Lowy Institute
4 of 12 This post is part of a debate on South China Sea ruling

Tuesday's South China Sea adjudication demonstrates that the UNCLOS framework is totally unsuited to sorting out the complex conflicting claims in the South China Sea in a way that the relevant parties will accept. By effectively announcing the Philippines as winner and China as loser, the tribunal's finding is now the basis for empty point-scoring. There is zero chance that China will accept an outcome arrived at in this way. 

UNCLOS acknowledges the futility of this sort of process: the over-arching UNCLOS principle is that the parties involved should sort things out by mutual agreement. UNCLOS then blesses whatever they have agreed on, even if it doesn't fit precisely into UNCLOS norms. 

With the South China Sea, a complex multi-party solution will be needed rather than a few general rules-of-thumb and one-sided legal proceedings. The South China Sea disputes can't be resolved by lawyers in a distant court or some surveyor's equidistant lines on charts.

Before the disputing parties dig themselves into positions from which retreat is difficult, a different negotiating pathway needs to be opened up. The first step would be to bring all the parties together in a single negotiation forum. The obvious grouping is ASEAN and China (but not Taiwan, as it just raises too many side issues). ASEAN hasn't had the unity or resolve to do this so far and China has worked to keep its dealings on a bilateral basis. But with Indonesia now feeling pressured by China in the Natuna Sea and China rebuffed in The Hague, there just might be the chance for ASEAN to seize the initiative. If this really is an important issue, the core ASEAN countries can't let the weak peripheral members dictate continuing irrelevance.

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What would be the basis of this 'Outside-UNCLOS' framework? The starting-point is a recognition that 'win-win' is better than a contest with a winner and a loser. Economics can provide this win-win. The key is to seek out opportunities for economic collaboration rather than make futile efforts to draw definitive borders. The first element might be to postpone attempts at border demarcation until later – much later. The second is to identify the many economic opportunities which would arise if the area is not actively contested and to seek opportunities for joint development. These could be in fishing (sorting out the illegal fishing and sharing the area equitably), petroleum joint ventures, and undersea pipes and cables which become feasible and profitable when areas are developed jointly. Seabed and water column could be divided up or shared in innovative ways, which delivers something for each of the contesting participants. Revenue from petroleum exploitation could be divided between the relevant parties by negotiation. China's engineering expertise can find an outlet in these projects. The ADB and AIIB could provide favoured funding, recognising the many beneficial externalities that would result from joint projects. The local marine environment, under great threat, could be a big winner.

Working together, all parties would have some interests at stake which would be lost if they decide to go it alone. Each has to feel that the deal is more beneficial than the traditional confrontation, in which any economic development in the area will be contested physically and diplomatically. 

Does this sound a bit like the state of play in the Timor Sea? At the time when the CMATS Treaty was agreed in 2006, it was seen by both Australia and Timor-Leste as a way of moving forward to reap the economic benefits in the disputed area (in particular, proceeding with Greater Sunrise gas), with a revenue sharing that reflected negotiation rather than geography. Seabed was separated from water column (as it had been earlier with Indonesia), contrary to UNCLOS norms but allowing each country to have an ongoing interest in the disputed area. Maritime boundaries were put on hold for fifty years. 

Since then, Timor has become disenchanted with the Treaty, and strong nationalist feelings have put the benefits offered by CMATS beyond reach. But the historical precedent is there: countries can sit down and hammer out complex agreements well beyond the scope of UNCLOS. The key is to shift the negotiating priority away from delineating borders and towards the economic benefits that lie on the seabed and in the waters, waiting to be shared.

Photo: Getty Images/VCG


Standard & Poor's (one of the 'Big Three' credit rating agencies) has put Australia on negative watch, with a one in three chance that our rating will be downgraded before long. On the face of it, this sounds like a big deal that can only be avoided by budget-tightening actions (which the close election result has made less likely). There would be knock-on effects from a rating downgrade, the banks, for instance, have the same threat hanging over them, as their rating can't be higher than that of the government. 

But hang on a moment! Aren't these the same agencies that handed out AAA ratings to financiers that packaged up a bundle of dubious mortgages into a portfolio with fancy name (Collateralised Debt Obligations, or CDOs)? Wasn't this endorsement provided by the credit rating agencies in exchange for fat payments from the CDO-promoters? The Standard & Poor's character in The Big Short movie blurts out the rationale: 'if we don't give them the rating, they'll go to Moodys.'

Yes, these are exactly the same, although of course (just to confuse the investing public), those AAAs for CDOs weren't exactly the same as AAAs for government debt. For government debt, the credit rating agencies' record is, however, only marginally less misleading. S&P took away Greece's investment-grade rating months after Greece's budget cover-up (and inevitable debt disaster) became public in 2009.

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So why would anyone take any notice of credit rating agencies? Despite the portentous reporting that always accompanies such announcements, in practice financial markets don't take much notice. The US AAA downgrade in 2011 and Japan's downgrade in 2002 were treated by financial markets with total equanimity, with no detectable change in financial prices. Similarly, the S&P announcement last week was greeted with calm composure by financial markets. The news media cited the exchange rate and weaker equity prices when reporting the downgrades, but any impact was indistinguishable from the normal daily fluctuations. Financial markets make their own judgments about risk, without help from the credit rating agencies.

Why do governments routinely take these announcements so seriously, and respond by confirming that they are doing exactly what the credit rating agency recommends? Usually, it is just part of the political parlour game. Treasurers wants to draw attention to how brilliantly they are steering their national economies in a tumultuous world. They can justify unpopular proposals by asserting they are necessary to avoid the threatened downgrades. It would take a brave government to tell these agencies that they were entitled to their opinion, but that the government will not take any notice.

If the clear experience is that rating downgrades have an imperceptible effect on market prices (bonds, shares and the exchange rate), maybe we should just ignore all this brouhaha. But the credit rating agencies have had some malign influences, both overseas and in Australia.

Future historians may well give a harsh judgment on the macro-policy response to the 2008 financial crisis. Policy responded appropriately to the sharp downturn by easing monetary policy and providing fiscal stimulus (endorsed by G20 in London in 2009). But by 2010, a debt-paranoia set in. This was turned into panic by the collapse of the European periphery (led by Greece). Even countries that had no pressing need to get their debt down were pressured by all the international agencies (including credit rating agencies) to rein in their budget deficits, even though this meant strong headwinds for the recovery. Over time, agencies such as the IMF came to see that the contractionary effect of this fiscal consolidation (also known as 'austerity') had been underestimated. The IMF reversed its advice for countries that can fund their deficits easily (as all the big countries can, in a world where governments can borrow long-term almost without cost). 

Of course, the credit rating agencies were not single-handedly responsible for the 2008 crisis or the subsequent policy mistakes; they were just one cause and one voice among many. But they were on the wrong side of the argument then, and they may still be now. This debt fetish has produced nearly a decade of unbalanced macro-policy (monetary policy too loose, fiscal policy too tight). The result is a pathetically limp recovery in Europe, with unemployment still in double-digits today. Some countries realised the error after a few years (USA, Japan and UK) and quietly abandoned austerity. Their growth performance immediately improved.

You might wonder how Australia avoided this same mistake. After all, we've had the international agencies and the credit rating agencies telling us about debt and external deficit vulnerability forever. The secret of our comparative success is the bipartisan policy of promising to prioritise restoring the budget to surplus quickly, yet not actually doing it. The very characteristic that S&P complain about (failure to deliver on budget promises) is the masterstroke that allowed Australia to sail through the crisis without a recession and record a rate of growth twice that of the advanced economies. This higher GDP gives us capacity to shoulder the increased debt S&P frets about.

That said, there is a long-standing malign influence on Australia from the credit rating agencies' debt fixation. For the past few decades, state governments have lived in fear of a downgrade. This is not because it would change borrowing costs much; the impact would be tiny. The fear is the damage to political reputations; such has been the focus on ratings that any state government that seemed indifferent to downgrade would be lucky to survive beyond the next election. 

As a result, state governments have shifted to a form of infrastructure funding which is around twice as expensive as issuing their own bonds, without in any way making their underlying financial position any stronger. Sydney's desalination plant illustrates the issue. This was funded by 'selling' the newly-completed plant to an offshore fund, involving a thirty-year take-or-pay contract which gives the investor the same sort of security and cash-flow that they would have from holding a government bond (although, admittedly, without the liquidity of a government bond), and twice the return. This contract is not counted as government debt although it has the same characteristics: an obligation by the government to make debt-like payments over a long term. The government's financial position is actually weakened because of the higher funding cost.

Most financial institutions which were caught up in the blame-game of the post-2008 period have had to make painful changes since then. The credit rating agencies, however, seem to be Teflon-coated. Their opinion is still a central requirement of various official prudential processes; they still adjudicate on the critical distinction between funds which are 'investment grade' and those which are 'junk'.

Assessing the full import of a country's debt position is hugely complex. Australia currently holds an AAA rating because its performance (even with budget deficits and a perpetual substantial external deficit) has been consistently competent. Australian government debt is remarkably low by international standards (much lower than Canada, which is also rated AAA). 

Source: Australian Parliamentary Library

Of course Australia needs to live within its means, making sure that overseas borrowings increase our capacity to service those borrowings and putting in place measures which will strengthen the budget by removing anomalies. We can do this without the constant hectoring from agencies whose egregious misjudgments are still fresh in our memories.

It's time to stop genuflecting at the ratings altar.

