June 2009


The return of deficit economics

By Robert Manne
Illustration by Jeff Fisher.

The Labor government of James Scullin was elected in October 1929, the month of the Wall Street crash, which history regards as the beginning of the Great Depression. In November 2007, the Labor government of Kevin Rudd was elected ten months before the collapse of Lehman Brothers, which history will almost certainly come to regard as the beginning of what is already being called the Great Recession. The story of how these governments responded to the two most catastrophic economic downturns since World War I is instructive and intriguing.

Scullin came to power before the Keynesian revolution in economic thought. His government, whose ambitions were far more radical than those of Rudd, and which sought to nationalise large parts of the Australian economy beginning with the banks, was destroyed by the economic orthodoxy of the day. Orthodoxy taught that in circumstances of rapidly falling revenues and pressing debt-repayment obligations, governments had no alternative but to cut their costs. Not everyone in the Labor movement accepted this orthodoxy. The left of the party, led by the New South Wales premier, JT Lang, argued for debt repudiation. The on-and-off treasurer, Ted Theodore, an instinctive Keynesian even before The General Theory, argued for modest expenditure increase. Scullin possessed neither the political will of Lang nor the intellectual resources of Theodore. He was unable, therefore, to resist the conservatives, like Sir Robert Gibson of the Commonwealth Bank, who produced the so-called Premiers' Plan calling for savage across-the-board reductions in pension payments and salaries of government employees. Scullin submitted meekly to orthodoxy. His government swiftly fell apart. Joseph Lyons defected to the conservatives. The Langites moved to the cross benches. Two years after the coming of the Great Depression, the Scullin Labor government, having achieved virtually nothing, was defeated by a no-confidence vote in parliament and humiliated in the consequent election.

On the question of political economy, the intellectual road along which all Western societies travelled between the time of Scullin and Rudd is a twisted one. To understand the very different responses of the Scullin and Rudd governments to the Great Depression and the Great Recession, its curious and unpredictable trajectory must first be briefly mapped.

According to conventional history, it was John Maynard Keynes who apparently discredited forever the kind of orthodoxy that had paralysed the governments of all the advanced capitalist economies, including Scullin's, during the Great Depression. According to this history, what Keynes taught the postwar generations in the West was that there was a relatively straightforward way for governments to avoid the kind of near-fatal catastrophe capitalism had faced during the Great Depression. At times when economies were confronted by recession and unemployment, governments needed to borrow and to spend, to stimulate demand. At times when economies were ‘overheating' and confronted by rising inflation, governments needed to reduce demand, to cut their spending and to save. For "30 glorious years", as the era between the mid-1940s and the mid-1970s came to be called, it appeared that Keynes was right. Under his guiding spirit, advanced capitalist economies experienced unprecedentedly benign conditions: negligible unemployment, negligible inflation, low interest rates, steady growth, an absence of cyclical boom and bust.

Unhappily, the conventional history continues, it turned out that Keynes was fundamentally mistaken, as his neo-liberal critics like Friedrich Hayek and Milton Friedman had long maintained. In the mid-1970s all advanced economies were afflicted suddenly and simultaneously by uncontrollable inflation and steep recession, for which a new term - stagflation - needed to be coined. For postwar Keynesians, inflation and unemployment were the alternative maladies to which capitalism was prone. Within the Keynesian paradigm, the idea of stagflation made as little sense as the idea of freezing fire or burning ice. For Keynesianism's most important neo-liberal critics, inflation and consequent recession were, however, not the alternative maladies of capitalism but the inevitable and entirely predictable outcome of the Keynesian heresy.

By the early 1980s neo-liberalism had displaced Keynesianism in a considerable part of the Western world. During the era of neo-liberal hegemony, managing capitalist economies was far more complicated than during the era of Keynes, with the global economy now punctuated by several short but sharp recessions. In addition, in the neo-liberal heartland in particular - the Anglo world - social inequality became ever more extreme. Nonetheless, during the 30 years of neo-liberal hegemony, economies almost everywhere throughout the Western world continued to grow at a genuinely impressive rate. At the end of these 30 years, it was not surprising that the neo-liberal paradigm seemed to be solidly entrenched.

Towards the end of 2008, the intellectual road separating Scullin from Rudd lurched sharply, suddenly and entirely unpredictably to the left. American and also European financial corporations had by this time become the sites for the obscene enrichment of their executive class, predominantly through the increasingly frenzied sale of trillions of dollars' worth of fraudulent and toxic derivatives products. With the collapse of one of these corporations, Lehman Brothers, financial markets froze in fright. A deep deflationary global downturn, of a kind not seen since the Great Depression, was the immediate result.

