Lowy Institute

A Greeek solidarity rally in Madrid yesterday. (Flickr/Adolfo Lujan.)

The Greek people have delivered a resounding ‘no’ in the referendum, but the tragedy is still unfolding. It will take some time for the implications to evolve, but it’s hard to see how the vote helps achieve a resolution. The Greek people want to stay in the euro but don’t want austerity. The European negotiators and the IMF have neither the inclination nor the wiggle-room to agree. With the Greek banks closed, time is pressing. Leaving the euro would be hugely disruptive. Staying in the euro means a continuation of the failed policy of austerity. Thus Greece is in for a hard time. But how important is this for the rest of us?

Disruption in Greece doesn't help Europe's lacklustre recovery, but it's not big enough to do substantial harm – Greece is less than 2% of Europe's GDP. Moreover, most of the damage has already been done, notably in 2010 when the unfolding Greek crisis diverted budget policies in the advanced economies from expansion to austerity, thus derailing the post-2008 recovery.

The peripheral countries (Spain, Italy, Ireland and Portugal) that seemed so vulnerable to contagion when the crisis began in 2010 may have their financial markets tested, and the drama queens of financial markets will do their best to turn this into another opportunity for profit-making market volatility. But there is not enough substance here to keep such disruption going for long. The European Central Bank has the ability and means to handle any financial fall-out.

Some see this as the beginning of the end for the euro experiment. With Greece staring at departure, will others follow and the euro disintegrate into national currencies? This outcome would be some kind of wish-fulfillment for the euro-sceptics who dominate the UK press. But for all its challenges (past and future), the core countries of the euro have built up massive synergies and benefited enormously, both economically and politically. The degree of integration now accomplished will not be abandoned lightly. Greece was always an outlier, a misfit in economic structure and maturity. The parting would be painful, but will not unravel the euro.

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Greek public debt is not insubstantial (the part owed to Europeans is conservatively estimated at 3.3% of the Eurosystem's GDP), but almost all is now owed to governments or international agencies, which can wear the losses without dramatic impact on their economies. The IMF has already asserted (rather boldly) that 'the IMF's shareholders will not suffer losses'. 

What are the economic lessons? Countries can run budget deficits, overly-generous pension schemes, and large external deficits for decades if foreigners provide the funding, but there is no free lunch. Unsustainable policies eventually stop and the longer countries have been off-track, the longer it will take to fix. Living standards can't rise if productivity remains low. Incompetent and sometimes corrupt governance might get by when the economic climate is benign, but can't cope when problems arise.

These are the old lessons. What are the new ones?

There is a melancholy message about the political-economy of decision-making: even when there is a better path for crisis resolution available, politics can sometimes push events down a worse path, which none of the participants wanted. When the current Greek Government was elected early this year, there was an opportunity for a fresh start based on mutually held objectives. There was unanimity among the negotiators that staying in the euro was desirable. There was a common recognition that Greece could not repay its government debt (even after the 2012 restructure), although the creditors were politically constrained from acknowledging this in public. Similarly, there was implicit understanding by all that the austerity package imposed in 2012 needed to be softened.

Skillful negotiators would have found a formula to put the debt to one side, thus opening up the opportunity to shift from the budget austerity required to repay the debt towards a more growth-oriented policy package, emphasising the medium-term nature of the reforms needed.

This would have created an outcome all parties could accept: the debt would not be written off but would be extended, with modest payments in the near-term. This would not only suit Greece, but would have allowed a continuation of the fiction in the creditors' balance sheets that the debt was worth its face value. Greece would have shifted from an austerity strategy to one which addressed structural problems, but at a pace which allowed growth. Greece's feet needed to be held to the fire, but reform takes time when structural problems are so entrenched.

Alas, the negotiators did not have these skills. Just who let down the side will be hotly debated, but it looks like all parties were to blame, with the possible exception of the European Central Bank.

We will learn more about the mistakes of the European Commission and Greece as each participant attempts to shift the blame over coming months. But one thing is clear already: the International Monetary Fund played its cards badly and has lost both prestige and credibility. The Fund should not have become involved in the first place. This was a matter for the Eurosystem to sort out, just as federated states such as the US or Australia would resolve state debt without calling in the Fund.

Dominique Strauss-Kahn, the Fund Managing Director at the time the crisis began, wanted to restore the waning influence of the Fund and perhaps burnish his own political ambitions in Europe. Instead, the outcome has been to demonstrate the Fund's weaknesses:

  • Its Euro-centric governance structure over-rode its own rules and precedents to achieve a support program which at the time suited Europe.
  • It was unable to orchestrate a timely bail-in of excessive private-sector debt in 2010 (thus allowing the private-sector creditors to get off too lightly), or arrange a subsequent realistic restructuring of sovereign debt.
  • Its forecast of Greek GDP in the face of budget austerity was, as usual with these support programs, hopelessly optimistic.
  • It forgot the lessons of the disastrous Indonesian 1997-98 support program. The Fund's detailed involvement in the politically sensitive Greek pension reform seems to be on a par with its insistence on Indonesian petrol-price increases during the fraught political circumstances of 1998. The prerequisite for competitiveness reforms is reminiscent of the Fund's requirement to dismantle the Indonesian clove monopoly two decades earlier.

So much for the economics. Much less has been said about the strategic politics of what is unfolding. Greece's small size keeps the global economic consequences manageable but the same can't be said within the strategic context, where small problems can have large ramifications: 'For want of a nail, the battle was lost'.


When we get enough perspective to write a balanced history of the 2008 global financial crisis and the subsequent feeble recovery, fiscal policy mistakes will surely feature largely in the narrative. In the form of a new IMF paper, we are beginning to see that history taking shape, and with it a clearer idea of what fiscal policy should have done.