Photo: Getty Images/Timur Emek


Sam Roggeveen reminds us that Brexit has spotlighted the political unpopularity of globalisation, immigration and the 'neoliberal' economic agenda. The politics of these issues is fraught, with strongly held opinions for and against each of these ideas. Yet economics is pretty clearly in favour of all three, at least as generalisations about complex issues. Why did the economic arguments gain so little traction in the UK debate? Closer to home, is Australian policy-making vulnerable to a populist political push based on these issues?

Let's try first to clear away the baggage surrounding the idea of 'Neoliberalism'. It has come to be used as a term of rhetorical abuse hurled by those on the left of the political spectrum at those on the right , just as 'socialist' is often used (at least in America) as an accusation rather than a description. The case in favour of market-based economies, as opposed to a centrally planned economy like the former Soviet Union, is no longer seriously debated. The clear-cut victory of the market didn't come out of either doctrinal wrangling or text-book analysis: central planning failed comprehensively wherever it was tried, including the rare cases where it still survives; Cuba and North Korea.

That said, this triumph of the market did not result in libertarian economies with minimalist government and little regulation. The same period of history that demonstrated the failure of central planning also demonstrated the inadequacy of the libertarian model. The 1930s depression showed that markets are not self-equilibrating and need quite a lot of government interference to work tolerably well. In the course of the last century, America (where the rhetoric of free markets is loudest) went from the age of the free-ranging robber barons (astonishingly successful if judged purely in economic terms) to the intrusive institutions and ubiquitous regulations of today.

There was another clear lesson from the post-WWII period: countries with very different degrees of government intervention (as measured, say, by the size of the public sector and the degree of regulation) can succeed equally well. Government-heavy Scandinavia has done as well as countries where the public sector is little more than half as large.

What about globalisation? Just as the empirical evidence is clear that market-based economies perform better than centrally planned economies, the Post-WWII experience shows that economies work better if they are open to interaction with the outside world. Even the big-government/high-taxing Scandinavians have made sure they remain deeply engaged and competitive in the outside world. For such a small country (just 10 million people), Sweden has substantial world brands (Ikea, Ericsson, Volvo, Astra/Zenica, Electrolux, H&M, Skype and Spotify, for example). The most dirigist economic planners (such as the amazingly-successful South Koreans) had international competitiveness as the key policy element driving dynamism and weeding out weak players.

The demonstrated benefits of globalisation just confirm a closely-related idea that economists have long promoted: free trade. This is one of the few ideas that economists agree on (with just a minimum of caveats). Countries should specialise in the things that they are good at, export these and import the things which others are better-suited to making. The benefits go well beyond the cloth-for-wine exchanges that Ricardo explained two centuries ago: exposure to foreign competition enhances dynamism. Productivity growth is always higher in the tradables sector than in the sheltered domestic sector.

Yet the public has never bought this argument. The benefit of being seamlessly connected to a large foreign market was the core of the 'Remain' argument: the Brexit losses predicted by the UK Treasury reflected a big hit to forecast productivity. A majority of voters remained unconvinced.

Perhaps this is because globalisation gets blamed for unemployment and increasing income-inequality. Read More

Competition from low-wage countries (notably China) is seen as hollowing-out manufacturing, with the loss of its well-paid jobs.

Certainly, China's transformation to become 'manufacturer to the world' put pressure on labour markets everywhere, although other factors — labour-saving technology and the decline of trade-union power — were probably more important in squeezing the labour share of GDP. But even if the direct effects on labour-share are small, globalisation doubtless has a down-side: global exposure involves doing things differently, sometimes with new firms replacing old. Success now depends on being sharper, perhaps working harder. The disruption is often painful and not everyone adapts.

In any case free trade certainly doesn't claim to make everyone better off: all it says is that the benefit to the country as a whole is sufficiently large so that the winners could compensate the losers, leaving some better off and no-one worse off. In Britain, however, instead of compensating the losers, the fruits were showered on a small high-profile elite who epitomise this brave new unequal world. Ostentatious income disparity, combined with a lacklustre recovery from the 2008 crisis, left many in the working class unimpressed by what globalisation had done for them.

Their search for scapegoats went further: to the EU's open-border immigration policy. Immigration illustrates the chasm between general economic principles and political reality. The overwhelming majority of economists favour market-based solutions in general, and yet you rarely hear advocacy for cross-border free labour markets. Economists know that this would be a futile argument, overwhelmed by politics. Since the US restrictions on immigration in the 1920s, no country has had free labour markets, open to all comers.

With the hard-working migrants from Eastern Europe already putting pressure on UK labour and the threat of greater numbers if Turks were allowed to join the flow, a gap opened up between those who benefited from EU migration freedoms (the cosmopolitan elite and the mobile young) and those who did not. In the lead-up to Brexit, the UK Treasury cited numerous studies showing that UK's immigration had been good for the economy and was a net-positive for the budget: in addition, it had not harmed the employment prospects of Britons. Some telling evidence: UK unemployment is historically quite low. Yet the public doesn't believe this: they are more swayed by the anecdotal evidence, from friends and the press, that Britons have been pushed into unemployment by the flood of Eastern Europeans. More anecdotal evidence gives credence to the widely-held view that social security benefits attract indigent immigrants who are a drain on the budget and a burden to society.

There was strong tension between the EU's eastward enlargement and the sensitivity of the immigration issue. There is not much an economist can say to mitigate this. It's up to the politicians to gauge what society will tolerate, with its diversity of perceived losers and beneficiaries. David Cameron tried to negotiate some migration amelioration in Brussels, but the fundamental tension remains between those who want a United States of Europe (where there cannot be constraints on internal migration), and Britain's vision of a more limited economics-based integration.

Dani Rodrik argues that there is a 'trilemma' that would constrain such a 'globalisation-lite' option. In his view, globalisation requires supra-national rules, which are incompatible with democratically-based national sovereignty. This draws the choices too starkly: a globalised world will have multiple layers of rules, some perforce global while other rules can reflect the idiosyncrasies of the local environment. It is true, however, that measures to soften the down-side of globalisation can undermine the upside, dampening incentives and leaving inefficient production in place. The answer is to devise tempering strategies which encourage flexibility and adaptation without ossifying existing production practices.

Ed Miliband, former UK Labour Party leader, argues that the political-right can't provide the offsets to inequality which successful globalisation needs: 'The right can't solve the problem of inequality because to do so would be to abandon too much of what they believe, from a belief in the small state to trickle-down economics.' Again, this may overstate the contradiction. 

What lessons are there for Australia? The success of Pauline Hanson's One Nation Party (with its strong anti-immigration baggage) and Nick Xenophon's team of industry protectionists demonstrate that the same issues resonate with some Australian voters. Australia's tough policy towards undocumented arrivals is now bipartisan, which has allowed the high rate of formal immigration to continue without much debate. Nick Xenophon may succeed in keeping South Australian steel production going, even though it has been made uneconomic by China's massive overcapacity. But this is a small distortion in the larger economy which continues to integrate with the outside world.

Despite Malcolm Turnbull's lauding of smaller government, freedom and entrepreneurship, both major parties have provided about the same level of government expenditure and much the same safety-net for those left behind by the modern world. Most of us can reconcile with equanimity the Prime Minister's theme-tune that 'there has never been a more exciting time to be an Australian' with the view that we are exposed to a world over which we have little control. After all, Australia has operated successfully in this volatile world environment without a recession for a quarter century and is adapting without drama to the end of the globalisation-induced resources cycle. In this exciting world, who misses John Howard's 'relaxed and comfortable'?

Photo courtesy of Flickr user Loic Lagarde

The Brexit referendum

A vote to leave would represent an immediate and profound shock to our economy. That shock would push our economy into a recession and lead to an increase in unemployment of around 500,000, GDP would be 3.6% smaller, average real wages would be lower, inflation higher, sterling weaker, house prices would be hit and public borrowing would rise compared with a vote to remain.

George Osborne, Chancellor of the Exchequer, May 2016.

The longer-term consequences are predicted to be even more parlous:

If we take as a central assumption that the UK would seek a negotiated bilateral agreement, like Canada has, the costs to Britain are clear. Based on the Treasury's estimates, our GDP would be 6.2% lower, families would be £4,300 worse off and our tax receipts would face an annual £36 billion black hole. This is more than a third of the NHS budget and equivalent to 8p on the basic rate of income tax.

George Osborne, April 2016.

And yet Britain has voted to leave.

As usual in economics, 'it all depends', but there is near unanimity that this will turn out badly for Britain's economy, even in the longer run when the shockwaves have dissipated. See the chart on page 24 of the IMF's assessment. The only positive prediction is from a cock-eyed optimist who sees Britain retaining the substance of its EU relationship, supplementing this with free-trade agreements with fast-growing economies, and a productivity burst resulting from deregulation.

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The main economic issues are:

  • trade
  • investment
  • regulation
  • fiscal costs of membership
  • immigration.

On trade, the starting point is that favoured access to a large nearby market should provide a clear advantage, and about half of Britain's exports currently go to Europe. Many economists are lukewarm about so-called 'free-trade agreements' and common markets as they distort trade and Britain is currently buying some EU goods which could be obtained more cheaply from a non-EU supplier. Let's not, however, make too much of this argument. The EU is a large market and the distortions are probably small (with the notable exception of agriculture — more later). Losing preferential tariff rates doesn't matter much because tariffs are generally low, but it will be painful to lose the seamless connectivity that a common market provides with its uniform regulations and procedures.

It might seem that Britain could negotiate a deal with the EU that retains its current access (as Norway has done). The EU may well be peeved about Britain's departure, but it is still in the EU's interest to maintain a larger trading block. The UK is much less important for Europe than Europe is for the UK (its exports to the UK amount to 3% of the EU GDP, compared to Britain's 13% of GDP from exports to Europe). That said, Europe would be better off with close integration with the UK. 

