Pressures on globalisation—echoes of the past, policies for the future, and the role of the G20

Pressures on globalisation—echoes of the past, policies for the future, and the role of the G20

PM&C Who We Are The Secretary
Thursday, October 6, 2016

Department of the Prime Minister and Cabinet

Check against delivery

Thank you for inviting me here today.

I would like to begin by acknowledging the Traditional Custodians of the land on which we meet today and pay my respects to their Elders past and present. I extend that respect to Aboriginal and Torres Strait Islander peoples here today.

The Lowy Institute has a unique place in the Australian policy firmament and all of us here today, policy makers, commentators and the broader public, benefit from the excellent work being done by the Institute.

The focus of my remarks today is the implications of changing attitudes towards globalisation, both in terms of domestic policy choices and the role of multilateral forums like the G20.

The experience of the three decades preceding the Global Financial Crisis was that countries that embraced open trade and investment policies experienced significant gains in income, employment and national living standards. Globally, those policies have reduced the number of people living in extreme poverty from 1.9 billion in 1990 to 836 million in 2015.

However, growing concerns about the distribution of those gains, particularly in the context of weaker overall income growth since the Global Financial Crisis, is leading to an escalation of protectionist pressures, both here and abroad, an issue which was front and centre of G20 Leaders’ discussions in Hangzhou only a few weeks ago.

Today I will argue that the appropriate response to these pressures domestically and globally is not to suppress gains in overall income

and prosperity by returning to the failed protectionist policies of the past.

Rather, the response from all countries should be to focus domestic policies on better equipping their citizens to capitalise on the opportunities that globalisation presents and to use income redistribution and structural adjustment policies to ensure that nobody is left behind.

I’ll also argue that global policy frameworks should continue to embrace collaborative and rules–based approaches to open trade and investment policies and that forums like the G20 have a significant role to play in this regard.

Australia’s free market history

The pressures on governments to retreat from open trade and investment policies are not new.

Indeed, if we cast back to the late 19th century, heated exchanges between Victoria’s protectionists and the free traders from New South Wales were at the centre of debate on the terms under which Australia’s six colonies should become a federation.

While it took around two decades to resolve, ultimately the matter was determined in favour of free trade. Australia started off the 20th century as a newly-forged nation ‘global’ in our policy settings.

We were an open, high-trading economy that capitalised on our natural endowments and embraced the opportunities presented by rapid trade growth within the British Empire.

Wool, wheat and minerals were our dominant exports.

We were successful and rich—we had among the highest per capita GDP in the world, and the Australian standard of living was the envy of other nations.

But shortly after the trauma of the First World War, Australia changed tack on industry and trade policy.

From the 1920s, Australia became a highly-protected economy, sheltering our manufacturing industries from international competition.

Australia’s protectionist period started in earnest in 1921 with the creation of the Tariff Board, motivated by an infant industry argument.

This was the idea that we needed to diversify our economy beyond broad-acre crops and minerals into large-scale manufacturing and that Australian industry had not yet developed to the point that it would be able to compete in the global marketplace.

A cursory examination of Australia’s economic performance appeared to vindicate proponents of Australia’s protectionist policies.

Writing on this period of Australia’s economic history, Gary Banks (the former Chairman of the Productivity Commission) has noted that Australians enjoyed close to full employment from the 1940s through to the 1970s, with incomes still higher, on average, than those in most other OECD countries.

What the champions of protectionism failed to acknowledge then, as they do today, was the difficulty of removing industry support once it had been provided and the impact of protectionism on other parts of the economy.

This included the increased costs that Australia’s high tariff wall imposed on consumers, downstream producers including those competing internationally, and domestic businesses vying with protected industries for scarce labour and capital.

In The Lucky Country, published in 1964 at the height of Australia’s protectionist period, the late Donald Horne wrote this about protectionism and the Tariff Board:

"[The Tariff Board] was originally intended to protect young and inexperienced businesses but now everyone hops in for his cut. Once protection is dished out it usually stays. In the absence of any government plan for sustaining unemployed men over a retraining period or in assisting diversification, the political risks in allowing an inefficient industry to collapse are too great."

This comes from his discussion of ‘the Australian settlement’, during which, as both Paul Kelly and Gerard Henderson have described, we moved to a world of ‘protection all round’.