After a bold start with the G20-coordinated fiscal stimulus of 2009, the Greek crisis at the end of that year (and the knock-on crises in Ireland, Spain, Italy and Portugal) shifted the focus onto excessive public debt. Instead of making a distinction between these grossly over-indebted countries and others in which the debt was easily sustainable, there was a universal shift to budget tightening in the advanced economies, urged on by all the international economic agencies – the IMF, the OECD and the Bank of International Settlements. The result of this fiscal austerity has been a pathetically weak recovery which has left per capita GDP in quite a few advanced countries not much higher than it was before the crisis, seven years ago.

Some of the IMF's most heterodox thinkers have now begun to make this distinction, which was missing in the rush to austerity in 2010. The full paper is here, but a more accessible version is here

To make sense of the complexity involved in fiscal policy, the authors separate the debt analysis from the heated debate about Keynesian stimulus versus fiscal austerity (whether budget deficits boost the economy through the usual Keynesian stimulatory effects, or alternatively whether a round of fiscal austerity would work better by boosting private sector confidence). Instead, they focus just on the debt.

Should countries that find themselves, post-crisis, with a substantial increase in debt make it a matter of priority to get this debt down?

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If a country pays down its debt, it has to do so by raising revenue or lowering spending, which will slow growth. On the other hand, once the debt is down, underlying growth will be faster because the cost of servicing debt will be a smaller burden on the economy. What's the trade-off here? The IMF authors argue that these two effects are equal, so there is no compelling reason to think that getting the debt down is a policy priority. As they say, 'When and only if countries have ample fiscal space, there is no need to obsess about paying down the debt. Living with the debt is likely to be the better policy.'

They offer the graph below, which identifies the countries with 'fiscal space'.  It's worth noting that in an international comparison, Australia's public debt level is modest and its fiscal space large. You might wonder why the political-economy narrative here is centred on getting the budget into surplus.

Not that this Fund paper is in itself a sufficient basis for policy. To start with, its analytical simplifications need to be taken into account. And there are many other aspects of fiscal policy that need to be considered.

Why not, for example, use the opportunity of low interest rates and spare productive capacity to issue more debt to fund socially profitable infrastructure? Such debt liabilities would then be balanced by the infrastructure assets. If the latter are well chosen, the government's net debt position is stronger, not weaker.

The fiscal rethink at the Fund is also exploring how to make automatic fiscal stabilisers work better so that governments don't simply spend the extra revenue that accrues to them in the cyclical upswing (or, more typically, offer vote-winning tax cuts), but instead put it aside to cover the fall in revenue and extra social expenditure that accompany the downturn of the cycle. The ABC's just-screened The Killing Season touched on the lamentable story of how we fumbled the opportunity to put in place the key element of strong automatic stabilisation in the form of a counter-cyclical super-tax on our minerals industry.

The influence of the Fund's analysis is strengthened because this rethink comes from such a fiscally conservative institution (it's often said that IMF really stands for 'it's mainly fiscal'). Better late than never.

Photo courtesy of Flickr user International Monetary Fund.


Trade agreements were in the news last week. Australia signed the China-Australia Free Trade Agreement (Chafta), while the Trans-Pacific Partnership (TPP) struggled to achieve the required support in the US Congress. Both agreements include measures for investor-state dispute settlement (ISDS). What's at issue here?

In the Chafta, negotiated last year but only just signed, the ISDS provisions remain to be finalised by committee. Just what is entailed remains under wraps. Even in the case of the TPP (which is likely to get Congressional support, despite the current hiccups), the details are still not public.

It's easy to see why ISDS is a source of controversy. While the original intention of such clauses might have been to give foreign investors some protection when investing in countries with dodgy legal systems, ISDS provisions have been misused in attempts to give foreigners special treatment in opposing well supported domestic legislation. For example, Philip Morris is using an ISDS clause to attack Australia's Tobacco Plain Packaging Act.

In response, the then-Labor government said in 2011 that it wouldn't sign any further agreement that included ISDSs. The current Labor opposition says it doesn't support ISDSs, while the Greens oppose them. The Government has a 'case-by-case' approach. Some of our past agreements (eg. the Australia-US FTA) don't include ISDSs, while others do (The Korea –Australia FTA).

It's also easy to see potential for further misuse of ISDSs. The UN Conference on Trade and Development records around 50 disputes initiated annually in recent years, with a rising share (40%) initiated against developed countries.

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One case has been brought by the Swedish owner of a German nuclear power station affected by Germany's decision (after Fukushima) to phase out nuclear electricity generation. Two cases against Canada also involve environmental issues (regional bans on fracking and wind farms). When Australia eventually comes to grips with climate change, there are likely to be similar environmental disputes. What happens, for example, when Australia legislates to ban the burning of high-polluting brown coal? Will the foreign owners of Victoria's brown-coal generators be ready to accept Australian law as the final arbiter?

A transparent debate would be more helpful here than the generalised assurances given so far. Australia's High Court Chief Justice Robert French points the way, with academic lawyers and economists also expressing their concerns. Canada's G20-oriented Centre for Governance Innovation (CIGI) sees the issue as important enough to commission a research project compiling the current state of play of ISDS cases.

Where is the Government's substantive response? What is the case, in the Australian context, for giving foreigners more favoured treatment than domestic players? Negotiating tactics should not be an excuse for lack of transparency here: an open debate is just part of good governance. The Government should make the case why ISDS benefits Australia. ISDS is not something to be bargained away in exchange for some (probably ephemeral) export advantage.

Photo by Flickr user Chris Guy.


'What's in a name?' Shakespeare's Juliet asks. Quite a lot, as things turned out for her. And so it is for the just-published proceedings of the ANU Indonesian Update, titled The Yudhoyono Presidency: Indonesia's Decade of Stability and Stagnation. A 'mini' version of the Update was held at the Lowy Institute, but this volume contains a much fuller record of the diverse opinions on the SBY years.