While economics doesn't stand in the way of this outcome, politics probably does. Norway has to abide by all the EU rules except fishing (an outcome was critically important to its economy), including immigration. Switzerland has negotiated largely-free access to the EU, but contributes to the EU budget, abides by EU rules and is a signatory to the Schengen immigration protocols; all without a vote in Brussels. With these precedents, it seems unlikely that the EU would provide the current degree of access without insisting on many of the existing obligations (including immigration) and fiscal contributions.

The main trade advantage which the UK has at the moment is the ease-of-doing-business which harmonisation of standards and protocols brings. Whatever the deal finally reached, it won't be as good as Britain has at present.

The EU currently has 60 FTAs (and even more under negotiation), with the likelihood that Britain will be excluded from these once it leaves. Where will Britain stand in the Transatlantic Trade and Investment Partnership (TTIP) currently under negotiation? Maybe there is a glimmer of hope here. The US aim is to make this type of high-level agreement the new model for global trade. If Britain could somehow tag along with these arrangements, the result might provide good access to Europe. But the TTIP is a long way off and in any case these broad rules and high level principles are far removed from the detailed harmonisation of the EU common market. 

Potentially just as serious is the impact on foreign investment into Britain. There is not much doubt that Britain has benefited very substantially from being the first choice as an investment destination for non-EU companies looking for easy access to the EU market. Similarly, EU firms find the global orientation of Britain's legal system and language attractive in their dealings with the outside world. This applies particularly to London's financial sector which accounts for 8% of UK GDP. Under the 'passport' system, financial transactions are seamless not just for travel, but for mutual acceptance of prudential regulation. Some of this financial business will shift to Frankfurt, Paris and other European cities. No wonder London voted overwhelmingly to stay!

The popular complaints are about over-regulation, with lots of risible anecdotes about requirements on the dimensions and shape of bananas and cucumbers. But Britain has managed to remain lightly regulated overall, including (most importantly) in the labour market. Derisory anecdotes are legion, but the reality of a globalised economy is that any exporter will have to meet foreign-designated specification (at a minimum, for biosecurity, product safety and rules-of-origin) if it wants to do business overseas. This won't change much. In any case, many of the most efficiency-sapping regulations are home-made (such as urban planning and building regulation). Britain could go its own way on issues such as the environment, but again there are powerful pressures to conform (not least from the domestic public). Thus, EU regulations will probably be replaced by similar domestic rules.

Won't Britain be freed from the undoubted inefficiency of the Common Agricultural Policy (where domestic farm production is sheltered by the highest tariff levels, around 20%)? Much of British agriculture is subsidised (Britain gets back around half of what it puts into funding the CAP) and wouldn't survive without subsidies. It is inevitable that the CAP subsidy will be replaced by a domestic one in the short term, and even in the longer term it will be hard to wean British farmers off their subsidies.

What about the burden of supporting the EU's budget, with all its bureaucracy and costly subsidies for Europe's poorer members? The net cost of EU membership to Britain is around 0.3% of its GDP: not small change, but not all that large either.

Even free-market economists understand there are political sensitivities when it comes to labour markets. Nevertheless, they generally see economic advantage in immigration. The IMF assessment (section 25) quotes a number of studies showing the positive impact of EU immigration on the UK. A growing labour force is usually thought of as a positive for an economy (for the counter example, think of the gloom associated with Japan's declining demographics). That said, the public generally doesn't like outsiders. Looking more closely at the composition, however, only about half of Britain's recent immigrants come from the EU, and these tend to be, in economic terms, the best immigrants; educated, young, mobile, hard-working, motivated, and often bringing special skills. If there is a political imperative to cut immigration, reducing the non-EU migrants could be done without leaving the EU.

From an economic perspective, Britain obtained an attractive deal within the EU. It isn't a member of the euro-zone (it kept its own currency), so it continues to have independence in monetary policy. It is not a member of Schengen, so it keeps control over its borders. It had to accept EU immigration, but this is a plus in economic terms, especially as Britain negotiated the right to restrict social security benefits for the newcomers. Its net membership cost is below average as a share of GDP. It negotiated specific exclusion from the inevitable costs of bailing out troubled EU members like Greece. The sometimes-weirdness of regulatory burden is a source of endless amusement, but is a serious issue only for doctrinaire libertarians; an increasingly globalised economy requires more regulation at a supra-national level. Britain's natural advantages of language and law meant that it could dominate Europe's finance industry and that led to lots of high-paying jobs.

Thus from an economic viewpoint, Brexit is inexplicable. Does it make more sense in a longer timeframe? If the 'Europe' project is moving inexorably towards a huge country called 'Europe', with fully integrated budgetary policy involving large transfers to the poorer members, then the push-back is more understandable. Perhaps Britain's half-hearted integration (notably, its decision to stay outside the euro zone) was a forewarning that it wasn't a suitable candidate for the Europe project, and what happened last Thursday was inevitable at some stage.

Even if this were true as a longer-term trajectory for Britain, why not ride along for the benefits which remain to be gained for continuing membership? The economic case for remaining in the EU is so overwhelming that Brexit has to be counted as yet another case where the economic arguments never gained traction. Of course the economics may not turn out as badly as Chancellor Osborne predicted (he was, after all, a biased source). Financial markets hate uncertainty and always overreact. But what is indisputable is that the down-side risks facing the economies of both Britain and Europe have substantially increased.




David Lipton, recently reappointed first deputy managing director at the IMF (effectively number two to Christine Lagarde) was at the Peterson Institute recently to give some insights into being 'fireman in chief' for US international economic policy for the past three decades, ready to act 'every time the IMF needed to be second-guessed'.

His career alternated between the US Treasury and the IMF. He was indeed a key figure during the Asian crisis of 1997-98, sitting in an adjacent room while the IMF negotiated its program with South Korea and acting as chief enforcer for the misguided monetary policies in Indonesia in early 1998. 

Thus his reflections on the success of these policies, nearly 20 years later, are of interest:

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When Thailand, Korea and Indonesia fell into crisis less than three years later, we learned that even countries with successful policies and access to foreign finance can develop vulnerabilities.

We also learned that global financial markets could focus on those vulnerabilities, move as a herd, and generate a reversal of capital flows – not only for one country, but for many other countries seen as similar. We were forced to re-examine our efforts to promote capital market openness and integration. Many countries came to fear the political and economic costs of financial sudden stops, recession, and banking sector stress. Emerging market countries also worried about market access and began to act more defensively – building up international reserves through intervention.

How this assessment has changed since 1997! When Thailand and Indonesia came under speculative attack in 1997, the key economic problems were seen in terms of domestic policy mistakes: fixed exchange rates, large current account deficits and weak financial sectors. But above all, the diagnosis for Indonesia was 'KKN' (corruption, collusion and nepotism), factors which hadn't stopped Indonesia from growing at 7% annually for three decades.

The remedy was to float exchange rates, ignoring the inevitability that free floating in these circumstances would lead to huge overshooting (as occurred, spectacularly, in Indonesia). Budgets were tightened sharply, which ensured that the downturn became a crippling collapse in economic activity. Troubled banks were closed without provision to prevent contagion, which brought down the entire banking system. Interest rates were raised drastically in the misguided belief that capital outflow would reverse and the exchange rate rout would be halted. All it did was bankrupt borrowers. A shopping list of structural conditionality was imposed (desirable for the long run, but in the middle of a crisis this was like insisting that a bleeding road accident victim take a pledge to give up smoking).

With the Indonesian rescue program in chaos, it was easy to add an uncooperative President Suharto to the list of problems that had to be dealt with. The final straw was the program requirement to raise petroleum prices sharply, always a super-sensitive political issue. The resultant riots in May 1998 brought about Suharto's resignation (one senior American had told me earlier in January that 'the quicker this fucking regime goes, the better').

Now the story can be re-written in a way that makes more sense. In the years leading up to the crisis, capital markets were opened up to foreign inflows too quickly and for no good reason (Stan Fischer, who led the IMF's Asian rescue operations in 1997-98, now asks 'what useful purpose is served by short-term international capital flows?'). The excessive inflows pushed up exchange rates (leaving them vulnerable to speculative attack). The inflows overextended bank balance sheets and created a speculative boom in assets. Domestic borrowers took out loans in foreign currency, which bankrupted them when the exchange rate collapsed. The crisis response was seriously flawed. Unlike in Mexico in 1994, there was not enough external funding assistance to stabilise the capital outflow. Direct intervention to limit capital outflows and 'bail-in' foreign creditors was specifically ruled out by the IMF, even though it was later successfully applied in South Korea and had been a central element of Poland's 1989 reforms.

How could the rescue operation have been so misguided? Perhaps one clue is David Lipton's own description of his prior experience:

Working with Jeff Sachs, we did what graduate students do: we built a mathematical model, fancy for its time (with two countries, fully maximizing, infinite horizon, rational expectations, etc.). 

After this, he worked with the IMF on the Latin American crises of the 1980s, and with Jeff Sachs on Poland (usually regarded as a successful, if painful, transition from a command economy to one based on markets). He observed Mexico during its 1994 crisis, where excessive capital inflows were the core problem. Thus there is no excuse for missing their key role in Asia three years later. But none of this fitted the textbook model of capital flows, where:

Everyone gains: the poor country experiences a boom and living standards converge upward. Even the rich country gets richer as investors reap returns to capital higher than any available at home.