What was to be done? It was now as if the apparently discredited lesson Keynes had drawn from the catastrophe of the 1930s, which had in quite different circumstances guided the capitalist economies from the mid-1940s until the mid-1970s, had been preserved in collective memory intact. Western governments woke as if from a long sleep. Almost all suddenly recognised the limitations of unfettered free markets and the need for more stringent financial regulation. Almost all, even more importantly, recognised that in a period of global deflationary downturn the only answer to impending catastrophe was the funding of massive government stimulus packages through the unembarrassed embrace, in the short term at least, of a deficit economics. Even the once solidly Keynesian Bretton Woods institutions - the World Bank and the International Monetary Fund - which had apparently been thoroughly converted to neo-liberalism by the 1980s, now reconverted instantly to aspects of their original Keynesianism. The small tribe of still-extant Keynesian economists was delighted at this unexpected turn of events. As James K Galbraith put it in a recent interview: "Friends of mine said that I had been moved to the centre faster than any man in history who didn't change his views." The much larger tribe of puzzled non-economists (like myself) could merely scratch their heads.

As I argued last year in this magazine, the previous Labor prime minister Kevin Rudd most resembles is not John Curtin or Bob Hawke or Paul Keating but Gough Whitlam. There are, of course, fundamental differences. Rudd's political skills are first-rate; Whitlam's were execrable. Whitlam was a great orator; Rudd's speeches are more impressive on the printed page. Under Rudd the Labor Party has been extremely disciplined; under Whitlam it lurched from one crisis to the next. Nonetheless what Whitlam and Rudd share is more important than their differences - a systematic transformative program and a reforming zeal. Not only did Whitlam achieve more in his three years than Menzies in his 16. Most of the Whitlam reforms - Medibank; university expansion; the creation of our national cultural institutions; the expansion of the welfare state; the initiation of indigenous land rights; the passage of the Racial Discrimination Act - made Australia a distinctly better place. If Rudd is able to implement even a decent part of his agenda, the same may eventually be able to be said of him.

In his first nine months of office much of Rudd's reform program was outlined - an education revolution for both schools and universities; a massive nation-building infrastructure plan beginning but not ending with a nation-wide broadband network; an activist innovation policy for both manufacturing and service industries; the introduction of long-needed welfare reforms, most importantly paid parental leave; the extension of public housing; the investment in clean energy technologies; a long-term commitment, following the apology to the Stolen Generations, to ‘closing the gap' between the living standards of Indigenous and non-Indigenous Australians; the softening of the industrial relations system; the humanisation of the border control regime; the creation of a defence and foreign policy suitable to an independent but pro-American middle power. This program was ambitious. Much of it was expensive. With the arrival of the Great Recession and the collapse in government revenues, the overwhelming political question, as I concluded last year, was how much of this program would now have to be jettisoned and how much would survive.

As last month's budget made clear, not one of the major reform initiatives of the Rudd government announced in 2008, no matter how expensive, has been abandoned. The broadband network will, of course, still be laid down. Very serious money will still be spent on schools; serious money on universities, on clean energy initiatives and on technologies chasing the chimera of ‘clean coal'. New public housing will still be built. The government will still try to close the Indigenous living standards gap. Single old-age pensioners will receive reasonably generous increased payments. Promised pre-election income-tax cuts will be honoured. Even more dramatically, shortly before the forecasts of the collapse in public revenues were announced - amounting to some $200 billion over the next four years - the Rudd government detailed the most expensive long-term defence program in the history of Australia, conservatively estimated to cost at least $100 billion. At the time of the budget, in addition, it provided the details of its vast infrastructure program for roads, railway and ports, which will clearly require massive public and private investments in the long term. Only the most minor concessions were made as a result of the estimated $200 billion four-year revenue shortfall. At the margins, the government nibbled at ‘middle-class welfare' - like private health insurance subsidy for the wealthy or the almost ludicrously profligate Howard government superannuation schemes. Even though the parental leave was not abandoned, its beginning was postponed. Generation Xers were warned that unlike the baby-boomers they would not receive their old-age pensions until they reached the age of 67. Of structural savings there was nothing more.

Because it was unable to liberate itself from the economic orthodoxy of the times, the Great Depression paralysed and then destroyed the Scullin government. Because of the sudden and unanticipated revival of Keynesian deficit economics across the globe following the sudden arrival of a global deflationary downturn, it is now clear that the coming of the Great Recession has almost altogether failed to blow the Rudd government off course. Before September 2008, the Rudd government had the capacity to fund its ambitious reform program while remaining in budget surplus, in particular because of the revenues from the continued mining boom. After September, the reform program was simply re-packaged as the Australian contribution to the $5 trillion global stimulus investment advocated by the countries of the G20 and the newborn Keynesian international institutions, the World Bank and the IMF. Rudd is a prime minister of tidy mind. He soon divided this stimulus package into three parts. In the short term, as he put it, his government gave $22 billion to less privileged citizens in the hope that they would spend. In the middle term, it planned to use its commitment to an education revolution to employ "tradies" and "sparkies" across Australia and turn every school into "a construction site". In the long term, it would provide the necessary stimulus with the massive national infrastructure projects and also with the beginning of the construction in ailing Adelaide of 12 cruise missile-equipped submarines. In the pre-Keynesian neo-liberal era, the Rudd government budgeted for a $22 billion surplus. In the post-neo-liberal new Keynesian era, it budgeted for a $58 billion deficit. Nothing much else had changed.

