Institute for Private Enterprise

I apologise for the length of the following report on my discussions overseas with central banks, treasuries, international organisations and think-tanks but it basically covers two months and subjects that are, hopefully, of more than usual interest. The more normal one month newsletter will resume next month. I have tried to focus on issues not adequately covered in the media here.

Meantime, please note two conferences: viz (1) An HR Nicholls Conference on 27-28 August in Melbourne, entitled The Third Way: Welcome to the Third World ; and (2) a Quadrant seminar in Sydney on Aboriginal issues on 21 August, with Senator Herron as a guest speaker.

My discussions overseas left me with the feeling that we have to take more seriously the optimistic thesis, emanating mainly in the US, that the "developed" world may now be in a new economic paradigm that offers faster economic growth with less fluctuations and recessions. Of course, we have all been told before about so-called "golden ages" that never eventuated and, with the S and P share index pricing US shares at an extravagant 35 times earnings, such optimism must be discounted. But there does appear to be some basis to it.

Popular attention is focussed on the IT revolution because of the actual and potential revolutionary changes the new technology offers. To take just one example, US teenagers are now downloading popular music straight from the Internet and that is threatening to displace CDs (copyright problems aside, think of the increase in productivity!). But, important as the IT revolution is, it should not be overlooked that improvements in government policies have helped create a more certain, more risk-encouraging, more-productivity enhancing economic environment, viz:

1. More stable, more medium-term and less "Keynesian" budgetary and monetary policies have now become widely accepted, even in Europe. (Whatever doubts one may have about the monetary union, there are already signs that the macro-policy compliance provisions of the Maastricht Treaty are being of particular benefit to countries previously behind the ball park. Spain appears one such example and Belgium - said to be almost ungovernable domestically - another. More generally, EU bond rates are now mostly below US and Australian rates even though the average EU inflation rate is slightly higher). The most important benefits from such improved policies are coming from the winning of the long battle against inflation, resulting in lower real interest rates and lower risk premiums on investment;
2. Structural reforms have exposed both product and labour markets to greater competition. The result is increased growth in living standards, reflected in faster growth in employment and productivity (some of the latter is unmeasured - there is widespread doubt about statisticians' capacity to capture productivity gains in service industries in particular);
3. Rising asset ownership which, as US think-tank Cato points out, has "transformed this nation in cultural, political and economic terms." Cato argues (with some validity) that, once account is taken of increased asset values (and even discounting for likely current over-valuations), the US is not the low saving nation that conventional analysis suggests. This is relevant to Australia too.
4. Improved efficiency of international capital markets which is contributing importantly to the adoption of responsible policies and "rewarding" those who pursue them. Australia has certainly benefited and may now be able to run higher current account deficits for longer - see my attached comments in The Age of 29 July. (This may seem an odd view given the withdrawal of foreign capital in the Asian crisis. But the underlying cause of that was the realisation that unsustainable government policies were being pursued. The withdrawal has contributed to some improvements in policies in the countries concerned).

Of course, not all countries are benefiting equally and the entrepreneurial-encouraging environment in the US is keeping it the leader. However, many overseas have noted that Australia's recently improved productivity growth suggests that (at last) we are in the main game. There are also some encouraging signs (including from Ministerial staffing changes) that Prime Minister Howard, Treasurer Costello and Workplace Relations Minister Reith are now recognising the importance of Australia's improved "institutional" arrangements - and the need for further reforms to create a truly entrepreneurial institutional environment.

Given the new economic paradigm thesis, it is not surprising that economic reforms are continuing in both the US and the UK (though not in the latter's labour market). That they are not proceeding faster probably reflects the continued "doom and gloom" messages about social problems emanating from social/religious lobby groups (supported by the largely left media), and the continued resistance from the hard left, plus the normal time lag between achieving results and having them recognised in the wider community. Another factor is the inability of individual business leaders to justify the role of business in society, startlingly revealed from the Laws affair (which threatens to further promote the increasing nonsense about the need for "business ethics" and for greater attention to "stakeholders" rather than shareholders). It is not surprising, perhaps, that there remains at the political level a belief that reforms are more difficult to achieve and that, in consequence, the community has to be better persuaded than in the past.