Australia doubled down on protectionism and industry support for almost another two decades after Horne penned these insightful words. While there was a 25 per cent tariff cut in 1973, this was motivated by macroeconomic stabilisation concerns and turned out to be a one-off, with Australia’s protectionist measures and industry support largely remaining intact through the 1970s and into the early 1980s.

As Gary Banks has noted, “the economic costs of this regime were masked by the performance of our broad-acre agricultural and mining industries”.

We benefitted from strong growth in demand for our commodities after the Second World War and this boosted our terms of trade and national income.
Australia was riding on the sheep’s back. But as Gary has stated:

“…we were riding for a fall. During the 1970s, the prices we received for our commodity exports commenced a long decline, while the costs of imports began to rise. The resulting terms of trade deterioration would, in turn, expose the underlying problem of Australia’s poor productivity performance.”

Over time, the related reduction in our international competitiveness had placed us in a precarious economic position and was undermining our national prosperity.

As I discuss in my essay published last year, TheLucky Country: Has It Run Out of Luck?, by the early to mid-1980s, after a decade book- ended by recessions and characterised by stubbornly high unemployment, stagnant growth, persistent inflation and declining relative living standards, Australians knew that we needed to change.

In 1980 then Singaporean Prime Minister Lee Kuan Yew sharpened this recognition when he directly challenged our national pride and sense of self by asserting that Australians were on the way to being “the poor white trash of Asia”.

This was followed by the warning from then Treasurer Paul Keating in 1986 that, without change, we would become “a third rate country…a banana republic.”

And change we did.

Beginning in the early 1980s, Australia embarked on one of the most significant reform programs ever seen in an advanced country.

We floated the currency, deregulated the financial system, reframed macroeconomic policy and opened up product and labour markets by sweeping away ossifying rules and regulations designed to create a cosy life for business and unions at the expense of consumers.

The agility of our economy increased markedly through reforms to our financial, labour and product markets. Australia was open for trade and business, and job opportunities flourished as a result.

Rising living standards and the expanding range of opportunities have seen the vast majority of Australians benefit from this era of outward-focused economic reforms and we continue to enjoy the gains today.

Indeed, an objective look at the evidence would indicate that there are few countries that have so clearly benefited from being part of a larger, dynamic global market place than has Australia.

As a small, open economy, globalisation allows us to reap significant gains by specialising in things we are particularly good at. This means that our businesses are not constrained by our small population, instead operating as if the world is their domestic market.

Of course, we’re not the only country to have benefitted from outward looking trade and investment policies.

When we look overseas, globalisation has also been responsible for driving dramatic reductions in global poverty. Within a lifetime, countries like China, and the original Asian tigers, South Korea, Singapore, Taiwan and Hong Kong, have witnessed an increase in their living standards unprecedented in human existence, while rapid strides are now being witnessed in India, Vietnam and elsewhere.

The driver of the Asian economic miracle was exposure to world markets. What many people call the ‘export led’ growth model is not solely about exports. The real gains come from the exposure to competition and to better ways of doing things: the ideas; international standards and norms; business practices; and investment flows.

The re-emergence of global protectionism

 Notwithstanding the evident success of countries that have opened their borders to trade and investment, globalisation is under renewed pressure and protectionism is again on the rise.

A WTO report released earlier this year showed that 1,583 trade restrictive measures have been put in place by G20 countries since 2009. There is also evidence that the pace of protectionism has recently accelerated. Between October 2015 and May 2016, G20 economies introduced new protectionist trade measures at the fastest pace seen since the Global Financial Crisis, rolling out the equivalent of five each week.

Australia has been complicit in this rise in protectionism, although it surfaces under subtle guises.  A prominent example is the uptick in

new anti-dumping investigations since the GFC, and in the number of new anti-dumping measures imposed each year.

The Anti-Dumping Commission reports that there are currently 65 anti-dumping and countervailing measures in force in Australia, up from 23 in June 2010. The Productivity Commission (2016) reports that “changes to the system since 2009 have made it more favourable for user industries and increased its protective impact.” And, as always, the losers are consumers.

Where’s the drive for protectionism coming from?

So where does this drive for protectionism come from?

There are a multitude of theories expressed in economic, social and political terms.

The two that I find the most compelling are: firstly, the desire to support local jobs in the context of weak global demand; and second, growing discontent with rising within-country income disparities.