There is a contradiction at the heart of the Rudd government. On the one hand, it is extremely ambitious. On the other, it is extremely risk-averse. This is the kind of contradiction that it will eventually be forced to face.

Almost everyone recognises that the government's financial forecasts are heroic. The government predicts that within two years the Australian economy will begin growing at a rate of at least 4%. It predicts that its debt will peak in four years' time at around $180 billion and then begin to be wound back. Both predictions are precarious. At all times, but especially in times like these, the future is unknowable. The government promises, in addition, that it will be able to deliver on its ambitious stimulus program without increasing its spending by more than 2% a year. It also promises that when growth returns in two years' time it will be able to implement its program while keeping taxation revenue below the level of 2007-08 as a percentage of GDP.

I am unconvinced. It seems almost fanciful to think that a program as ambitious as that of the Rudd government can be continued while government spending is contained to an annual increase of 2% at most. Moreover, as the economist John Edwards pointed out shortly after the delivery of the budget, the tax cuts delivered during the Howard-Costello years were premised on the indefinite continuation of the mining boom and are thus unsustainable in the long term. Eventually it seems likely, therefore, that if the Rudd government is committed to reforms in health, education, social welfare, nation-building and defence, it will have no alternative but to make significant cuts in middle-class welfare and significant increases in tax. After a generation of neo-liberal argument in favour of so-called "small government", such counter-cyclical changes to the revenue base will bring with them the kind of potentially lethal risk to which the Rudd government has thus far shown itself to be exceptionally averse.

An even greater political risk is stalking the Rudd government, which eventually it will no longer be able to evade.

As the prime minister understands, humanity is presently marching with open eyes towards catastrophic climate change. Since the adoption of the Kyoto Protocol, carbon emissions have continued to grow at an accelerating pace. Among developed economies Australia's record is one of the worst. Not only are our per-capita emissions rivalled only by the United States. If one ignores foregone deforestation, Kyoto's so-called ‘Australia clause', since 1990 our emissions have actually increased by some 30%. Rudd was elected on the promise of global-warming action. After taking power, to great applause, he signed the Kyoto Protocol. Since that time virtually nothing has been achieved. Rudd inherited the idea of an emissions-trading scheme from the Howard government. Rudd's climate-change adviser, Ross Garnaut, had recommended emissions cuts in the scheme of up to 25% by 2020. If an almost impossibly good international agreement was negotiated at Copenhagen in late 2009, the Rudd government offered 15%; in its absence it promised a miserly 5%. Garnaut argued against any special deals for rent-seeking high-emission industries. As the date for the introduction of the emissions-trading scheme has grown close, Rudd has showered both coal and the so-called trade-exposed, emission-intensive industries with increasingly generous special deals. Initially Rudd had promised that the scheme would be introduced in 2010. Shortly before this year's budget its starting date was delayed by a year. The delay won the government the temporary support of the Business Council; a promised increase from 15% to 25%, in the case of an unimaginably favourable Copenhagen outcome, won it the temporary support of the Climate Institute and the Australian Conservation Foundation.

The reason for the Rudd government's loss of nerve in the area of climate change is almost too obvious to need to be spelt out. Over time a formidable do-nothing alliance on the question of climate change has formed, comprising the coal, mining and even farming industries; a part of the Liberal Party; almost the entire National Party; the free-market think tanks; and our most significant daily newspaper, the Australian. In the face of this alliance and at a time when the Great Recession begins to bite, bold and principled action will obviously require high-order political courage and political skill.

Before becoming prime minister, Kevin Rudd told us that the human being he most admired was Dietrich Bonhoeffer. Through fidelity to his beliefs, Bonhoeffer risked his life. By comparison, if he were now to stand true to his climate-change principles, the worst that Kevin Rudd has to fear is leading his party to defeat, most likely at the election after next. No fair-minded observer will find it difficult to grasp why the Rudd government has dithered over climate change. Unfortunately, the Earth is not a fair-minded observer. Concerning the political difficulties of its inhabitants, it does not give a damn.

Robert Manne

Robert Manne is emeritus professor of politics and vice-chancellor’s fellow at La Trobe University. His most recent books are The Mind of the Islamic State and On Borrowed Time.

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