The title of the volume has triggered debate among both Indonesian commentators and the 'batik-shirt brigade' of Australian Indonesia watchers, some of whom see the word 'stagnation' as too harsh a judgment on SBY's decade as president.

Taken literally, both words – 'stability' and 'stagnation' – have the same meaning. But one is positive, the other negative. For many political scientists, it was not enough that SBY presided over a decade when democracy was maintained and strengthened (he implemented the policy of democratically elected heads of provinces, cities and districts; the Corruption Eradication Commission [KPK] also became operational during his term). Yudhoyono, says one contributor to the ANU volume, 'merely stabilised Indonesia's fragile democracy without ensuring that democracy became "the only game in town".'

Even at the start of his presidency, local cynics said SBY stood for Saya Belum Yakin ('I'm not sure'), and this proved to be a persistent criticism. He was a hesitator and vacillator.

This volume sets out SBY's own answer to the charge. He saw himself as a moderator 'leading a polity and a society characterized by deep divisions...he believed that his most important role was to moderate these divisions by mediating between the conflicting forces and interests to which they gave rise'. He was also a president with a multi-party parliament, an inherently difficult arrangement. In response, he maintained over-sized government coalitions whose internal differences he fuzzed over rather than resolved. This is what enabled him to maintain stability. It also explains the stagnation.

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Thus he failed to support the KPK at critical junctures, was weak on human rights in failing to protect minority religious groups, and failed to safeguard the budget from the enormous rise in petroleum subsidies during his second term. 'Yudhoyono's constant poring over the polls and thin skin for criticism often had a paralyzing effect on him'. But he achieved the Aceh peace accord and gave Indonesia a higher profile on the international stage, especially at the G20. Above all, he held the ship of state steady after the weak performances of Gus Dur and Megawati, his predecessors. In his own defence, he says: 

Whenever the winner takes all, it's harmful, there will be losers, and losers generally like to hit back and if that gets out of control, then it can be terrible. Ya, I must admit that I love to maintain balance, yes, the balance in life, in our country.

The economists who contributed to the volume, while acknowledging the shortcomings, give SBY a pass mark. He maintained 5% annual growth and lowered poverty rates.

The contrast with the Soeharto era is brought out in a volume coincidentally published at the same time: A Tribute to Ali Wardhana (available soon from Gramedia). Ali Wardhana was Indonesia's finance minister for a record-breaking 15 years (1968-83), followed by a decade as Coordinating Minister for the Economy.

It's hard to overstate the differences of policy-making style and environment between this period and the SBY years – 7% annual growth was maintained for three decades despite persistent shocks, both domestic and foreign. And this period was characterised by decisiveness. Two examples stand out. The first was the 50% currency devaluation in 1978, despite the strong current account. It was a path-breaking response to Indonesia's loss of international competitiveness as a result of the 1970s oil shock (the so-called 'Dutch disease'). The second example was the replacement of the entire (hopelessly corrupt) Indonesian customs service by a Swiss company to carry out the task of customs inspection. Not much of SBY's moderation and balance there.

Whatever the judgment on the words 'stability' and 'stagnation', the early days of the Jokowi regime provide plenty of room for a more generous and forgiving view of SBY. It's early days, but some commentators, both domestic and Australian, have already fallen out of love with President Jokowi. Perhaps both SBY and Jokowi suffer from the problem of overly optimistic initial expectations. 

Indonesia will always be judged as having missed many opportunities to do better. More than 50 years ago Clifford Geertz, a sympathetic observer of Indonesia, said: 'Indonesia at its base is an anthology of missed opportunities, a conservatory of squandered possibilities'. Yet for all this, the country has transformed radically for the better since then, both politically and economically, confounding the critics while disappointing the optimists.

With Australia-Indonesia relations at a nadir, The Yudhoyono Presidency is a must-read for anyone who thinks this relationship matters.

Photo courtesy of Flickr user AK Rockefeller.


The unexpected policy failures associated with the 2008 global financial crisis have provoked soul-searching among macro-economists. The leading lights among the profession were at the International Monetary Fund's Rethinking Macro Policy conference in April. Olivier Blanchard, the widely admired IMF Chief Economist, encapsulated the state of the debate in his Ten Takeaways: Progress or Confusion? 

There is actually more agreement than might be implied by Blanchard's title – and more recognition of how far the conventional wisdom had to be changed to fit the evolving world.

Nowhere is this more evident than with international capital flows. Blanchard 'see(s) this as one area where the rethinking has been striking, compared to ten years ago'.

Indeed, ten years ago the Fund was urging countries to open up their capital accounts for foreign flows, unconstrained by any interference in the market. The promise was that the impact of volatile foreign flows would be ironed out with flexible exchange rates. The new consensus is that the effects of volatile capital flows are complex (impinging especially on the stability of the domestic financial sector) and can't be counter-balanced simply by exchange rate movements. In any case, exchange rates often overshoot, creating problems of their own.

So much for demolishing the old paradigm. Its policy implication was 'masterly inactivity' (leave it up to the market). Now the challenge is to formulate active policies which would address these newly perceived problems. There is less agreement here.

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Some see the all-purpose answer in macro-prudential policies: adjusting the financial regulation parameters according to the state of the cycle, imposing lending limits and extra capital requirements during the upswing and easing them in the downswing. Some older hands among the central bankers remember that this is what used to be done before the financial deregulation revolution of the 1980s. But extra constraints on the regulated financial sector cause the action to shift to the less regulated shadow banking sector (this process used to be called 'disintermediation'), leaving the economy still vulnerable to surges and retreats of foreign capital flows.

While not a consensus, the majority opinion now accepts the need for foreign exchange intervention (a no-no in the old world) and restrictions to help manage capital flows, but without any firm belief that this is a complete answer to the challenge.

All this may get a field-test before long, when global financial markets, already twitchy about the impending shift of US monetary policy away from its stance of extreme ease, finally have to respond to the reality of tightening.

