying theme of a recent Lowy Analysis paper (Trade Protectionism in Indonesia: Bad Times and Bad Policy) is that current Indonesian economic policy-making is refuting 'Sadli's Law': good times give rise to lazy populist economic policies while crisis times produce good policies.

Mohamad Sadli, a key member of the 'Berkeley Mafia' of economic technocrats who guided economic policy through much of the Soeharto era, certainly had enough economic ups-and-downs on which to base this insight. But in this Lowy Analysis, Arianto Patunru and Sjamsu Rahardja argue that politics has undermined Sadli's Law: bad times are producing bad policies. Will last week's cabinet reshuffle change this melancholy assessment?

On the surface, Susilo Bambang Yudhoyono's decade as president (2004-2014) seem to have provided some confirmation of the 'easy' phase of the Law: good times encouraged lackadaisical policy-making, with serious reform stuck in the 'too hard' tray. Indonesia's export commodity prices were strong and China's spectacular growth provided a ready market. The good times saw little progress  and even some slippage, through creeping interventionism and industry protection. More fundamental reforms (eg. in finance, the legal system, the bureaucracy and state-owned enterprises) were sidelined by immediate distractions. Indonesia's infrastructure shortfall went from poor to parlous.

But the policy environment has changed post-Soeharto, with democracy encouraging populist policies and self-interested parliamentarians limiting what a president can achieve. Was SBY's rather disappointing economic performance an example of Sadli's Law, or instead a reflection of this more difficult policy environment?

The real test of the Law comes when times are tough. Now, with the benign international environment of high commodity prices gone, where is the reforming policy response, emboldened by the urgency of the moment? Can the current economic ministers reprise the crisis-resolving reforms of the 1970s and 1980s?

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The differences with today's economic policy-making are profound. Then, the technocrats were a close-knit team with a clear leader who imposed a consistency of approach. For most of the Soeharto era, Widjojo Nitisastro was an influential advocate in cabinet for sensible economics. The technocrats operated in an environment (both in public opinion and among rival policy camps) deeply suspicious of so-called 'free-market liberalism' (a legacy of the colonial period), and yet by a combination of Javanese guile and force of argument, they were able to keep the economy open to foreign competition and foreign direct investment.

The technocrats demonstrated that if the big-picture macro-economics could be kept in reasonable order – with balanced budgets, small external deficits, restrained monetary policy and a competitive exchange rate – then the economy would operate quite well, even if many of the micro issues were far from ideal and much potential was left untapped. Crony capitalism, for all its unattractive and harmful effects, was still consistent with three decades of 7% annual growth.

Perhaps the greatest difference was that Soeharto trusted the technocrats and turned to them whenever the going was tough. Jokowi, the former businessman, seems to have confidence that running an economy is just like running a scaled-up business. There are many examples in the wider world where successful businesspeople believe that their skills are readily transferable to the economy as a whole. But skills in running a business are not readily transferrable to the overall economy. A key macro-economic insight distinguishes the business mindset from that of the economist : 'in the macro-economy, everything is connected to everything else'.

Rather than being guided by this macro view, current policies are essentially reacting in isolation to the latest problem as it emerges. The first response is to attempt to influence demand and supply in individual industries through subsidies and protection. Import quotas are tightened to protect domestic producers, then expanded again when supply shortages push up prices for consumers. Protection for one industry makes life harder for other industries and stifles dynamism.

The Jokowi presidency is less than a year old. Former finance minister Chatib Basri has suggested that all governments come to power with new ideas, and in time end up with the same old tried-and-true views. This is a version of 'mugged by reality', but there are many paths to bad policy, and new players can waste too much time exploring them. Some of Jokowi's Big Ideas, such as infrastructure and maritime development, make good sense if they can be well implemented. But Indonesia currently lacks the supporting bureaucracy and trustworthy legal system to deliver on this strategy.