The operational lesson he learned from the IMF, Jeff Sachs, and Poland was to see economic reform as a matter of revolutionary change ('shock therapy'); to swiftly impose market-based systems and slash the role of state ownership. The failure, as usual, was with Douglass North's 'institutions'; the absence of deeply embedded norms of behaviour which are necessary for markets to work well. Like many IMF staff, he was well-equipped in book learning, but the practical application was distorted by preconceptions about how well markets (particularly financial markets) would work in these environments. The neoliberal agenda guided policy. 

Belatedly, lessons were learned, but only through experiencing crisis at home a decade after the Asian Crisis. The lessons of 1997-98 were seen as applicable only to developing economies. The response to the 2008 crisis could hardly have been more different: interest rates were lowered dramatically; fiscal policy was eased (at least initially); and financial institutions were shored up with massive government funding. 

Larry Summers gives David Lipton credit for shifting the IMF to a more accommodating attitude to fiscal consolidation during the recovery from the 2008 crisis. The IMF has also shifted rhetoric on capital flow management, even if it's hard to see evidence of an operational shift. There is a long way to go. Most relevant to crises such as Greece, adequate sovereign debt restructure seems as distant as ever.

The enduring legacy of the 1997-98 Asian crisis is that Asian policy-makers are adamant they will never again ask for IMF assistance, preferring inefficient self-insurance in the form of current account surpluses and large foreign exchange reserves to the risk of finding themselves once again subject to IMF policy strictures.

Photo: Getty Images/Milos Bicanski


Last Friday Sam Roggeveen called on Interpreter readers to nominate their pick for the best national anthem. This is the first response.

Judging national anthems without context is akin to asking whether the madeleines baked by Proust's Aunt Leonie were the best sponge-cakes ever. It's not just about the music, and certainly not about the words. A lot of what moves us to emotion is context: what are the circumstances in which we experience the anthem, or remember past renditions?

Who can forget the scene in Casablanca when Victor Laszlo orders the band to play La Marseillaise, Ric nods, and the café patrons rise up to drown out the German carousing?

For me, The Star Spangled Banner wins, because of circumstance. The context was Saigon in 1970. The PX cinema was filled with US service personnel — enlisted and conscripts. Half the audience stood up for the anthem and half of those who remained seated heckled the first group with loud calls of 'lifer, lifer'. For some standing, and for many more who remained seated, this was an emotion-filled moment, with US soldiers torn between observation of a deeply-held ritual and unhappiness about where their country had taken them.


Like all big bureaucracies, the IMF shifts its operational doctrines slowly, rewriting its own history as it does so in order to avoid admitting past errors. We are currently witnessing another episode of this glacial move in relation to two issues: budget austerity and foreign capital flows.

EIMF Chief Economist Maurice Obstfeld and World Economic Studies Division Chief Oya Celasun, 12 April 2016 (Flickr/IMF)

The current debate was triggered by some Young(ish) Turks in the Fund's research department asking whether economic 'neoliberalism' had been oversold. For the authors, 'neoliberalism' is typified by two elements:

The first is increased competition—achieved through deregulation and the opening up of domestic markets, including financial markets, to foreign competition. The second is a smaller role for the state, achieved through privatization and limits on the ability of governments to run fiscal deficits and accumulate debt.

Neoliberalism is a big canvas, and they actually wanted to discuss just two elements: capital flows and budget austerity (aka 'fiscal consolidation'). 

What did the maverick Young Turks have to say about capital flows?:

The mounting evidence on the high cost-to-benefit ratio of capital account openness, particularly with respect to short-term flows, led the IMF's former First Deputy Managing Director, Stanley Fischer, now the vice chair of the U.S. Federal Reserve Board, to exclaim recently: 'What useful purpose is served by short-term international capital flows?' Among policymakers today, there is increased acceptance of controls to limit short-term debt flows that are viewed as likely to lead to—or compound—a financial crisis.

On budget austerity, the Fund has always been a strong proponent of fiscal rectitude. The common quip is that 'IMF' stands for 'It's Mostly Fiscal'. While the 2008 financial crisis was not caused by budget profligacy, deficits did expand in response to falling GDP and the need to shore up the financial sector. The resulting impact on government debt became a major policy issue during the recovery phase. The Fund was part of the chorus of international economic institutions (including the OECD and the Bank of International Settlements) that urged a quick return to budget balance after the brief G20-endorsed fiscal expansions of 2009. By 2012, however, some Fund staff (notably then-Chief Economist Olivier Blanchard) saw that the attempt to get budget deficits back to balance quickly was constraining the recovery: the fiscal multiplier was much larger than had been thought.

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Thus the Fund's advocacy of universal fiscal austerity was modified, although the moment for the Fund to have a useful voice in this debate had passed. Policy in the main crisis countries — the US, UK and Europe — was determined by the domestic debate. 

On both capital flows and austerity, the Fund has shifted its position in recent years, and has debated these issues extensively. The shift, however, may be more in the rhetoric than in the Fund's actual operations. The IMF's Chief Economist Maurice Obstfelt quickly entered the current debate to downplay any notion that the Fund is shifting much – this is 'evolution not revolution': 

Countries need credible medium-term fiscal frameworks that leave markets confident the public debt can be repaid without very high inflation. Countries with such frameworks will typically have room to soften economic slumps through fiscal means, including automatic stabilizers. Unfortunately, some countries let public debt rise to such high levels that they risk losing market access, and have no choice but to tighten their belts even when their economies are doing badly...Of course, there are limits to the pain economies can or should sustain, so in especially difficult cases we recommend debt re-profiling or debt reduction, which require creditors to bear part of the cost of adjustment.

So it looks like the Fund hasn't moved much at all on fiscal advice: build up fiscal space with budget surpluses so that the budget can soften a downturn by allowing the automatic stabilisers to operate when budget revenue falls and unemployment benefits rise. Even the hard-core proponents of fiscal rectitude would find nothing to disagree with here. But this says nothing about whether the US, the UK and Europe (which clearly were not threatened with loss of market access) were right to impose austerity in the recovery phase from the 2008 crisis.

The shift on capital flows may also be more rhetorical than operational. In 2012 the Fund recognised the role for capital flow management in certain limited cases. It's not clear, however, what this means in practice. The Fund still has its technical assistance teams actively promoting international integration of financial markets which encourage greater short-term flows – the very flows now being questioned.

Obstfelt was quick to point out that budget austerity and capital flows are just two elements in the much broader context of economic neoliberalism and that the Fund's re-examination of these two issues 'has not fundamentally changed the core of our approach, which is based on open and competitive markets, robust macro policy frameworks, financial stability, and strong institutions.'

It was probably unhelpful that the Young Turks put these two issues into the broader context of neoliberalism. It triggered a vitriolic response from the Financial Times editorial writers ('childish rhetoric...in seeking to be trendy, instead the IMF looks as out-of-date as a middle-aged man wearing a baseball cap backwards'). 

In fact, the broad parameters of the neoliberal debate were settled long ago: centrally planned economies all fail (the Soviet Union, China before 1980 and Cuba), and market-based economies succeed if they can find the right institutions and rules. The transition from one to the other is painful (as it was in Russia and Poland) and often gives away too much to individual private interests. 

The sensible debate is at the operational level, in the detail. The devil, of course, is also in the detail.

China is a successful economy with a lot of government interference and ownership. South Korea has been stunningly successful with very dirigist policies, especially initially. Sensible economic policies don't come out of doctrinal debates, but out of measures which recognise the existing conditions (institutions, administrative competence, physical infrastructure and so on), and the limited capacity to change these over time.


None of the US presidential candidates is keen on the Trans-Pacific Partnership. Does this mean that the treaty — signed but unratified — is finished and all that debate, negotiation and angst will have been vain?

President Obama doesn’t see it that way. He’s still plugging away in the hope of presenting enabling legislation to Congress before it breaks in mid-July for the party conventions. It is at least technically possible that Congress could approve it before the presidential election, or even in the ‘lame-duck’ post-election period before the new president takes over. But this is a big ask.

Hillary Clinton has not only come out against the agreement in its current form, but has ruled out any action in the lame duck period if she is elected.  Donald Trump wouldn’t be supporting it. Thus the best chance — if a slim one — is that President Obama sees it as so important for his own legacy that he puts in the huge effort required to see this through in his term.

Unlikely though this seems, there are TPP advocates,  including powerful sectoral interests that would benefit from the agreement signed last February. They understand that if the TPP doesn’t get through this year, it will be on the back-burner for years to come. If it doesn’t go ahead, where does that leave Obama’s ‘pivot’ to Asia? For her part Clinton, if elected, might be content to have had the TPP resolved before she takes over responsibility. 

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Some of the necessary prior actions have been taken. The US International Trade Commission has examined the agreement and concluded that it will benefit the USA, even if the impact on GDP is tiny

Many members of Congress have a fixation with ‘currency manipulation’ and are still calling for counter-measures to be included in the TPP. But the compromise reached earlier was for the US Treasury to address this issue unilaterally, which it has done by spelling out more precisely what it would regard as ‘currency manipulation’.

The Treasury’s criteria illustrates the muddle that arises when bureaucrats attempt to placate public ignorance. Of the three criteria developed for identifying ‘manipulation’, only one makes any economic sense. Perhaps substantial official intervention in foreign-exchange markets might constitute ‘manipulation’ (although the Swiss authorities would regard their attempt to constrain their growth-sapping appreciation as being worth a try, even if it was ultimately unsuccessful).  But the second criterion — concern about large current account imbalances — is harder to justify. And the third — concern about bilateral imbalances (i.e the trade position between the US and its individual trading partners) — is not just nonsensical, but actually harmful. If all countries responded to large bilateral imbalances by imposing trade restrictions, global trade would shrink dramatically. A key advantage of free international trade is that a country can obtain imports from one trading partner and pay for them by exporting to another partner. The bilateral balance between individual trading partners is irrelevant.