Seven years after the world economy emerged from a deep recession, a return to broader-based, robust global economic growth remains elusive. A slow growth world and elevated levels of uncertainty are

proving more difficult to break free from than most of us had anticipated.

Global institutions continue to downgrade forecasts and push out the timetable for economic recovery. Slower global economic growth has been accompanied by dramatic falls in the rate of trade growth, slower growth in foreign investment flows and slower credit growth, and this is expected to remain the case for a considerable period to come.

One response to this lack of global demand has been growing pressure on governments to shield local industries or to attempt to give them a competitive advantage. Protectionist policies are seen as a way to achieve this in domestic markets, while accusations surface periodically that countries are resorting to currency devaluations as a tool to improve competitiveness in external markets.

As I mentioned earlier, in this context of weaker global income growth, a second driver of growing protectionist pressures is growing dissatisfaction with rising income disparities.

While most advanced and emerging market economies experienced significant growth in national incomes in the three decades preceding

the Global Financial Crisis, the distribution of these gains has been very uneven within countries.

The following chart shows cumulative real income growth over 23 years up to the latest available data, 2011, and how that growth has been distributed across global income deciles.

Most of the world is much poorer than the average Australian, so most of our population is in the top income decile on the right hand side of the chart.

Cumulative change in global real incomes: 1988–2011

Chart 1, Growth in global real incomes by decile, 1988–2011. The chart shows the percentage growth in real incomes at various points along the distribution of global income levels. Growth is clearly strongest for those in the middle of the distribution, which includes much of the populations of the large emerging economies. There has also been relatively strong growth at the very top of the distribution. However, growth has been weak at around the 90th percentile of the global income distribution, which contains much of the lower- and middle-classes of the advanced economies. Sourced from Branko Milanovic’s book, “Global inequality: A new approach for the age of globalization”, published in 2016.

Source: Milanovic B (2016), Global inequality: A new approach for the age of globalization, The Belknap Press of Harvard University Press, Cambridge, Massachusetts.

You can see in this chart the impressive rise in real incomes enjoyed by most emerging market economies, which dominate the middle part of the global income distribution. The peak in the middle shows that average incomes at the global median more than doubled in real terms between 1988 and 2011. And note the solid increases at the bottom end—this is what we mean we talk about people being lifted from poverty.

Real incomes at the very top of the distribution have also continued to climb, consistent with globalisation and improvements in technology disproportionately benefitting the owners of capital and workers with higher skills.

But what’s also evident in this chart is the lack of income growth around the 90th percentile. This is a reflection of the lower and middle classes in the advanced world having realised only limited gains in real incomes over the past three decades.

With the rise of globalisation, the middle classes of Europe, the United States and other advanced economies are now competing with the skilled workers of Asia.

Many jobs in advanced economy manufacturing sectors, and more recently in the services sectors, have been offshored to lower-wage countries. Advances in technology have also seen people replaced in production processes and in some services areas by machines. This has suppressed real income growth for many low income and middle class workers, particularly in the US.

Essentially, the story is that we have seen a decline in global income inequality as incomes for those in poorer countries have grown faster than for those further up the global income distribution. But, at the same time, for many countries within-country income inequality has risen.

Rising protectionist pressures are in part a reaction to these growing income disparities, manifesting in renewed calls to protect or support local jobs and local industries.

While Australia is not immune to these global income trends, they are much less prominent here than in the US and parts of Western Europe.

If we look only at market income (defined as the returns from labour and capital), inequality as measured by the Gini coefficient shows only a small gap between Australia and the United States over the past two decades.

But once account is taken of our progressive tax and transfer system, income inequality is clearly lower in Australia than in the US and a number of other advanced economies.

Chart 2, Time series of Gini coefficients for the US and Australia between 1995 and 2014. Gini coefficients are calculated using both market income and disposable income. The US and Australia have fairly similar Gini coefficients when calculated using market incomes. However, after taking into account each country’s tax and transfer system, Gini coefficients calculated using disposable incomes are noticeably lower in Australia than in the US. For disposable income, the US Gini coefficient grows from 0.36 to 0.39, and the Australia Gini coefficient from 0.31 to 0.34.The gap between the Australian and US disposable income Gini coefficients has been broadly constant over time. Sourced from the OECD statistics database.