As Paul Krugman often reminds his readers, anyone who followed the 1997-98 Asian crisis would have recognised the inadequacy of the free-market view of capital flows. It was only when the problems directly impinged on the advanced economies that mainstream economists (and the Fund) saw the need for rethinking. This process has been assisted by mavericks within the IMF such as Jonathan Ostry, and more recently by the high-profile evangelising of Helene Rey.

This was just one of Blanchard's ten 'takeaways'. We'll return to the other important shifts in policy thinking at a later date.

Photo by Flickr user IMF.


The renminbi is still some distance from being an 'international currency', but it is moving fast in that direction, passing some important waypoints over recent months.

It's not exactly clear what being an 'international currency' means, but one aspect is whether the currency is included in the IMF's notional currency, the Special Drawing Rights.

China is pushing strongly on this. Central bank governor Zhou Xiaochuan made the case at the recent IMF meeting. Since then capital controls have been eased further, especially for outgoing capital flows, but Governor Zhou notes the lessons of the 1997-98 Asian crisis – that completely unregulated capital flows, with their surges and 'sudden stops', have caused great disruption. China intends to retain enough controls to avoid these pitfalls.

In practical terms, being included in the SDR basket is no big deal, but there would be considerable prestige involved, symbolising China's arrival at the epicentre of international transactions (the SDR currently includes just four currencies: the US dollar, the euro, the UK pound and the Japanese yen). The US is looking for more reform before the renminbi is included.

The pressure to have the renminbi included will continue when the 'SDR basket' comes up for its regular five-yearly reappraisal at the end of this year. The present focus is on capital account openness, but this is not the only criterion. The currency must also be 'freely available', which for China might mean a much deeper domestic bond market with greater foreign participation, as suggested here

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The IMF has also changed its tune on whether the renminbi is undervalued ('manipulated'), giving China extra international competitiveness. Again, the US is resisting this assessment, with the US Treasury maintaining that the strengthening has not been 'as fast or as much as is needed'. 

This debate, however, has lost its fervour. The Chinese current account surplus is now 2% rather than the 10% recorded in 2007; foreign exchange reserves are no longer growing; and the yuan has appreciated by 30% over the past decade. More recently it has maintained its value against an appreciating US dollar, which means it has lost competitiveness against just about everyone else. 

Even one-time renminbi warrior Ted Truman (a long-serving senior official at the US Treasury and the Federal Reserve) not only accepts that the renminbi is no longer 'manipulated', but also that if the US pushes too dogmatically on this issue (as is being done by his colleague at the Peterson Institute, Fred Bergsten), the US might have to acknowledge that its quantitative easing policies have also had the effect of enhancing US international competitiveness. 


Thomas Piketty's Capital in the Twenty-first Century put inequality centre-stage in the economic debate. But the topic has been around for a long while. Brookings has recently republished Arthur Okun's 40 year-old Equality and Efficiency: The Big Trade-off, The launch was an opportunity to bring it up to date.

Okun set out the arguments which became the mainstream among economists for the next three decades, up until the global financial crisis of 2008. The key idea was that there was an trade-off between growth and equity. If you imposed high marginal tax rates on entrepreneurs, or set the minimum wage too high, or tried to fix inequality using the 'leaky bucket' of government tax-and-redistribute policies, you would pay a substantial price in terms of lower growth. In poorer countries, some would get rich while others lagged behind, but too much concern about how the national-income pie was sliced up would result in a smaller pie.

The failure of socialism, notably the collapse of the USSR, lent support to these views.

What's changed in four decades? First and foremost, the equal distribution of income in many economies, notably America, has become much worse. 40 years ago the consensus opinion was that income distribution was fairly constant, and rises in living standards had to come from growth rather than redistribution.

That's not how it has turned out.

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In America, the share of income received by the top 1% has gone from 8% in the 1970s to 20% today. It gets worse right at the top of the pyramid: the top 0.01% got 1% of the income while today they get 6%. As one analyst has said:

Okun pondered a trade-off between equality and efficiency just when those at the top of the wealth and income ladder began hauling off all the gains of economic growth.... When Okun was writing, the typical CEO earned about 25 times the typical worker. How could he know that today, they earn nearly 300 times the typical worker?

The wealth distribution has shifted even more than the income distribution:

Okun writes that the richest one percent of American families have about a third of all the wealth, and the bottom half hold about five percent.... [Today] the richest one percent have over 40 percent of the wealth, and the bottom half have only one percent.

This unpalatable reality is not all that's changed since Okun wrote. We have taken a more comprehensive view about what drives growth. There is now greater recognition that if substantial sections of the population are poorly equipped for the modern economy – either through poor education or constraints on social mobility – then the outcome will be low growth. It's all very well to make sure the top entrepreneurs have incentives, but when those lower in the distribution have no clear path for advancement, their incentives are damaged and growth suffers.

Others have been more pointed – and more political – in their criticism of how the rich got to be at the top of the pile. The free-market, regulation-reducing, tax-lowering policies begun in the Thatcher/Reagan period have boosted inequality more than growth. The economic elite have turned rent-seeking into an art form, exploiting the many distortions and monopolies in the economy. They have buttressed their favoured position by manipulating the political process. Their share of national income reflects their power rather than their productivity.

As if on cue, the OECD has produced another fascinating study contributing to the inequality debate: Why Less Inequality Benefits All (try the OECD's online survey to see how well you know the equality position in your own country). This focuses on the growth-constraining effects of leaving the poorest 40% of the population without adequate opportunities to realise their potential. Greater participation in the workforce by women has substantially helped income distribution, but there is a long way to go. Freeing up the labour market through more 'non-standard' jobs (ie. not a full-time permanent job) has created opportunities but also inequalities. 

The power of the OECD report is its international comparisons. When senior officials say we need to lower tax rates to foster growth, the refutation is in the counter-examples overseas.