Fortunately it is unlikely that all three criteria would be infringed simultaneously, and even if they were, the penalties imposed could be trivial. But this sop to Congressional misunderstandings illustrates the illogical compromises that arise in international rule-making.

What about the alternative set of inferior trade rules which President Obama fears China will put in place if the TPP doesn’t go ahead?

As we speak, China is negotiating a trade deal that would carve up some of the fastest-growing markets in the world at our expense, putting American jobs, businesses and goods at risk.

What he has in mind is the Regional Comprehensive Economic Partnership (RCEP), which is actually an ASEAN initiative, not a rival China ploy. The RCEP envisages a set of rules or reforms which are aimed principally at practical impediments to trade, rather than establishing high-level principles as the TPP aims to do. It won’t address some US concerns (the role of state-owned enterprises, intellectual property rights or industry/state dispute resolution), but some would argue that the TPP over-reaches on these issues. Sensibly enough, Australia regards the two trade deals as conceptually compatible and supports both.  In any case it seems most unlikely that RCEP will be completed on schedule by the end of the year (ASEAN schedules tend to slip, and the negotiating schedule seems open-ended).

Perhaps more seriously, the case for TPP (and the characterisation of RCEP as China’s rules) is increasingly looking like a ‘contain–China’ play. In the Washington Post article, President Obama said:

America should write the rules. America should call the shots. Other countries should play by the rules that America and our partners set, and not the other way around. 

A more nuanced approach might offer China both carrot and stick: cooperation in developing mutually beneficial global trading rules while at the same time pushing-back against China’s South China Sea territorial claims.

Photo courtesy of Flickr user Jens Schnott Knudsen

Election Interpreter 2016

In the United States, international trade is a hot-button political issue. Australia, on the other hand, is likely to get through the long election campaign with hardly a mention of tariffs and industry protection. Why the difference?

Donald Trump’s policy positions may be a kaleidoscope of contradictions, but his message on foreign trade is pretty consistent: exports are good but imports are bad. Hillary Clinton, always a bit ambivalent but at least initially a tentative supporter of the Trans-Pacific Partnership (which she described as the ‘gold-standard in trade agreements’), has now changed her mind and ‘currently opposes it in its current form’.  The US Congress takes a keen interest in ensuring that trade deals favour American interests.

This insularity mirrors a wider public perception that opening up the economy to international trade has been harmful, especially to manufacturing employment. Concern about the ‘giant sucking sound’ of NAFTA taking away American jobs may not have won Ross Perot the presidency in 1992, but this jaundiced view of international trade has remained. It is widely seen as the main cause of the stagnant real incomes of America’s blue-collar workers. Indeed, this discontent might be the single biggest driver of the astonishing rise of The Donald.

Meanwhile in Australia, the Trans-Pacific Partnership (and globalisation more generally) haven’t yet figured in the election campaign. Of course the current Coalition government supports TPP and all it stands for — after all, it negotiated and signed the draft. The Labor Party might have some specific concerns.  It is (justifiably) suspicious of the dispute settlement processes (ISDS), and wants to be assured that the intellectual property provisions don’t undermine Australia’s pharmaceutical benefits program. And of course it is the defender of Australian workers. Thus it was concerned that the China-Australia Free Trade Agreement (ChAFTA) didn’t open up opportunities for temporary import of Chinese workers to undercut Australian labour.

But having rehearsed these concerns and had them allayed, Labor will not stand in the way of ratification the TPP, not just because of its economic content, but because of its place in the wider context of Australia’s position in the world and more specifically Australian-US relations. If an American administration is strongly pushing the TPP, we will sign up without a whimper of disagreement. Similar political realities would prevent Labor from undermining ChAFTA’s ratification.

The Greens and independents, with no prospect of having to actually run the country, can afford to tap more populist concerns about damage to specific local industries and jobs,  but even they have focused on the detail (such as the ISDS) rather than promoted an anti-globalisation agenda.

The current bipartisan support for free trade reflects the consensual resolution of a century–old debate. Free–trade versus protection was one of the fundamental issues in the Australian Federation (the Lowy Institute’s usual home is in the building of the now-defunct New South Wales Club, established to support free trade). Until 1973 widespread industry protection (‘protection all round’) was the norm.  This was a key element in the ‘Australian settlement’, Paul Kelly’s interpretation of the first 70 years of Federation.

By the late 1960s, however, both main political parties had come to recognise that Australia, as a medium-sized country, would be hugely disadvantaged if it cut itself off from the global economy through protection.

Perhaps surprising at first sight, the key episodes of tariff-reduction actually took place under Labor Party governments, with its close ties to the union movement. Tariffs were reduced across–the–board by 25% in 1973. Further reductions in 1988 and 1991 (in the middle of a deep recession) took tariffs down to negligible levels, with the important exceptions of footwear, textiles and clothing, and passenger motor vehicles.

While the actual reductions took place under Labor, the conservative Coalition had laid the groundwork in the late 1960, and there was always pressure from the powerful National Party, representing rural and resource export sectors with self-interest in promoting international openness. Radical policy change is always easier if the government of the day is pushing at an open door, with the parliamentary opposition already agreeing with the policies.

One Labor Party insider attributes his party’s free-trade conversion to the power of ideas, overriding the vested interests which had dominated the debate. The Labor Party in this reform era was dominated by big-thinking internationalist politicians who envisaged a global role for Australia and saw that this was incompatible with inward-focused industry protection. Australia’s role in forming APEC (the high point being the tariff reduction pledges at Bogor in 1994), was not compatible with protectionist policies at home. Others were influenced by the example of Sweden, a small economy whose wealth relied on trading with the world.

The detail of history is always more nuanced. Energetic bureaucrats and policy-oriented academics also played an important role. Whatever the true interpretation of this extraordinary reform era, by 1999 Simon Crean, Labor Party stalwart, declared the protectionist debate was ‘confined to the dustbin of history’ for Australia and there it has remained.

Meanwhile, America’s position and pressures are different. Read More

The huge and diverse economy has no need to compensate for small scale by being integrated into the global economy. Its tradition is more self-reliant and inward looking (remember the famous New Yorker cover ‘View of the world from 9th Avenue’?)

Vested interests are more dominant in the US, and more effectively linked into the political process. The squeeze on blue–collar and lower middle class workers is more keenly felt because of the lacklustre recovery from the 2008 crisis. Australia, on the other hand, has experienced nearly a quarter–century without recession.

There can be nit-picking criticism and slippage in execution of pure free trade in the guise of ‘industry policy’.   But the fundamental point remains: this debate is over and Australia is committed to globalisation.

Photo courtesy of Flickr user russellstreet


Last week's budget contained two taxation measures affecting foreign investment in Australia: one lowering tax while the other aims to increase it. The first lowers the rate of company tax, which will fall from 30% to 25% by 2026. The second aims to tax more effectively those large multinational companies, such as Google, which have so far paid derisory amounts of tax considering their Australian revenues.

The reduction in company tax has been promoted as a measure to attract more foreign investment. The argument is that Australia's 30% rate looks high compared with many international jurisdictions, particular low-tax countries such as Singapore and Ireland. The Treasurer himself said; 'Australia has the seventh highest company tax rate of the 34 OECD countries and it is much higher than our neighbours in the Asian region.' This debate, however, has missed some key issues.

First, is the effective company tax rate high? Australia has a system of imputation, which means that Australian shareholders effectively receive a credit for the tax paid by an Australian company in which they have shares, thus reducing their own income tax. The laudable outcome avoids taxing both the company and the shareholder on the same income. With imputation, lowering the company tax rate makes no difference to the return for Australian shareholders: the company tax was already effectively zero. 

Foreign shareholders don't get the benefit of imputation. Is it fair to require them to pay tax in Australia, and if so, how much? The logic for taxing foreign companies operating here is unassailable. They benefit from a well-functioning economy where their intellectual property is protected, the legal system is second-to-none, the regulatory framework is sound and the business environment conducive to enterprise. This secure environment of good governance costs money to maintain and the foreigners should pay for the benefit, in the same way that domestic shareholders pay income tax to fund these services.

We want foreign investment, but there is no reason to discriminate in favour of foreigners by allowing them a better tax deal than domestic shareholders have. Domestic shareholders typically pay more than 30% tax on their income, so why give the foreigners a discount? Let's not argue about where the 'value add' of the production has occurred: these companies make more profit because they have the benefit of operating in Australia.

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Fairness between foreign and domestic investors didn't figure in the discussion of company tax. The debate was settled by esoteric Treasury modelling showing that lower company tax would raise GDP. In econometric modeling there is a counterpart to Newton's third law: for every model there is another model with an opposite result. This model demonstrated that GDP might rise if company tax were to be cut, but foreigners' dividends would increase, so Australians would lose out.

In any case, the unspoken purpose of the company tax cut may have been quite different – business groups have been lobbying for lower company tax so that wealthy Australians can benefit from the substantial difference between tax on companies and that on individuals by incorporation, with their income accruing to the corporation.