Source: OECD

Another important difference in Australia’s case is that this has been in the context of strong growth across the income distribution, as shown in the below chart.

Real household disposable income growth by decile: 1986–2013

Chart 3, United States and Australia, real household disposable income growth by decile, 1986–2013. Over the period, Australian real household disposable incomes have grown by around 50 per cent at each decile cut-off, with the exception of those at the top cut-off, where real incomes have grown by a little over 60 per cent. In contrast, US real incomes have only grown by around 10 to 20 per cent, with stronger growth at higher income levels and slower growth around the middle income levels. Sourced from Luxembourg Income Study data used by Thewissen, Nolan and Roser (2016) in their article “Incomes across the distribution”, published on OurWorldInData.org. Australian growth rates after 2010 are spliced on using ABS data  and calculation is from 1985.

Source: Luxembourg Income Study; Thewissen S, B Nolan and M Roser (2016), ‘Incomes across the Distribution’, OurWorldInData.org; PM&C calculations. Growth rates are for decile means of real equivalised household disposable income, population. Australian growth rates after 2010 are spliced on using ABS data and calculation is from 1985. US calculation is from 1986.

Without the terms of trade boom, the Australian experience may have been very similar to that of the United States, with those below the median income experiencing relatively slower growth in incomes.  The US experience is stark with the hollowing out of middle class incomes and gains over the period predominantly directed to the rich.

Of course, income growth has become more difficult to achieve following the Global Financial Crisis and this has been exacerbated in Australia’s case by the decline in our terms of trade over the past 5 years.

As I’ve said on other occasions, in the absence of another period of productivity enhancing reforms, Australia’s quarter century of superior economic performance could be followed by a period of sustained mediocre performance and significantly lower income growth than we’ve enjoyed over the past three decades.

If this turns out to be the case, the social consequences will, as always, be concentrated, with marked impacts on the poor, low-to middle-income earners, and the young.

In the face of this, we are hearing echoes of the protectionist sentiments of the past with calls from some quarters for a return to direct industry support and more restrictive approaches to trade and investment.

In some parts of the world, globalisation has become a dirty word.

This poses significant challenges that are being manifested in the polarisation of politics in the United States, Western Europe and, to a lesser extent, here in Australia. Those who are arguing that advanced countries have failed to take seriously how the benefits of globalisation are distributed have developed a compelling narrative and are gaining support for a return to isolationist policy approaches. One of Australia's challenges is not to go down that road.

As Prime Minister Turnbull noted in his recent CEDA speech “Political divisions in advanced economies, particularly where there is high unemployment or a high risk of unemployment, are feeding on a sense of disenfranchisement among many people who feel the rapid economic changes of our time, have left them behind. Political responses to this mood of disaffection can have the potential to destabilise global growth, perhaps even reversing some of the spectacular gains that we have made over recent decades, through open markets and free trade.”

Looking for policy solutions

The question that needs to be asked is: why would we imagine that the failed policies of the past will succeed in the future?

While the gains from open trade and investment are clear, there is absolutely no evidence to suggest that the protectionist policies which held back growth in previous decades will miraculously do the opposite and improve growth this time around.

A retreat from globalisation would be to the detriment of all the world’s economies and dramatically slow growth in global living standards. And for countries like Australia, not part of any natural bloc or grouping, such policies would likely consign us to a relative, if not absolute, decline in living standards over time.

So, what should Australia do in response to renewed calls for industry support and the imposition of protectionist measures?

The first response should be to resist these pressures. Rather than retreat to the failed policies of the past, we need to strengthen our engagement with the global economy and with the fast-growing nations in our region.

We need to recognise that Australia will only succeed in the 21st century if we can tap into the enormous worldwide flows of technology, innovation, knowledge and commerce.

While we will continue to export natural resources, we also need to build on our successes in advanced manufacturing and find ways to sell more Australian services to Asia’s expanding middle class.

As a technologically advanced, safe, English speaking country we may enjoy some competitive advantages in areas like education, tourism and health.

But in general we don’t enjoy an inherent comparative advantage in services exports and advanced manufacturing, unlike our resource and resource processing industries.

What’s needed is a reinvigorated structural reform agenda based on open trade and investment policies that lifts our competitiveness, attracts greater investment and positions Australia to capitalise on opportunities in the world economy.