What to do? We should accept that Okun identified issues which are still relevant today: 

  • Confiscatory rates of tax will dampen entrepreneurship and encourage capital and skills to move to lower-taxed jurisdictions. But the Scandinavian countries have demonstrated that it is possible to have high taxes and good growth. As a result, they lead all the indices of equality set out by the OECD.
  • It is possible to seriously damage an economy with excessive minimum wages, as we did in Australia in the 1970s. But Australia's current minimum wage is around twice America's, and so far this has been consistent with good growth and greater equality. Larry Summers notes that the US minimum wage in real terms is lower now than when Okun wrote his book.
  • While entrepreneurship needs to be fostered, it's hard to argue that the rewards needs to be as big (or as widely spread) as they have become. Salaries for top business people and financiers are more a reflection of relative pecking-order rather than necessary to reward talent. Again, Scandinavia shows the way.
  • The leaky bucket of government redistribution can be addressed intelligently, through focusing on social mobility (especially through education) and encouraging labour-market participation.

As well, there are clearly many opportunities to help both growth and equality at the same time. Better public transport is one example. While Piketty (and also Anthony B Atkinson) sound unworldly in their advocacy of 'tax-and-redistribute' policies, addressing tax evasion should not remain forever in the policy-makers' 'too hard' basket.

So much for the gloomy story of income distribution within countries. In the emerging economies, where income distribution is typically bad, the overall rate of growth has lifted a billion people out of abject poverty, with the process of convergence still leaving room for much more reduction in income inequalities between countries.


Despite gloomy talk about slowing economic growth, Asia has continued to grow strongly, and the IMF has forecast this will continue this year and next.

Asia is still by far the most dynamic region in the world, accounting for 40% of world GDP but nearly two-thirds of global growth. Look, too, at the red bars (graph below) showing China's contribution to global growth. Take off the unsustainable growth burst which followed the massive stimulus in 2009, and China's contribution to global growth remains much the same over the 2008-2018 decade (including the projection period).

The growth rate might be slowing a tad, but China's increased bulk of global GDP means that its contribution to global economic growth is undiminished.

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Of course there are risks to this outlook. To forecast that India's growth will continue at 7.5% (the fastest in the region and based on debatable GDP figures) is a bold call. As well, the Fund itself frets about financial vulnerabilities in China, especially in relation to a housing sector coming off the boil. Japan might need a bit of luck to make the 1-1.2% growth foreseen by the IMF.

All that said, where would you rather be doing business – in Australia next to the most dynamic region in the world or in Europe, waiting for the next chapter in the unfolding Greek tragedy?


Infrastructure is now a standard item on the G20 agenda. Serious infrastructure shortages are ubiquitous. With global economic growth slow, ample construction capacity and interest rates at historic lows, there seems to be an opportunity to address the infrastructure gap. But many governments see themselves as constrained by high debt levels.

Is the answer to get the private sector to fund infrastructure through public-private partnerships (PPPs)?

Turkey, as the current G20 president, supports this idea. Turkish Deputy Prime Minister Ali Babacan has said:

Some countries do not have the budgetary room to raise investment spending: they have high debt rates, are undergoing fiscal consolidation, and are hardly able to cut down budget deficits and debt rates. When we ask them to raise investments, they talk about budget constraints. Consequently, public-private partnerships need to gain more prevalence all around the world.

But are PPPs the answer? An article in the latest Lowy Institute G20 Monitor makes the case that this emphasis on funding misunderstands the role of PPPs.

Infrastructure projects present mighty challenges. They are often big, long-lasting, technically challenging and can be controversial as they sometimes involve social disruption. Even when the project is highly desirable and socially useful, it is hard to make it commercially viable because the outputs are often public goods (that is, they are 'non-excludable'; everyone can use the street-lights, so no-one pays), natural monopolies (no point in having two pipes supplying your house with water), or they have historically been provided free or been heavily subsidised.

These challenges are, almost always, much more serious than the issue of funding.

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Certainly, there are financial constraints on governments. But these are usually self-imposed. The political process has imposed spending caps and debt limits for good reason: as a response to pork-barrel spending, white elephant projects, inefficient implementation or over-manned operations. Very few governments, however, have actually reached the limit of their ability to sell debt and use the proceeds to fund infrastructure expenditure. Paradoxically, these self-imposed constraints have been put in place specifically because it is so easy for governments to borrow. 

What's the case for involving the private sector?

In recent decades there have been many successful full privatisations (as opposed to partnerships). In Australia, Telstra and Qantas provide just two instances among the many global examples. If a project is suitable to be handed over entirely to the private sector, this will usually be better than a PPP. Implemented privately, the project benefits from the profit motive – a powerful driver of efficiency. This approach does not entirely eliminate white elephants (big, technically difficult projects can fail, whether in the public or the private sector), but it would stop pork-barreling ('bridges to nowhere'). As well, the private sector may be better at operational issues, including imposing user charges (tolls on roads and full cost recovery for utilities).

Full privatisation is suitable where the industry is not a natural monopoly. Technological change has helped put more projects into this category, turning natural monopolies such as telecommunications into multi-firm industries with vigorous competition.

But in many sectors, the public good characteristics of the industry are central to the provision of the service. If the function is fully privatised, it would have to be comprehensively and intrusively regulated to prevent the private owners from exploiting the monopoly position, in terms of price or service quality. The closer the industry is to a monopolistic utility, the harder it is to offset these issues with regulation.

PPPs fall into an ambiguous middle ground. In early uses of PPPs, the private sector partner often showed itself to be more skillful at shifting risk to the public partner, with the cost of failure borne by the taxpayer. As the public sector became more experienced at avoiding this deficiency, the private sector became less enthusiastic about the PPP model. In Australia, the private sector prefers to finance risk-free projects, with construction already complete and 'take-or-pay' contracts. But getting the private sector to fund risk-free projects makes little sense: governments can borrow more cheaply than any private investor.