What of the new economic ministers? It's true that the new economic coordinating minister, Darmin Nasution, has a wider policy-making background than his predecessor, having held senior roles in financial supervision, tax administration, and as governor of the central bank. But in the latter role, his interventionist policies in the foreign exchange market give him a much-criticised reputation for micro-management. The appointment of a former economic coordinating minister Rizal Ramli to coordinate maritime affairs should enliven cabinet meetings with verbal fireworks. His well-established reputation as a scatter-gun critic has already offended other cabinet members, who resent his interference in their territory (even if he may well be right).

Meanwhile, the economy is slowing but is still growing close to 5% (twice as fast as Australia). Maybe Indonesia will just muddle though, falling well short of its potential (and Jokowi's target of 7% growth). As usual, both the optimists and the pessimists will be disappointed that their predictions have not come to pass. One thing is clear: Sadli's Law is no longer operating.

Photo by Flickr user Ignatius Win Tanuwidjaja.


Given the tragic history of East Timor, it is understandable that Senator Nick Xenophon should argue for an early and generous settlement of the Timor Gap border issues with East Timor. We are rich and they are poor. Current agreements do not draw the division between Australia and Timor equidistant between the two countries, as might seem equitable.

But, as I argued in an earlier post, it's not so simple.

First, this poor country has already accumulated a fund of almost $US17 billion from oil revenues from the existing petroleum agreements between our two countries. They can't effectively spend this money as fast as it is coming in. They receive 90% of the revenues from the Joint Petroleum Development Area (JPDA). If development of Greater Sunrise were to go ahead (with prospective returns often estimated at $40 billion), Timor would receive half the revenue under the existing agreement.

Is Timor entitled to more? If it is about geography, then you have to go to the charts. Drawing the southern edge of the border (running roughly east-west) so that it is equidistant between the two countries would not put Sunrise in Timor's territory, as 80% of Sunrise lies to the east to the JPDA. To get Sunrise into Timor territory, you would have to shift the eastern edge of the JPDA.

This edge of the JPDA is usually described as a 'simplified equidistant line between East Timor and Indonesia', and so there would seem to be no reason for shifting it. In the fraught history, however, there have been claims that it should be redrawn. The most extreme of these came from the Lowe opinion, provided in 2002 by lawyers retained by one of the firms which had been given exploration rights for this area by the Portuguese before they abandoned Timor in 1975. This legal opinion was an ambit opening bid, never taken seriously.

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The map which accompanies Senator Xenophon's article (shown above) also shifts this eastern border. It may be based on this 2006 article, which seems to be a biased source with arbitrary specification of boundaries – judge the article for yourself!

More recently, an American lawyer (sympathetic to the Timor position) has produced some beautiful Google Earth maps analysing possible borders, one of which puts 70% of Sunrise in Timor territory. But it depends on just where you start your eastern border. The critical point where this hypothetical border meets the Sunrise field is actually closer to Indonesia than to Timor, while the existing JPDA edge is about equidistant, as you would expect it to be.

Here is the dilemma: this border depends on East Timorese and Indonesian territory, not Australian. If you want to draw this border with a view to getting Sunrise into Timor's territory, you will surely open up the issue of Indonesia's border. It is certainly true that Sunrise is closer to Timor than it is to Australia, but it is closer to Indonesia than it is to Timor. Indonesia could well claim that the 1972 border was drawn under duress, at a time when Australia was strong and Indonesia was weak, and that it should be redrawn to reflect current UNCLOS norms. If that were to happen, it seems unlikely Indonesia would be ready to give 50% of Sunrise revenue to Timor.

Then there is the vexed issue of the continental shelf. A glance at any chart showing sea-depth (such as the DFAT map immediately above) reveals why the 1972 borders were drawn where they were: Australia has a well-defined continental shelf delimited in this region by a deep trench (the 'Timor Trough').

The continental shelf is still the basis of many international maritime borders, but where countries are less than 400 nautical miles apart, UNCLOS arbitrators have had such trouble with arguments about just where a continental shelf ends that they have taken the easy way out, routinely ignoring the continental shelf and settling on an equidistant border. This is presumably why Australia is reluctant to put this issue to international arbitration. And of course we are not the only country that sees UNCLOS arbitration as unsatisfactory. The US, for example, has not even ratified the agreement.