The second response to the pressures on globalisation should be to better equip our workforce to participate in and prosper from the

changes taking place in the global economy and the evolving nature of work.

Education and training are important domestic policy levers which Australia, and other nations, can pull to build growth and support those who are more at risk from unemployment or underemployment during periods of structural change.

Increasing the level of human capital is critical for improving labour productivity and ensuring that Australians are equipped with the skills and knowledge to adapt to technological progress and our economy’s changing workforce needs.

The third response to the challenges of structural change should be to continue supporting those who, despite their best efforts, aren’t able to rapidly reskill or find reasonable paying work and therefore require income assistance to sustain a reasonable standard of living.

Rising inequality is not destiny or a necessary consequence of the forces of globalisation. It is a choice made by individual countries.

All governments have the policy apparatus at their disposal to build a more economically and socially equitable society that remains internationally competitive.

Australia is already a standout in this regard, redistributing more to the poorest 20 per cent of the population than any other OECD country except Denmark, a testament to the sustained bipartisan commitment to supporting the disadvantaged and low income earners in our society.

And before the critics write me off as believing in big government, let me be clear—Australia’s problem is not the redistribution to the poorest, but the spread of welfare much further up the income distribution.

The design of redistributive policies is even more important—policies need to support work incentives, not create disincentives to work.

To this end, the new focus on the social investment approach to welfare is a profound structural reform, potentially one of the most important of recent decades.

Supporting the global foundations of growth

But strong domestic policies on their own will not suffice.

Another priority is to use our voice in global forums, such as the G20, to push back against protectionism and participate in shaping the evolution of the rules-based global trade and investment system.

That Asia has benefitted so profoundly from globalization, from the import of ideas from the Western world, and the export of goods and services based on those ideas, owes much to its participation in the liberal economic order.

It is that regime of open markets, trade and investment flows, rules and effective institutions, that has contributed to the environment in which Asian economies have been able to grow and flourish.

The G20 in particular has played a critical role in shaping the liberal international rules-based environment in the past decade and a half.

Formed in the wake of the Asian Financial Crisis, the G20 played a crucial role in steering the world through the Global Financial Crisis, facilitating a high level of cooperation amongst the world’s

systemically important countries on macroeconomic and financial sector policies.

Reflecting on the important role that the G20 has played during these episodes, it is sometimes claimed that the G20 is at its best during crises.

There may be an element of truth to this, but it undersells the G20’s worth and achievements.

The G20 also has been important outside of crises for building and sustaining the policies and institutional frameworks that are important for achieving stronger growth and rising global prosperity.

The G20 provides an avenue through which Australia can continue to push for global institutions like the IMF to be more inclusive of emerging market economies as they become a larger part of the international rules setting process.

This is essential to the legitimacy of these institutions, the rules that they seek to apply and ultimately our shared success in driving a cooperative and mutually beneficial economic and financial architecture for the world economy.

This year also marks the mid-point for the five-year horizon of the Brisbane commitment to raise G20 collective GDP by 2 per cent by the end of 2018 (the 2-in-5 ambition).

Analysis from the international organisations suggests the G20 has so far achieved about half of this growth ambition, with fully- implemented policy commitments made since the Brisbane Summit expected to contribute an additional 1 per cent to collective G20 GDP.

Some argue that the G20’s failure to have delivered the full 2 per cent growth ambition by now threatens to undermine the G20’s credibility. I couldn’t disagree more.

Before rushing to judgement we need to consider the counterfactual. Where would we be today if Australia hadn’t put the collective ‘2-in-5’ growth target on the table in Brisbane two years ago?

Given the more than 1300 structural reform commitments that have been made since Brisbane, I find it hard to believe that global growth would be in a better place without the growth target.

Having said that, more ambitious structural reform efforts and additional policies to support growth and innovation are clearly necessary if we are to avoid a new normal of mediocre global growth.

This is as much the case for Australia as it is for the other G20 economies.

In addition to promoting stronger growth, the G20 is also addressing concerns about global inequality, both within and between countries.

Promoting open trade and investment is one way that the G20 can act to reduce ‘between’ country inequality. And while G20 members have not been ‘pure’ when it comes to protection, my judgement is that the collective responsibility exercised within the G20 has helped restrain these tendencies.