Rather than funding shortages, the greater obstacle to faster expansion of infrastructure investment is the dearth of projects whose commercial viability has been firmly established by detailed assessment. Projects fail because of misforecasting of demand and construction costs, through legal difficulties with land acquisition or the myriad risks which surround large technically complex construction. Better project assessment is the key to deciding which projects are viable and to reducing the intrinsic risks. 

The G20 is in a position to encourage the international development banks (the World Bank and the regional banks) to resume a more active role in this sort of project assessment. Infrastructure was once the bread-and-butter of these institutions, but limited funds and governance issues (including pressure from NGOs on environmental issues) have restrained their contribution. 

G20 finance ministers and leaders could usefully debate how to return these development banks to a key infrastructure role: as expert assessors, able to evaluate cost/benefit, technical and environmental issues. At the same time, their assessment will make it clearer which projects should be fully privatised, which ones are best left in public hands and which (if any) fall into the ambiguous category of public-private partnerships.

Photo courtesy of Flickr user Daniel Parks.


One aspect of the Trans-Pacific Partnership (TPP) that has come under criticism is the lack of transparency in the negotiating process. Could a more transparent model be used for these kinds of negotiations?

In other areas of official decision-making, recent decades have seen a big shift towards greater transparency. Monetary policy provides an example. The closed-door confidential model of decision-making was universal best-practice until the early 1990s. Policy was set without prior public discussion and then implemented without press release or comment. This was not just for bureaucratic convenience; it was often justified in terms of efficiency.

How things have changed! Now the essence of good policy-making is transparency: an explicit decision model and frequent communication with the public.

In Australia, hardly a week goes by without a senior RBA official discoursing on some aspect of monetary policy. The US Federal Reserve is exerting itself mightily to make sure that everyone understands how it is thinking about the unwinding of quantitative easing. The Bank of England has experimented with 'forward guidance': telling the public its current thinking about its future actions. This flood of information is now regarded as 'best practice' for central bankers everywhere.

How curious, then, that nothing substantive can be said publicly about the TPP until the negotiation is over, when the only choice for the Australian parliament will be to accept or reject the treaty.

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No one is suggesting that the actual negotiations should be open to the public, any more than a RBA policy-setting meeting should take place in public. But what central bankers have attempted to do, with their copious speeches and publications, is to tell the public what their decision-making criteria are. When they decide, they make sure everyone is told at exactly the same time (no one has an information advantage). Shortly afterwards, the minutes of the decision process are released so that the public can confirm that the decision conforms to the framework.

Or take the Productivity Commission. When an inquiry begins, submissions are invited and public hearings are held. In recent months, we've had the Murray inquiry into the financial sector and the Harper review of competition. Both not only had submissions, but also produced a preliminary report indicating what the committee had in mind, open for further public comment.

Contrast this with the TPP. The public framework is bland generalities. If bargaining trade-offs are necessary, we have no sense of the priorities which will guide our negotiators. What horse-trading between the big treaty-partners (say, a special deal between Japan and America to encourage Japan to sign up) would cause our negotiators to get up from the table and leave?

Just as disquieting, we are told that there have been frequent consultations with various domestic interest-groups. This would be like the RBA consulting privately with a few favoured players in financial markets, seeking their input into the decision. 

Does the fact that the TPP is a negotiating process prevent transparency? Transparency has more pluses than minuses: our negotiators would come to the table backed up by public opinion. A vigorous public debate in Australia might remind the major players that rules on intellectual property should foster innovation and competition, not simply benefit yesterday's inventors. Debating the industry-state dispute settlement process might show strong resistance to giving foreigners a special right to override Australia's legislative intent. 

A transparent process might help to ensure that the rules balance the interests of all parties rather than just benefiting America. When President Obama says 'If we don't write the rules, China will', who does the 'we' include? Will the rules favour creditor countries against net borrowers like Australia? Will they favour IP owners against IP users, like Australia?

The TPP process is too far advanced for such changes. If the US Congress allows it to go ahead, we will sign up. But we might hope for a more transparent process next time.

Photo courtesy of Flickr user Council of Canadians


With Greece once again teetering on the brink of default, a recent paper from the Centre for International Governance Innovation explores one episode in the amazing saga of how this tiny country came to threaten the viability of the euro, and left a damaging legacy for procedures and governance at the IMF.

When the Greek crisis emerged late in 2009, many European leaders believed the problems should be resolved within the eurozone, just as a financial crisis in one of Australia's states would be resolved by Australian authorities without calling in the IMF to assist.

But the IMF, after a decade without any major call on its services, was anxious to affirm its raison d'etre. Its then Managing Director, Dominique Strauss-Kahn, perhaps with some personal political motivations, was eager to take a substantive role. The outcome, orchestrated by the powerful European voting faction in the IMF Board, was a key role for the Fund, but also a failure to restructure Greece's unsustainable foreign debt burden (much of it owed to German and French banks). The IMF's participation required it to depart from its own principles, under which it provided assistance only where there was a 'high probability' that foreign creditors would be repaid.

The Greek story is, of course, still unfolding. Despite the 2012 debt restructuring, the current level of  debt is unsustainable and will require further restructuring – a central element of the current impasse.

Meanwhile, the IMF has acknowledged some of the mistakes made in 2010, but the unhappy legacy remains. Having established the precedent of lending to countries which have an unsustainable debt level, Ukraine has also been given substantial assistance. The broad issue of rescheduling sovereign debt, which the Fund has struggled to resolve for more than a decade, remains. Perhaps most important all, this story is a reminder of why governance reform is so vital for the Fund's credibility. 

Photo courtesy of Flickr user Theophilos Papadopoulos.


Forecasts prepared for the IMF's 'Spring Meeting' in Washington last week predict global growth of around 3.5% this year, about the same as in the last few years. This is not the 'slowing' discussed so often in earlier Fund documents, but nor is it the normal robust recovery that might be expected after a deep downturn like the 2008 crisis. 