The continental shelf is not a trivial issue for Australia. This map (reproduced below) shows our sea-borders are largely based on the geography of our well-defined continental shelf, with special provisions for various off-shore 'rises' such as in the Antarctic. This approach has been blessed by the relevant UNCLOS Commission on the Limits of the Continental Shelf. Note, however, the yellow section relating to the JPDA. Drawing the border equidistant with Timor would be giving away an area which we have long regarded as part of our continental shelf.

What would be the result of accepting Senator Xenophon's argument? Replacing the southern edge of the JPDA with an equidistant border would make little difference to Timor's petroleum revenue, as they already get 90% of JPDA revenue. But it would give away a chunk of our continental shelf and might set precedents. Shifting the eastern boundary of the JPDA with the objective of giving Timor all of the potential Sunrise revenue (rather than the 50% in the existing agreement) would open up the border negotiations with Indonesia, with a good chance that Sunrise would end up in Indonesian territory, and Timor would get nothing.

Thus, Australia's core negotiating position seems sensible and easily defensible: we are ready to give Timor the greater part of the petroleum revenues from the disputed area (which would give Timor very substantial revenue for decades to come), but we are not ready to give away the continental shelf or open up the 1972 border agreement with Indonesia.

Unfortunately these negotiations have been seriously tainted by the ham-fisted actions of our intelligence operators, to our enormous disadvantage and shame. As former Foreign Minister Downer said: 'you didn't have to spy on the East Timorese to find out what their position was'. Senator Xenophon might usefully turn his prodigious energies to providing some proper oversight of the Inspector Clouseaus in our intelligence service. 

Ed. note: This article was originally published without the last section (beginning 'The continental shelf is not a trivial issue for Australia...'). We apologise for the error.


Gareth Evans is usually credited with initiating the idea that the Indonesia-Australia relationship needed 'ballast' to keep it upright against the storms it inevitably encounters:

For many years now we have possessed what could be called common strategic interests. These interests are important, but they have not been enough to give ballast to the overly intense political relationship.

This powerful image has reappeared many times since 1988. But just what is the 'ballast', and how do we create enough of it to counterbalance the 'overly intense political relationship'?

There isn't just one answer or one approach. But one example, the ANU Indonesia Project, celebrated its 50th anniversary in Canberra last week. This well-attended celebration included the launch of Colin Brown's history of the project, Australia's Indonesia Project: 50 Years of Engagement.

Those thinking that the present strained juncture is the lowest point in the relationship might contemplate the unpropitious climate in 1965 when the Project was established. Laid out in Australia's Indonesia Project, the proposal that the economist Heinz Arndt put to the ANU vice chancellor stated:

There is an almost complete lack of the macro-economic data one normally takes for granted...The present government is unlikely to evince interest in, or facilitate, economic research or policy advice based on research. If political relations between Australia and Indonesia should further deteriorate, fieldwork, already difficult to organise on the outer islands, may become impracticable even in Java

Nor did the Project have support from academic colleagues, as outlined by Arndt: 'Everyone, almost everyone I consulted advised against the effort'. At the time, Indonesia's economy had collapsed. The currency was valueless, exports had shrunken, hyperinflation was rampant and the country was in default of its enormous foreign debt. Indonesia was about to experience the traumatic and drawn-out transition from Sukarno to Soeharto.

Nevertheless, Arndt went ahead.

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50 years later, the convivial anniversary was attended by three former Indonesian ministers (one of them also former vice-president), all alumni from ANU. The Project's academic journal – the Bulletin of Indonesian Economic Studies – has been published continuously three times a year. It's the best (perhaps the only) comprehensive record of the progress of the Indonesian economy from the basket-case days of the 1960s to a well-performing emerging economy with GDP within sight of overtaking Australia.

Perhaps the greatest insight of the Project's founders was their conviction that this should not be solely an Australian-oriented effort. It needed substantive Indonesian participation. The famous 'Berkeley Mafia' economists were all involved, many of them making regular trips to Canberra for project events. A strenuous effort was made to have Indonesians write in the Bulletin (Arndt's intrusive editorial hand bringing them up to scratch in the early days when drafts needed his ministrations).