As far as the foreigners are concerned, many foreign companies don't pay much tax here anyway, so a lower company rate wouldn't make much difference. Hence the interest in the so called 'Google tax' – the second change in taxing arrangements. The previous budget had already contained measures to make it harder for foreign companies to shift profit to lower-tax jurisdictions. The main change in last week's budget was to boost tax compliance staffing to enforce the latest version of the measures, which includes copying Britain's 'diverted profits' legislation.

The underlying problem is that the long-standing tax rules, ossified in difficult-to-change international treaties, have not adapted to a globalised world; companies can readily shift profits to a subsidiary in a low-income jurisdiction. These actions aren't confined to foreign companies: the locals do it too. The arguments against the budget's course of action were set out here. The OECD has been working hard to put in place a consistent response to these vexed issues and if individual countries address the problems with their own laws, the global outcome will be an incoherent mess.

The counter-argument for doing something is more compelling. Despite the earnest endeavours of the OECD and the G20, it seems unlikely that any consensus will be reached which leaves the beneficiaries of the current system (basically, the mature investor-states of the G7 countries) with a smaller share of company taxes than they have at the moment.

It can be argued that the improvements in international tax that have occurred over recent years have not been a result of consensus reached in international negotiations at the OECD or G20, but from fortuitous leaks of information about existing practices (the Panama Papers are just the latest instance). These practices have been so blatantly contrary to any notion of fairness that transparency is enough to bring about voluntary changes in behaviour, at least among companies concerned about their reputation, without any revision to principles or regulations. Company directors who have had to defend in public their current egregious practices may be shamed into changing their ways. Putting more pressure on the global compliance norms through uncoordinated action by individual countries may not be the best-practice way to develop global 'rules of law' but may at least put reformist pressure on a system which has allowed these rorts to flourish.

Photo courtesy of Flickr user Denise.


Budgets are always pretty boring. Any controversial issues have been leaked (and spun) beforehand. Last night's was no exception. But it does provide an opportunity for a stock-take on longer-term debates about how the economy is travelling.

In a world which has been 'too slow for too long', the Australian performance has been pretty good, especially considering the collapse of commodity prices since 2011 (the graph below shows just how big this terms-of-trade shock has been). On the usual aggregate GDP measure, Australia has grown 22% over the eight years since 2007, just before the crisis. This compares with 10% for the USA, 7% for the UK and 12% for Canada, a rather similar economy. This looks even better against the dismal performance of Europe, where France is up just 3%, Germany up 7% and Italy down (yes, down!) 8%. Among the mature economies, New Zealand is closest, with 16% expansion. (all data from IMF WEO April 2016 database).

If we look at per capita GDP, Australia is less of a stand-out, with an increase of 7% over these eight years. On this measure the out-performance narrows: even Japan is up a couple of percent. But Australia still has twice the growth of the US.

RBA Chartpack

It's too early for a definitive assessment of how the transition from the resources boom is going, but so far the cautious optimists like John Edwards are ahead. There is now a wider acceptance that the impact of the resources boom was exaggerated. Half the increase in resource investment was spent on imports rather than in the domestic economy; the calculation of the terms-of-trade impact on income left a lot of room for different interpretation; and so much of the resources sector is foreign-owned that the big swings (both up and down) are felt more by foreign investors than by locals. Coal miner Peabody is now in Chapter 11 insolvency and Xstrata-owner Glencore is restructuring its balance sheet, but these are wholly foreign-owned.

None of the predicted disasters has come to pass. The banks were said to be vulnerable because of their dependence on foreign funding but this was given a real-life ultimate stress-test in 2008 and they came through untroubled. Anyone predicting a repeat of the freezing of the New York money markets hasn't noticed what prudential supervisors have been doing since then. Another popular alarmist prediction was a house-price bust (with the knock-on effect this might have on the banks' mortgage-heavy balance sheets). Again, so far so good: asset-prices seem to be levelling out and even if they drop back, the biggest exposures are with well-placed borrowers. Unless there is a big rise in unemployment, all this seem a case of scare-mongering — or commentators without enough real issues to talk about.

Moody's has put the government on notice that it must do more to get the budget into surplus. It's a puzzle why anyone would take any notice of the credit-rating agencies after their pre-crisis performance in handing out AAA securitization ratings on demand. Certainly the markets didn't take any notice of past down-grading of Japan and the US. But Australian politicians have made a rod for their own backs here, by using the threat of downgrading as an impetus for budget stringency.

In the global context, this pressure for a quick return to budget surplus has been the driver of austerity in the crisis-affected countries. This macro-economic mistake is perhaps the main explanation for 'too slow for too long'. The crisis expanded deficits, more because of the economic downturn rather than the need to support failing banks. Winding these deficits back greatly weakened the recovery: even with a conservative estimate of the fiscal multiplier, each percent reduction in the deficit-to-GDP ratio takes a percent off the growth rate. Look at this graph to see the contraction applied by austerity in 2011-13 and weep.

Source: IMF WEO April 2015 Figure 1.7

Australia had the same debate, with successive governments vying with their opposition in promising faster return to surplus. This was, in fact, unnecessary here. With no recession or bank failures to cause a huge deficit blow-out, moderate government debt levels and time-bound fiscal stimulus, there was no pressing need to return quickly to surplus. Fortunately, the austerity needed to achieve a surplus was never applied. The promised surplus has progressively receded into the future. We were saved by prevarication.

Long-planned resources projects (including LNG) have kept the level of investment from dropping precipitately, and housing investment has helped fill the gap. Total investment has fallen from 28% of GDP in 2007 to 26% in 2015, still strong by international comparison. Unemployment is fairly low, thanks to wages restraint. The slowing has been softened by exchange rates and interest rates. The real (inflation-adjusted) exchange rate is more than 20% lower than its peak in 2012 (the largest fall among mature economies). Interest rates are low in historic terms, but the RBA has not had to resort to the desperation-driven near-zero (and even negative) rates prevailing overseas. Ross Garnaut's advocacy for still-lower rates to get the exchange rate down further seems misplaced in an inflation-targeting regime which has served Australia well.

Of course further structural transition is still needed. While productivity is notoriously hard (maybe impossible) to measure, there is not much doubt that Australia is mimicking the global weakness. At some stage, the budget has to be brought back to surplus.

The valid criticism of past policies is not that they have been seriously wrong, but that the political process has not only failed to take desirable options: it has also blocked them off in the future. The government ignored the main lesson of the successful reforms of the 1980s: when your political opposition advocates good policy, you should seize it as your own. In the current context, trimming back the excesses of negative gearing is an example. Labor's total hash of a resources super-tax in 2010 has put that option off the agenda for as long as memory lasts. Combined with a sovereign wealth fund, this would have been a powerful automatic counter-cyclical instrument for Australian's chronic problem of commodity cycles. The current government botched sensible climate-change policies just as decisively. A carbon-tax was labeled as a 'big new tax' and scuttled forever, ignoring the opportunity it provided to lower other taxes which distort, rather than offset a distortion, as a carbon tax would have done.

Economic reform requires patient gathering of support through rational argument and sensible compromise, not the now-standard point-scoring negative politics. Parties pander to their constituencies. The modest cut in company tax this budget responds to vested interests, ignoring the fact that Australia's imputation policy fully offsets company tax for domestic shareholders. Foreign multinationals are the target of a potentially budget-fixing 'Google' tax, with the actual collection being a problem conveniently in the future. South Australia's political blackmail on ship-building succeeds brilliantly, as industry policy disappears down a dead-end.

Economists, for their part, should be ready to offer compromise second-best solutions, rather than incomprehensible optimality (as was Treasury's proposed resources super-tax).

The key issues for the economy's future are not to be found in last night's door-stop of budget documents. Far-sighted initiatives (such as an infrastructure fund, financed outside the budget) were left for another day. Tinkering has prevailed over structural reform. The strategy which will in due course return the budget to surplus remains uncertain.

On the resources debate, John Edwards' measured assessment of the not-too-disastrous impact of the resources boom is proving correct, but Ross Garnaut's somber message of lost opportunities resounds. With all the advantages of resource endowment and proximity to the globe's fastest-growing region, we should do better than just muddling through. The overall assessment is: 'Lazy: could try harder'.

Photo by Stefan Postles/Getty Images


So we’ve decided to build twelve submarines in Adelaide, a decision which:

  • contradicts the only idea that economists unanimously endorse — free trade;
  • ignores opportunity cost i.e what else might be done with $50 billion of labour, capital and managerial talent;
  • had no apparent operational budget constraints, with the number of vessels determined by the need to create continuous construction and;
  • makes little sense in terms of industry policy; there is no hope of developing an industry exporting bespoke ships.

Perhaps the comprehensive failure of economics to achieve any traction in this debate could be understood (and forgiven) by simply observing that the decision was the inevitable result of Senate politics. But that would let the guardians of rational economists — particularly the Departments of Treasury and Finance — off too lightly. The all-too-common failure of economics in policy debates is its penchant for analytical purity. Economists promote economically uncompromising solutions. But there is no point in pushing pure-economics arguments that can’t fly politically. In the face of irrefutably-rational economic arguments, the politicians reply: ‘We all know what we should do: we just don’t know how to get re-elected after we have done it.’ 

Last week I reviewed Concrete Economics by Stephen Cohen and Brad De Long, who address this political economy dimension.  They see the essence of good economic policy as requiring governments to play a major role in determining the structure of the economy and setting broad direction, so they can’t be accused of being laissez-faire, free market ideologues. The authors also support the sort of dirigist economics pursued by East Asian economies, so they have no objection to industry policy as such. They approve of protecting domestic industry while subsidising exports (by whatever means, including an artificially competitive exchange rate), in order to obtain the scale economies needed to compete on global markets. Above all, they accept the need to step outside the narrow world of economic analysis in order to develop a political consensus. This consensus will involve compromise; placating and neutralising vested interests while accepting second-best outcomes, provided that the core economic component makes some sense.