Larry Summers and Raghuram Rajan, Governor of the Reserve Bank of India, during the 2015 IMF/World Bank Spring Meetings, Washington DC. (Flickr/IMF)

Managing Director Christine Lagarde clearly thinks growth is too slow and that more should be done. Given the constraints on blunt speaking, however, Lagarde's policy message lacks punch: keep monetary policy accommodating; those countries not weighed down by excessive official debt should implement fiscal easing; and, as usual, everyone should implement structural reform.

But the post-2008 recovery has been so feeble that others are talking in terms of 'secular stagnation', the idea that the advanced economies have run out of dynamism and are stuck with chronic slow growth.

This idea was last in vogue in 1938. Rapid post-World War II expansion then took it off the table for a generation, but the slow recovery from 2008 has revived it. Robert Gordon blamed the stagnation partly on slower population growth. More controversially, he asserted that most of the really good ideas (innovations in technology, education and labour markets) have already been put into practice.

Since then a group of heavyweight economists have refined their arguments and policy prescriptions. Former US Treasury Secretary Larry Summers agrees with the idea of secular stagnation, but sees it as a shortage of demand rather than a supply-side limitation. The 'animal spirits' that should drive investment have become dormant. With policy interest rates already close to zero, monetary policy can't do any more to stimulate demand. But, at the same time, these low interest rates open the opportunity for countries (especially America, but Germany as well) to greatly expand fiscal spending on infrastructure, which is woefully run down in both countries.

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Former US Fed Chairman and now avid blogger Ben Bernanke agrees that the problem is deficient demand. While he supports the idea of more infrastructure spending as a short-term palliative, he worries about the longer-term implications for official debt if stagnation is indeed a chronic problem. As an alternative policy prescription, he has enlarged on his earlier view that the demand-sapping problem is global excess saving. Nearly a decade ago, he pointed the finger of blame at China, which supported its domestic economy by keeping its exchange rate artificially undervalued. This promoted exports, boosting Chinese production and income. Most of this boost was saved rather than spent, in the form of a substantial current account surplus.

Bernanke's preferred policy prescription focuses on the ongoing global current account surpluses. He sees this 'excess saving' as resulting from market-distorting policy settings in the surplus countries, which should be corrected. More 'naming and shaming' of foreigners is needed so that they rectify these policies.

How can these ideas be translated into policy?

Even if Bernanke is right about global excess savings (and his own table shows that the global imbalances have dramatically fallen since 2006), there doesn't seem much that policy can do about it. China was an easy target in 2006, but its surplus is now small. Germany isn't ready to do anything about its external surplus, running at over 7% of GDP, and the depreciating euro will actually strengthen its international competitiveness. Switzerland and Singapore (whose external surpluses are far larger than Germany's as a ratio to GDP) haven't even been named as recalcitrants. 

That leaves Summers' idea of greatly expanding infrastructure spending in America, Germany and some emerging economies. But what about the debt concerns that put an end to fiscal expansion in 2010?

Summers and Brad DeLong argue that the hand-wringing about government debt has been unwarranted for most advanced economies (Japan is the notable exception). Investors seem only too happy to take up government debt (Germany's 10-year bond yield is less than one-fifth of a percent; almost free money). They could borrow a lot more, and if they use it for beneficial purposes (some would say that is a big 'if'), it can be self-funding as it adds to GDP as well as to debt. In any case, DeLong argues that as countries get richer, they should have more public debt, because richer consumers want more of the goods which governments supply.

Meanwhile, the financial markets are fixated on something largely irrelevant to the challenge of boosting growth. They are trying to pick exactly when the Fed will raise the short-term policy interest rate, outdoing each other to name the day. All this single-minded anticipation might actually encourage the Fed to repeat the mistake of 1937 by raising rates too early in the recovery (a mistake made more recently by the Swedish central bank). Bernanke says that the rate should be set so as to bring savings and investment into equality at full employment. With all this talk of secular stagnation, the interest-rate rise should be much further off than the markets (or some members of the current Fed Board) are thinking.


Indonesian and Australian journalists were at the Lowy Institute on Monday, once again trying to explain why the press in each country plays such a minor and often perverse role in helping mutual understanding.

The causes are many, but one that deserves more thought is the way China hogs the headlines in Australia. This pushes out other Asian reporting. Once the editor has a couple of China stories, that's Asia covered for the day. Particularly in the financial press, China gets saturation coverage and Indonesia almost nothing.

Some might think this is as it should be, since China is so large and important to Australia. Indeed, China dominates our exports and affects global commodity prices in a way that sets it apart from the rest of Asia. And there is plenty of scope for hand-wringing over security issues.

But there is so little insightful hard news about China that most of these stories repeat what we already know. How many hundred stories have talked about the slowing of the Chinese economy, when all they amount to is that it has slowed from 7.5% to 7.1%, which means nothing given the unreliability of Chinese data? And none of this reporting has any real implication for the reader. Sure, the Chinese economy is important in a general way, but its importance is not changing from day to day. It's hard to get excited over China's inward-looking and secretive politics. Remember those endless articles on the formulaic changes to the Politburo Standing Committee, when the journalists didn't even know in advance when its meetings would be held, let alone what it all meant?

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Indonesia, on the other hand, has a new and amazing story every day, just waiting to be told. Its politics is open, packed full of gossip and fascinating goings-on. And it is possible to find out what is happening. Journalists can travel freely almost anywhere and report without Big Brother threating their visa if they don't stick to the party line.

As for security issues, our future in Asia might well involve vital issues between our two countries, perhaps bringing us closer together or perhaps tearing us apart. We're much more likely to be sorting this out without help from our Great and Powerful Friends, so it will be much more important for the Australian public to have a good understanding of the issues.