Today the project is headed by an Indonesian. There are two annual lecture series in Indonesia (the Sadli lecture and the Hadi Soesastro lecture, both given in honour of Indonesians closely associated with the Project). The PhD students studying in the Project are almost exclusively Indonesian. Yet the centre of gravity remains ANU in Canberra.

The other great quality the Project brought was its emphasis on people. Arndt aimed to create 'not an institution, but a network'. The key task was getting people together to focus on the issues of Indonesian economic development. The reach was wide, with many visits to universities outside Jakarta. The central role of the annual Indonesia Update was not to write academic papers just to add to authors' CVs but to attract a crowd ready to learn more about Indonesia. A mini-version of the Update takes place every year at the Lowy Institute, bringing it to a different audience.

Much of Colin Brown's history records the struggle to fund the Project, especially as increasing demands for higher governance and accountability replaced the informal world in which the project had been born. The book usefully records the begging letters to Australia's aid agency pleading for funding – a reminder that this project could have ended several times during its life, never to be revived.

There has been plenty of Indonesian recognition of the Project's value as a source of research. One top Indonesian economist said 'It is ironic that the best institution...on the Indonesian economy is not in Indonesia but is to be found in Australia.' 

But evaluating its worth as 'ballast' in the relationship has proven harder and its value has often gone unrecognised. One of the regular reviewers noted that the Project's budget (less than A$1 million a year) 'represents significantly less than 1/10th of one percent of AusAID's country program in Indonesia. Effectively, the Project operates on a slender shoestring, while providing plenty of leverage for AusAID's money'.

Even in the tough current budget climate, the ANU Indonesia Project seems to have continuing support. But it's only one example of what is needed. The problem is not just funding. Colin Brown's book gives some indications of the critical need for energetic, resourceful, entrepreneurial people like Arndt and his successors. As usual, the luck of time and circumstance is also vital.

Another powerful image that has been invoked about Australia-Indonesia relations suggests we need to create spiderweb-like ties between our two countries. When the inevitable crises recur, these ties would flex, some would snap, but the relationship would be stabilised by those that held. Whether it is ballast or spiderweb ties, we need more.

Photo by Flickr user DFAT.


Lowy Institute Paper

Debating Condemned to Crisis?

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Maybe it's just the title – Condemned to Crisis? – that gives Ken Ward's book such a downbeat despairing tone, as if the accident of geography has locked us in an unhappy marriage with Indonesia and there is not much we can do about it.

Of course we should be realistic: we won't ever have the sort of familial ties that we have with New Zealand. The intrinsic sensitivities will be more substantial than the petty sibling rivalries we have with our Kiwi brothers. But we don't have to accept serial crises as the norm.

In examining the history, we should separate the problems which were unavoidable from those which were 'unforced errors' or 'own goals'. We can avoid the latter by trying harder.

Ken spends a significant amount of time on the Bali Two. This was an intrinsic conflict-point that was never going to work out well. It was hard for Australia to run an 'in principle' argument against the death penalty, given our stance on the Bali Bombers a few years earlier. But it was an 'unforced error' to link this to the Aceh aid. Even if you knew nothing about how Indonesia might react, the fact that this argument had been put forward by Alan Jones should have been a caution.

The wider lesson here is that our politicians understandably ask themselves what the Australian public are likely to think: our politicians have less concern for the Indonesian public, who don't vote here. With a few notable exceptions, our politicians understand that there is a degree of xenophobia just below the surface in Australia (as everywhere) and the unwritten rule is that this should not be exploited just to win votes.

Is it too much to expect Australian politicians to go a little further, showing international sensitivity?

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Live cattle exports produced another 'unforced error'. The ABC video was horrifying. Why didn't the live cattle industry see this coming? Once the images had been aired, the proper answer was immediate consultations with the Indonesian authorities while putting exports on temporary hold, pending arrangements to ensure that the cattle would be treated humanely, if necessary in abattoirs funded by our exporters.