While mainstream economics is often a poor fit with political realities, there is plenty of alternative economic analysis relevant for political economy synthesis. Read More

Three decades ago Paul Krugman analysed the benefits of alternatives to free trade, and got a Nobel Prize for his efforts.  Industry policy designed to promote specialisation could achieve economies of scale in sectors with increasing returns (the bigger the scale of production, the lower the per-unit cost). Comparative advantage, the lynch-pin of the simple free-trade case, can be over-ridden if comparative advantage can be changed over time through dynamic restructuring. This can justify protecting the domestic market from foreign competition and subsidising exports. But of course the industry has to be chosen on economic rather than political criteria: there has to be some prospect that the output can be sold globally.

Even if the political imperative is to manufacture submarines (rather than some more promising product) in Adelaide, economic advocacy might at least have headed off the prime minister’s open-ended commitment to make everything possible in Australia. This autarchy is a nineteenth century notion of production. The modern supply chain draws its components from whichever country can produce them efficiently. The supermarkets are full of goods ‘made in Australia from imported ingredients’. In the same way, during the great mining boom of 2004-2008, half the investment expenditure was on imports because components could be made cheaper and better in South Korea or Singapore and towed into place. In other areas of defence production such as aircraft, ‘offset agreements’ allow purchasing countries to participate efficiently in complex supply-chain manufacture.

But what about jobs? Don’t we need to make everything here (especially in Adelaide) to keep people employed? Overall, the economy is currently operating with a level of unemployment that matches the best periods in recent history. Within this aggregate, major transitions are underway, particularly to adjust to the end of the mining boom. This involves painful disruption, of the same kind which allowed the successful transformation of the Australian economy from its early agricultural base and then, over the past four decades, to restructure out of manufacturing in response to the inexorable rise of international competition. Adelaide was given the opportunity to be the exception to the inevitable decline of manufacturing: the eventual demise of the long-cosseted automobile industry and the dismal narrative of the Collins submarines are the result. While many across Australia go through painful transition, politics dictates that Adelaide should be protected. But if submarines have to be made in Adelaide, they should at least draw on the efficiency of the global supply chain.

Australia is likely to pay a heavy price for this failure to develop a political-economy solution, certainly in terms of cost of the submarines and, based on past experience with the Collins construction, in terms of the fitness-for-purpose of the finished product. As a small country with a limited defence budget in a world which may become more threatening, we can’t afford to leave sensible economics out of the decision.

This post has focused on the failure of economics to contribute effectively to a synthesis of politics and economics. But the main blame should go to the politicians of the two major parties, who have watched this state-based blackmail evolve over recent years. There is universal agreement that blackmailers’ demands should never be met, for fear of encouraging even larger demands. With the election pending, however, the major parties arrived at a formula for total surrender to the blackmail: both parties have been competing to make sure the other didn’t offer South Australia a more favourable deal. A bipartisan solution, in contrast, could have countered the blackmail. Both parties could have offered the same deal: build the submarines in Adelaide, but with a requirement to call international tenders for components.  This approach would have recognised the special requirements of South Australia within the Federation, while creating the competitive manufacturing environment that State needs if it is to succeed.

If the economics was lamentable, the politics has been abysmal.

Photo courtesy of Australian Defence Image Library


The last decade hasn’t been kind to economists’ egos. Almost no-one saw the 2008 crisis coming. The subsequent recovery has been ‘too slow for too long’. And, at a deeper level, there is widespread discontent with the way the middle class has been left behind while a tiny fraction is enjoying a repeat of the ‘gilded age’.

Thus economics seems to be in need of root-and-branch rethinking. The tried-and-true macro-economic policies that should have ensured a rapid recovery after 2008 are inadequate, with monetary policy resorting to distortionary settings of interest rates and exploring policies (‘helicopter money’) that speak more of desperation than rational analysis. Fiscal policy has been left on the sidelines by a combination of fixation with debt and far-fetched academic theories designed to support doctrine rather than recovery. 

This reappraisal has been underway for some time. On macro-policy, the International Monetary Fund has shifted a long way from its initial support for austerity, although it hasn’t much to offer other than the general mantra of ‘structural reform’. This falls on deaf political ears (‘We all know what to do: we just don’t know how to get re-elected after we have done it’).

Meanwhile there is the rise of structural explanations, each with its recommendations for change. Thomas Piketty’s analysis of the return to Downton Abbey has been overwhelmingly supported, but his solution of higher taxes has not. Larry Summers sees partial salvation in more infrastructure spending, but at the same time worries that entrepreneurial dynamism is dead. Robert Gordon’s view is similarly dismal: the dynamics of the 1870-1970 century were driven by life-altering innovation, which has petered out.

Stephen Cohen and Brad De Long add to this structural-focused analysis with Concrete Economics. They draw their lessons largely from the history of the US, described as ‘the place where economic policy has been, without a doubt, the most successful over the last couple of centuries’.

This book tries to remind us, in simple concrete terms, of how the American economy, again and again, was reshaped and reinvigorated by a loveless interplay of government making broad economic policy and entrepreneurs seeking business opportunities.

In recounting the history of America’s economic success, they show that in each phase of development the government played a central role in giving broad direction, leaving it to private-sector entrepreneurs to innovate and experiment within the environment of incentives and constraints set down by the government. Each new phase had broad public support, with trade-offs, compromises, subsidies and division of the benefits determined by the political process.

Some of the early history will be of more interest to Americans than to others, but the post-WWII period from Eisenhower to Kennedy had such international influence that the narrative is broadly familiar to all. The progressive elements that Cohen and De Long advocate were all present. Administrations were prepared to take a major role in the economy. Defence expenditure, running at 10% of GDP (twice the current level), was a major instrument in guiding private industry into areas that were seen as the most promising. Government-funded infrastructure (such as the national highways in the 1950s) opened up scale opportunities by reducing transport costs. Suburban housing proliferated, epitomising the ‘good life’ and providing strong demand for home-improvement. Education expanded rapidly, and with it high-level university research.

There was very little doctrine driving these decisions. Pragmatism and experimentation prevailed rather than dogma. The whole spectrum of policy tools was used: infrastructure development, tariff protection, direct picking and promoting of winners, exchange rate devaluation, and selective protectionism through import quotas and ‘voluntary’ export restraints by trading partners. The aim was not simply to direct resources according to comparative advantage, but rather to change America’s comparative advantage. This environment produced a flood of high-technology productivity-enhancing inventions.

The authors see the last redesign of the American economy, beginning in the 1980s, as quite different; and inferior. America allowed its manufacturing to be eroded by competition from East Asia, believing that the way ahead lay in a post-industrial world — the higher-value industries of the future. The government had no concrete practical plans for this new era: just a doctrinal faith that deregulation and free markets would deliver the right answer.

The pervasive doctrine of ‘the magic of the market’ was sometimes beneficial (deregulation of airlines), but more often encouraged resources to flow into areas of doubtful benefit for productivity and living standards. Read More

The prime example is the financial sector, which doubled its share of GDP and put the best-and-brightest into innumerable variations of re-packaging finance and trading, with no more benefit to society than a casino. The additional resources in finance didn't improve price discovery and investment allocation. And it all unraveled in the 2008 crisis.

Finance is not the only example. America’s litigious society means its best brains arm-wrestle each other. A market-based health system accounts for 17% of US GDP (compared with 11-12% in most advanced economies), weighed down by top-heavy, paper-shuffling administration. The pre-2008 real estate boom was a bonanza for those who organised the transactions, the real estate agents and lawyers.

Certainly, there are winners: there is no denying the success of Silicon Valley and Hollywood. But these industries are too small and too specialised to provide jobs for the blue-collar and clerical middle class, displaced by imports and technology.

Where do the strongly-dirigist policies of the East Asian successes (Japan, Taiwan, South Korea, Singapore and now China) fit into this narrative? Cohen and De Long seem to see these as having many of the desirable attributes the authors advocate, although a key ingredient of these countries' success — a ready global market for exports — is not an option for all. But aren’t these successes counterbalanced by the failures of similarly-dirigist policies in Latin America, starting with Argentina, once counted among the richest countries in the world? It’s hard to identify generalities which explain the diversity of the successes and failures.

Of course it is easy to find fault in this latest effort to pick apart what has gone wrong with economic policy-making. But each successive contributor to the debate — whether Piketty, Gordon, Summers or Cohen and DeLong — identifies three common themes. The pernicious influence of doctrine (and specifically the free-market ideologues); the insidious undermining of political consensus through income mal-distribution and the rise of politically-powerful vested interests; and the misallocation of our best talent into finance, with so little apparent benefit to society.

Photo courtesy of Flickr user Chris Devers


‘Too slow for too long’. This is the title of the just-released IMF World Economic Outlook. Global growth has been stuck in a rut, running between 3% and 3.5% for the past four years, and the forecast numbers are not much stronger. Policy-makers have become inured to this persistently feeble performance, with policy unresponsive to the pleas from the Fund (and a growing chorus of others) for policy action.

With its Plan A message (growth-enhancing policies) falling on deaf ears, the Fund has been exploring the adequacy of the existing Plan B — the global financial safety net, aimed at preventing a domestic crisis from becoming global. The Fund points to the greater complexity and interconnectedness of global finance now, compared with 2008. The Fund sees an important role for itself in this Plan B, but the starting point in thinking about this issue is to ask: ‘what role did the IMF play during the 2008 crisis — not just the worst recession since 1930, but also the most globally interconnected?’