This is not, of course, the only explanation for the dearth of Indonesia reporting, and for the unhelpful fixations of the stories that are reported. By all means, let's go on hearing the same old content-free reporting on China, but let's also have a bit more on Indonesia's fascinating story.

Photo by Flickr user Shreyans Bhansali.


Earlier posts have discussed how the Trans-Pacific Partnership (TPP) – if it comes into force – will be part of the process of setting global rules across a wide range of issues, including intellectual property rights. The just-released Harper Competition Policy Review notes the importance of international treaty agreements in this area, and includes the following recommendation:

A separate independent review should assess the Australian Government processes for establishing negotiating mandates to incorporate intellectual property provisions in international trade agreements. Trade negotiations should be informed by an independent and transparent analysis of the costs and benefits to Australia of any proposed intellectual property provisions. Such an analysis should be undertaken and published before negotiations are concluded.

Protecting intellectual property is complex and contentious: it's not just a matter of rewarding people for having a bright idea. The key issue is how to foster innovation, and creating a monopoly through intellectual property protection isn't a first-best answer. Let's hope our negotiators have more guidance than is provided here

If the TPP goes ahead as scheduled, Ian Harper's recommendation will be overtaken by events, at least as far as the TPP goes. Would we pull back from signing if the intellectual property arrangements heavily favour intellectual property-owning countries such as the US? Not likely.

If the TPP goes ahead, we'll have to sign up or be left on the outer. It's not as if we can opt to stay in the old pre-TPP world. Our global environment will have changed and we'll have to go with the flow.

Photo by Flickr user Osbornb.


There has been much fretting about China's growth over the past five years. One special focus for hand-wringing has been the Chinese financial system and its non-banking component – the shadow banking system – in particular.

Financial growth in China has certainly been rapid since 2007, a classic warning of impending trouble. In the decade before 2007, credit grew only a little faster than GDP, reaching 187% of GDP, which is about normal for an emerging economy.

Then China applied a huge stimulus in 2009 in response to the global financial crisis, mainly in the form of easing the constraints on credit expansion. As a result, China sailed through the crisis with double-digit growth. But by 2014 the credit to GDP ratio had risen to 282%, a bit more than Australia or the US and much more than is normal in emerging economies. The shadow banking component led the expansion, growing at 37% annually since 2007.

This issue received special attention in the recent McKinsey Global Institute report on global debt. The Fung Institute in Hong Kong has also recently produced a couple of excellent papers on the topic. 

The shadow banking sector is harder to delineate than the core banking system because its precise size is confused by fuzzy definitions, double counting of some institutions and under-reporting of others. Based on Chinese central bank data, the Fung Institute puts shadow banking assets a little over 50% of GDP, or less than one-third the size of bank credit. McKinsey estimates that the sector is a bit larger.

This is much smaller than the American shadow banking sector, and the Chinese institutions are much less complex.

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In China, as in most countries, the expansion of shadow banking is the result of controls and distortions on the core banking sector which prevent banks from meeting the needs of savers and borrowers. They take their unsatisfied financing requirements to the informal financial sector, which expands to meet these needs. Depositors left the banking system because government controls made the interest return unattractive for savers. Borrowers went to the shadow banking systems because banks would not give them loans, or offered only unattractive short-term funding. 

With this in mind, the rapid expansion of the shadow banking system should be seen as a phase in the ongoing development of China's finances. There are benefits as well as dangers.

The answer is not to shut it down, but to develop the benefits and minimise the dangers. In the pre-2007 world, much of China's enormous savings ended up funding the expansion of state-owned enterprises, with this investment (or over-investment) becoming less and less efficient over time. Private sector enterprise (the dynamic element in the economy) was starved of funds, receiving only 20% of bank credit. 

The growth of the shadow banking sector is the transitional means for correcting this – imperfect, but a step towards a better financial system.

An efficient financial system provides finance across the full range of risks, offering safety for risk-averse depositors while also offering high-risk funding for the most dynamic entrepreneurs. The shadow banking sector's proclivity for excess and mindlessly low credit standards (also demonstrated in America and Europe in the period leading up to the 2008 crisis) needs to be reined in while at the same time retaining the dynamism and flexibility. Finding the right balance for the less-regulated non-bank institutions is a challenge for financial policy-makers everywhere, not just China.

So is this a worry?

China's central government has the resources and administrative capacity to prevent a serious macro-economic financial crisis. The central government starts with modest debt levels – 27% of GDP. Even if it had to absorb the losses envisaged in McKinsey's most extreme disaster scenario, this would take official debt up to around 75% of GDP – less than in most advanced economies. Many borrowers also have substantial deposits to offset against their liabilities. While there are substantial credit risks in the housing industry (property developers and builders), most homeowners have little or no debt.

China's huge foreign reserves are not available in any substantive way for domestic financial problems. But these reserves (and the current-account surplus) ensure that China cannot be affected by the flight of foreign money that made the 1997-98 Asian crisis so disastrous.

All that said, it is quite possible, even likely, that there will be numerous bankruptcies (a property crash would be serious, as McKinsey estimates that housing-related credit accounts for 40-45% of lending). The central government would have to bail out some local governments (it has already begun taking over small amounts of their debt). As well, the links between shadow banking and the mainstream banks would precipitate balance sheet strains for the banking system. 

Financial history tells us that countries which undergo financial deregulation always experience a crisis, to a greater or lesser degree. In China, the deregulation is taking place in a carefully staged fashion. But policy-makers can make mistakes. Markets can lose confidence and growth can be knocked off trend. China's low official debt, substantial government ownership of banks and enterprises, and enormous foreign reserves don't give it immunity from financial troubles, but they do mean that when things go wrong, they can be fixed with less disruption and quicker bounce-back. A Chinese 'Lehman moment' still seems unlikely.

Photo courtesy of Flickr user Sharon Hahn Darlin.