Eavesdropping on the President's wife demonstrated an abysmal lack of judgment on the part of our intelligence service. Our damage-control added insult to injury. Instead of quickly saying that we wouldn't do this sort of thing again, we used SBY's desire to deal with it quickly as an excuse for changing nothing

The problem in Australian intelligence seems more systemic. It needs a more active watchdog than it has at present, and a thorough analysis of just how much of this 'intelligence' is just juicy gossip and ephemera. Let's shift resources into conventional diplomacy.

Operation Sovereign Borders also needs tougher oversight. If we are concerned about our sovereign borders, why would Indonesians (with a more fraught history) be less sensitive? A simple GPS plotter, as carried by any recreational boat that ventures onto the open sea, shows where the border is and where your boat is. You can check the coordinates yourself. It wasn't just the Indonesian public that were sceptical that a 'modern Western navy had made repeated accidental incursions'.

Thus looking back, there was nothing inevitable about these mistakes. We could have done better. But what about the future?

The first step is sensitivity training all round. Next time a government does a deal to rotate US troops through Darwin, let's chat with Jakarta before we announce it.

This sensitivity-training might involve getting to know Indonesia better. Our media editors are more interested in titillating stories about Schappelle Corby than in helping Australians understand their near neighbor. When the chief editor of the national newspaper suggests that Indonesia is 'probably the most corrupt country on earth', you can see how big the challenge is.

Upgrading understanding is hard work, but we should identify the places where our interests impinge or even coincide, and turn these into opportunities. The Australian Federal Police built a deep relationship with its Indonesian counterpart, but it took substantial resources. Specialised assets such as the ANU Indonesia Project on economics (celebrating its 50th anniversary this week) has been run on a shoe-string budget, without the resources to build more widely on its peerless Indonesian contacts, or take its accumulated knowledge to a global audience.

The obvious potential friction-point is Papua (not much discussed by Ken). There will be well-meaning Australians who are shocked by what happens there, and will want to do something – most likely protest at least. NGOs will likely want to go. For their part, Indonesians have a lot of historical colonial baggage there. Whenever we say we want Papua to remain part of Indonesia, they think 'that's what you said about Timor'. What's our plan for handling this inevitable conflict-point?

The supposed wise heads in Canberra tell us that these little tiffs in the relationship are normal and quickly forgotten. This is wrong. The relationship is like a marriage, with accumulated never-forgotten slights. We did better in the past, retaining working diplomatic relationships during Konfrontasi while simultaneously fighting Indonesia in Borneo. This diplomatic dexterity made it possible to quickly build close relations after 1966. We need to try harder, and the starting point is to recognise that this is worth doing.

Photo courtesy of Flickr user U.S. Department of State.


Further to my post on Hermann Abs' role in sorting out the debt of both Germany and Indonesia, there is a small historical footnote on the Indonesian debt negotiations which demonstrates that there was once a much more positive relationship between Jakarta and Canberra.

Some of the Sukarno-debt creditors opposed Australia's participation in the 1966 debt meeting, as we had no debt with Indonesia outstanding (our small aid program had been in the form of grants). These creditors thought Australia would be ready – perhaps too ready — to argue for debt forgiveness. The case had to be made that, as a provider of aid to Indonesia, we didn't want to see our money used simply to pay back creditors. This argument was accepted and, as predicted, our delegation spoke strongly for a generous debt outcome. This was duly noted with gratitude by the Indonesian delegation.


Just about everyone agrees that the Greek problem has been kicked down the road again, and probably not even very far. 

The fantasy nature of the 'agreekment' is clear. Let's put to one side, for instance, a structural reform program which demands that Sunday be mandated as a work-day. This might remind some readers of a more joyful time in Greece, as portrayed in the 1960s film Never on Sunday: a gorgeous, fun-loving Greek prostitute, played by Melina Mercouri (who later became Greece's Minister for Culture), wants Sundays to herself. 

Let's just keep our minds on the debt.