Foreseeing impending problems is the best way to avert them, however we shouldn't judge the Fund too harshly for its failure to see the 2008 crisis coming. Hardly anyone else did either, although the Bank for International Settlements staff did better, muffled and censored though they were by the Bank's major shareholders, particularly the US. The Fund’s monitoring, through the resource-intensive annual Article IV reports on every member country and the Financial Sector Action Plans, gave no operational forewarning of the problems to come.

Once the 2008 crisis began to unfold, the core issues reflected domestic failings, with ineffectual national prudential supervision at the epicentre. The main failings were in countries which had the capacity to handle their own problems (the US, the European Union, Switzerland and the UK), with national central banks and treasuries shoring up failing financial institutions.

Certainly, there was global contagion that affected ‘innocent bystanders’, such as South Korea and Indonesia. But the IMF was more or less irrelevant in the first phase (2008-2010), with tiny Iceland, among the affected countries, the only one to call on Fund assistance.

The key cross-border action was the US Fed’s provision of swap arrangements (i.e loans between central banks) to a range of countries in need of dollar-denominated liquidity. The 2009 G20 meeting in London provided the only example of international policy coordination, when it orchestrated what most countries were going to do anyway; provide fiscal stimulus.

The second stage of the GFC began in 2010, affecting the European periphery, where Greece, Spain, Portugal and Ireland all ran into trouble. Among these, the only one involving an IMF program was Greece, and a strong case can be made that the IMF should have left this to the Europeans to sort out. The IMF was involved because the then-managing director Dominique Strauss-Kahn saw political advantage for himself and the institution, and the Germans were glad to have someone else to share the rescue costs and the unenviable task of trying to put some discipline into Greek finances.

The Fund approved 27 assistance programs in the crisis period, but only Greece and Iceland had any close connection with the global crisis. There were large programs with Ukraine, Hungary and Romania, but economic contagion was not the main issue (although political contagion might have been a central motivation).

So much for the past. Will there be a greater role for the IMF next time?

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It’s true that the current Plan B is not in great shape, although the Fund itself is much better prepared. Countries’ first line of defence is their own foreign exchange reserves, which are a costly and inefficient form of insurance: as was demonstrated in 2008, a modest fall in reserve levels is taken by financial markets as a signal to panic. The various regional arrangements (such as the Chiang Mai Initiative Multilateral) have yet to be used and there is no formal coordination mechanism between them and the Fund. Many of the regional swap deals would not be much use in time of trouble.

The big change, however, is that the relevant part of Plan A (preventative measures in the financial sector) is in much better shape. For a start, the memories of 2008 are fresh, and awareness is a powerful antidote. The G20’s Financial Stability Board (successor to the BIS’ Financial Stability Forum) has had principal carriage of reinforcing the prudential framework. The national prudential supervisors are far better prepared than in 2008 and the domestic Plan Bs are much more fully developed.

This is important when thinking about the nature of any future financial crisis, and the need for a global ‘Plan B’ to contain the fallout. Europe might yet experience something that looks a bit like the 2010 crisis in the peripheral countries, if Italian banks fail. But this should be for the EU and the European Central Bank to sort out. Let’s hope the IMF has learned the lesson of Greece, and stays on the sidelines.

Elsewhere, the problems are much more likely to be the standard problem the Fund has dealt with since its creation: an individual country which gets into trouble through poor policies or bad luck (usually the former), whose problems are idiosyncratic and not very contagious. Brazil comes to mind, but there are others as well. The Fund’s resources have been substantially augmented since 2008 to handle these situations.

What about the Big One: if China has a financial crisis? This would certainly have repercussions for the rest of the world (including Australia) but it is hard to see much of an expanded role for the Fund. It seems extremely unlikely that China would ask for a Fund program to handle something which it has the resources and ‘fiscal space’ to look after itself. There might be ‘innocent bystanders’ dependent on China trade (Africa is probably more vulnerable than our region), but these are small-scale problems which the Fund’s existing programs seem well placed to handle, with not much likelihood of the sort of global contagion demonstrated in 2008.

It’s good that the Fund is ‘thinking the unthinkable’ and exploring all the things that might go wrong in its sphere. But having done that, there doesn’t seem much of a case for any empire-building in Washington.

Photo courtesy of Flickr user Graeme Maclean


What will our Prime Minister say about Chinese investment in Australia when he visits China later this week? Of course he will give his version of 'open for business': that we welcome foreign investment. After all, we have run a current account deficit almost every year for well over two centuries, funded by foreigners. But it's more complicated than that.

As the Chinese know well, we don't welcome every proposal. The Australian authorities were ready to knock back Chinalco's attempt to buy a larger share of Rio Tinto in 2009. The recent bid for the Kidman cattle properties was rejected because part of the property overlapped the Woomera Weapons Testing Range.

It's not as if we reject only Chinese bids. Singapore's attempt to take over the Australian Securities Exchange was rejected. Shell was not allowed to buy Woodside. Even our closest allies sometimes get knock-backs too: an American firm was denied Graincorp. Some areas are predesignated as off-limits: foreigners might, perhaps, be able to take over one of the big four banks, but not more than one.

That said, we don't treat all foreigners quite equally. If history has resulted in an economy with many state-owner-enterprises (SOEs) — which is the case with China — these SOEs will be treated with greater circumspection than privately-owned foreign firms.

Nor do we treat all Australian industries as equally open. Around 80% of Australian mining is foreign owned, while agriculture (with only a little more than 10% foreign owned) seems especially sensitive. When foreigners buy up housing, we feel ambivalent about higher house prices (depending on whether we are already owners) and see them as crowding out our children's ownership dreams.

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What principles emerge from this history? What nefarious activity would SOEs carry out that foreign investors like tax-avoiding reclusive Zug-based Glencore (sole owner of Xstrata) wouldn't do in its own market-oriented self-interest? The outrageously successful effort to torpedo the resources super-profit tax in 2009-10 was orchestrated and fronted by Aussies. When we have second thoughts about allowing China to have a lease of Darwin's port, what exactly did we think that the Chinese might do that could harm our security? None of this is transparent in the present system.

That said, letting foreigners own essential services has legitimate sensitivities. To disallow Chinese-maintained equipment into vital areas of our telecommunications might make sense, given their reputation for eaves-dropping. And yet, we don't mind Singapore owning one of the key telecoms companies, despite its reputation for official intrusiveness. Would these issues restrict China from owning key services like electricity? We've already sold off quite a bit of this utility to foreigners. Might the Hong Kong owners of the Latrobe Valley power stations be pressured into turning off the lights at some dark moment in the future? Might the Canadians who have a long-term lease on Sydney's desalination plant try to blackmail us into paying more for their water when we have a serious drought?

There seem to be some fanciful elements in some of these security-based arguments. The foreign-owned assets are physically here in Australia, subject to Australian regulation and law. Surely we can protect our own interests in these circumstances? 

The starting point for policy might be to sort out some of the ambivalence:

  • Yes, we want foreign investment, but since the float of the dollar in 1983 removed the external constraint, we should not have to beg or offer special incentives to foreigners to fill the nation's saving/investment gap. Our openness to foreign investment is an opportunity given to foreigners to join with us in taking up the many profitable opportunities which our resource-rich, well-governed, secure country offers – a benefit we are bestowing on the foreigners as much as it is a favour they are doing for us.
  • In exchange, the foreigners should make an explicit undertaking to be good corporate citizens. This means paying a fair amount of tax in Australia, not arranging their affairs to have the profits accrue in tax-avoidance centres like Ireland or Singapore. Australian shareholders make such a contribution through income tax, so it is not only fair. It is also economically efficient (competitively neutral) to expect foreigners to pay the same. Foreigner's profits come, to large degree, from the benefit of being able to exploit Australia's natural endowment and to sell into this well-functioning market with intellectual property protected and legal rights enforceable through due process. We don't want companies that are unwilling to contribute to the cost of running this governance infrastructure.
  • Sensitive areas should be either clearly off-limits or subject to negotiated safeguards. In most cases, the owners of vital service sectors can't do us much harm without doing more harm to themselves. Let's try to put a bit of realism into these nebulous security arguments.
  • Perhaps the greatest opportunity for a change in the mindset would be if we stopped thinking of the Foreign Investment Review Board's job in terms of allowing foreign investment unless a problem can be identified (a negative focus). Instead, we should ask the foreigners to set out why their proposal is positively good for us. This might actually change the nature of the proposals. Rather than tweaking them to get around the downside objections, foreigners could make proposals more inclusive and beneficial for Australia. Does the proposal open up markets in the foreign investor's home country? This should be particularly relevant for China, which needs to set up supply-side security in basic commodities – minerals, energy and food. How can they help us break into their huge market? It might be beneficial to have a substantial Australian partner. Don't try to take over our icons or national champions.
  • The trickiest issue is to articulate why we might want to discriminate between different foreigners on the basis of 'community concerns'. This has something to do with not wanting to be dominated by overly-powerful foreigners. The issue for China is that they are huge relative to us, and even modest proposals will easily overwhelm us: the 'elephant in the canoe'. This might be hard to explain to the Chinese, but the Prime Minister might begin the task.

Of course the Prime Minister has a winning rejoinder in the unlikely event that he is backed into a corner on this topic: the Chinese don't allow open investment in their own country, so any restrictions we apply are just reciprocity – tit for tat. But a better long-term answer is to develop some principles.

Photo: Lowy Institute/Peter Morris.