Making sure that our growth strategies support development and inclusive growth is another key way to address ‘within’ country inequality, and this has been a consistent theme of Leaders at recent summits.

Perhaps the most visible G20 commitments aimed at addressing inequality, though, are those concerning tax avoidance and anti-

corruption. The G20 has led the global crackdown on corporate tax base erosion and profit shifting, or BEPS, and the use of offshore financial accounts and entities in secrecy jurisdictions to avoid tax.

At the Leaders’ Summit in Hangzhou that I attended with the Prime Minister last month, the G20 called on all countries that have not yet done so to commit to automatic exchange of information between tax authorities by 2018 at the latest. G20 leaders also asked the OECD to prepare a list by the July 2017 Leaders’ Summit of those jurisdictions that have not yet sufficiently progressed toward a satisfactory level of implementation of the agreed international standards on tax transparency and agreed that defensive measures would be considered against listed jurisdictions. This firm statement of intent demonstrates the seriousness with which tax transparency is being taken within the G20.

The G20s Anti-corruption Working Group also contributes to fighting inequality, especially with respect to member actions to improve the transparency of business ownership structures, acting on the G20 High-Level Principles on Beneficial Ownership Transparency agreed by G20 Leaders at the Brisbane Summit.

The G20 has also made meaningful commitments to address inequality through work to reduce the cost of remittances, an area in which Australia is playing a key role, recognising the importance of remittances for our neighbours in the Pacific and in South East Asia.

Transfers to and from G20 countries account for almost 80 per cent of global remittance flows. This significant flow of funds can lift people out of poverty, improve economic infrastructure in receiving countries and increase engagement in the formal financial sector.

Significant progress is being made. In 2011, the G20 committed to reducing the cost of sending remittances to 5.0 per cent, which the World Bank estimates could save migrants and their families US$16 billion a year. Since then, the cost has been reduced from
9.3 per cent in mid-2011 to 7.6 per cent in mid-2016, a significant achievement with material benefits for the developing world.

The G20’s other great strength is its convening power. When issues of global economic significance arise, there are great advantages in being able to develop a response under the auspices of the G20. Doing so signals that the issue is one that the international community

takes seriously, which means that other institutions, both private and public, also take it seriously.

Examples of the benefits of this convening power are the work on global tax evasion and remittances that I spoke about earlier.
Another example, about which you may know much less, but which is an important global economic issue, and one on which the G20 will do more work in future, is the rising threat from antimicrobial resistance and the market failure arising from the limited incentive to discover new antibiotics in time to prevent future pandemics.

Finally, it’s also striking that the Presidents of the two most powerful countries on earth, the USA and China, chose to ratify their commitment to the Paris Climate Change Agreement in the margins of the recent G20 Leaders’ Summit. The message was clear—other countries need to get on and do it. But a more subtle message is that the two leading powers continue to see the G20 as the right venue for making announcements and signalling intentions on significant global issues.

Conclusion

To conclude, calls for industry protection and a retreat from open trade and investment policies are not new, but they are again gaining force.

After starting our journey as a federation with a global outlook, our retreat into protectionist policies after the First World War levied a heavy toll on the competitiveness of the Australian economy and our national living standards.  It was not until the 1980s that we systematically focused on improving our international competitiveness.

Since then, Australia has arguably been one of the greatest beneficiaries of globalisation. The significant increase in our living standards over the past three decades is testament to the reforms of the 1980s and 1990s that transformed Australia into an open and flexible economy.

It is important we build on these gains, avoiding calls for a return to the failed industry support and protectionist policies of the past and instead focus on equipping our current and future workforce to capitalise on the opportunities that globalisation presents and using

our progressive tax and transfer system to ensure that nobody is left behind.

As a small open economy we live and die by the success of a rules-based liberal economic order.  But that order needs legitimacy and buy-in from all major players—the creation of G20 was recognition of this in the face of a changing world. But almost two decades on, if the G20 didn’t exist, I doubt we could create it. And if we weren’t a member, I know we would never be invited to join.

So our national interest imperative is clear—work to make G20 a success, push the agenda by being constructive and use G20 experience to reflect back into the domestic arena the importance of key macro and structural policies focused on openness, innovation and competitiveness to sustain our living standards.

Thank you.