German bankers Karl Klasen, Hermann Abs and Franz Heinrich Ulrich, 1967. (Wikipedia Commons.)

Coinciding with the latest agreement, the IMF announced that the debt is 'highly unsustainable' under the most optimistic forecasts. Even if demonstrated good behaviour earns the Greeks another round of debt tweaking, this sort of piecemeal rescheduling won't do the job. It leaves a persistent unpayable overhang that will act like a wet blanket on investment and growth. 

Many commentators (including rock-star economist Thomas Piketty) have made pointed references to Germany's debt history – not just to the lessons of Versailles but also the London Debt Agreement of 1953, which left Germany with a light debt burden (and, incidentally, no 'conditionality' to tell them how to revive their economy). The London Agreement recognised that the issue was not a moral one, but about capacity. Thus repayment was linked to Germany's trade surplus, giving everyone an interest in Germany's economic success.

There is a less well known, but even more relevant, historical link here. The German delegation at London was led by Hermann Abs, one of Germany's most illustrious bankers. Thirteen years later, it was Abs who was given the task of sorting out Indonesia's unpayable debt legacy resulting from President Sukarno's profligate expenditure.

Most of the money had been spent on Russian military hardware, but there were also substantial debts to Western countries and Japan.

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By 1966, Soeharto's 'New Order' was beginning to come to terms with the economic collapse. Inflation that year was around 1000%, the currency valueless, exports had collapsed and the foreign debts were in default. Abs was appointed mediator and persuaded the creditors that they would have to give generous debt rescheduling (not, it is worth noting, haircuts that diminished the nominal debt figure). The debt relief came in the form of rescheduling over 30 years interest-free and with the option of delaying the first eight years of repayments. 

It is worth noting that this result was not achieved in the first meeting. It took three time-consuming annual meetings before this long-term solution was reached, allowing Indonesian policymakers to devote their full attention to the economy. They did this with extraordinary success, aided by the supportive guidance of the IMF and the World Bank ('conditionality' hadn't yet been invented).

The Indonesians were also inventive in offering private sector creditors some value. They offered to swap debt for new investment expenditure and explored the possibility of debt-for-equity swaps. Foreign companies which had been nationalised under Sukarno were given back to the original owners.

This highlights the big difference between Indonesia in 1966 and Greece in 2015. In Indonesia, there was full agreement and 'buy-in' on what should be done, and the key objective was to get the economy functioning normally. There was also a realistic view of how much 'structural' reform could occur. The answer was 'not much'. Three decades later, when Indonesia got into trouble again during the Asian financial crisis, the IMF identified many still-unfixed structural faults: cronyism, inefficient state-owned enterprises, an ill-supervised banking system and of course the famous clove monopoly. But in 1966, it was enough to get the economy moving forward again at a brisk pace (7% per year for the next three decades).

Greece will need something like the solution Indonesia developed after 1966, although the poisonous negotiating climate makes it impossible for the moment. There are some similarities with Indonesia:

  • The money Greece borrowed has been largely wasted and so has not created any capacity to repay.  So it makes no sense to develop detailed time-profiles of debt-to-GDP ratios, as the debt will not be repaid. It makes even less sense to calculate the required budget surplus on the basis that this surplus is needed to repay the debt, when everyone knows it won't be repaid. Instead, the budget should be set to foster medium-term sustainable GDP growth.
  • The country involved has a small economy but is important in geopolitical terms, with Western creditors unwilling to see it drift under the influence of Russia.

What is missing in this case is assurance that the Greeks will do the necessary reforms. In the Indonesian case, there was full 'buy-in', although it was still a brave gamble; there was no guarantee that an army general and a few inexperienced academic economists could fix the mess.

Let's leave the last word on debt repayment to Hermann Abs, quoted towards the end of his long career in banking:

I remember speaking some years ago on the same platform to the Association of Young Bankers. "When I was a young banker," Abs said, "we were taught to ask two questions of any borrower: what is the loan for, and how will it be repaid? Today we know the answers without asking: the purpose of the loan is to repay an earlier debt, and it will be repaid by another loan."