In the US, for example, the Republicans are trying to recover from the major setback in 1995 resulting from the brash leadership of former Speaker Gingrich by pushing George W Bush as the "compassionate conservative" Presidential candidate for next year. They have also instituted a program, run by Madison Av PR agencies, that is trying to "educate" Congressional reps to communicate the values behind reform proposals and the conservative agenda generally. Bush (who barring "accidents" seems certain to get the Republican nomination and should easily beat the deadly boring Gore if he is the Democrat candidate) may turn out in practice to be less conservative than now appears the case. Some suggest that his "say little", compassionate approach simply reflects the strategy judged necessary to get a Republican back in the Oval office - and boy are they desperate to achieve that!

Some of this may be relevant to how, politically, economic reform might continue in Australia and what the Senate-controlling Democrats might allow in the new Parliament. The Dems (and the current hopeless ALP leadership) are clearly a product of the above-mentioned time lag and they will have to be "massaged" until the Parliament more closely reflects the new reality. Having agreed to two major pieces of reform (sic) legislation (I/R and the GST), and tasted the political limelight that has gone with that, can the Dems be persuaded to accept more? If so, will the trade-offs they demand be such as to offset the benefits (as may be the case with Telstra's latest partial "privatisation")?

Nobody knows the answer to such questions. But all political parties are influenced by public opinion. The best hope may be to try to swing opinion more in favour of reform by an intensive highlighting of the (social and economic) benefits flowing from reforms both here and overseas. At the same time, the "dynamics" of poverty has to be exposed (see further below) and Australia's existing relatively generous social safety net, protecting those who are or become disadvantaged, emphasised.

For all his faults, and after his initial attempt to socialise medical care, Clinton is turning out to be the most "conservative" spending President for many years. Of course, he got the "dividends" from the reduced need to spend on defence and interest, and the absence of recessions. Also, according to US Treasury, Congress' adherence to its spending "caps" procedures (requiring increases in discretionary spending to be matched by savings elsewhere) has been "very important".

But Clinton is not (yet) spending the dividends: even with projections that (somewhat conservatively) assume US growth averaging only 2.2 per cent pa, his latest Budget projects Federal government spending to fall from 19.7 to 18.1 per cent of GDP over the next five years (by comparison, Commonwealth Government own purpose outlays are projected to fall from 17.4 to 16.4 per cent of GDP over the next five years). If achieved that would be the lowest since 1957.

The big argument now in the US is over what to do with the large projected surpluses (what a turn-around from just a few years ago!). Interestingly, the Republicans are putting little emphasis on debt reduction. They are pushing for big tax cuts and/or for allowing individuals to invest part of the (large) payroll taxes they pay to finance their own pensions. Clinton has not ruled out support for tax cuts but, as well as debt reduction, he would give priority to "saving" social security (ie pensions) by having the Federal Government (!) invest the existing surpluses in the stock-market so as to be available when the population ages and the social security "trust" funds start to run deficits. Clinton also proposes both increased Medicare benefits and increased cost sharing (in the US, Medicare only applies to the elderly and patients usually pay 20 per cent of costs, including a monthly premium).

An interesting feature of the US budget is the existence of "trust" funds within the overall budget structure. In particular, social security payroll taxes are paid into a separate fund to finance pensions and this fund is currently running a surplus. While this procedure has no substantive economic significance, the hypothecation is serving to focus attention on the need for pension reform to avoid the "shortfall" in funding early next century as the population ages - perhaps there is an idea here for those in Australia who are concerned to reform Medicare and reduce middle class welfare ?

I am proposing in due course to write a more detailed note on some possible implications of the new economic paradigm for monetary policy and will limit my observations here. The key immediate point is that the combined effects of the faster growth in productivity (and its unpredictability) and the greater flexibility in labour markets have made it difficult to forecast inflation with any confidence. Economic models, based on past experience, are not working, with the result that estimates of NAIRU and output gaps cannot be relied upon (the Fed, long stuck on its estimate of 2.25-2.5 per cent pa as the US trend growth rate, is now reluctant to give an estimate - "perhaps a little over 3 per cent ", I was told). This doesn't mean that inflation is dead - the problem is how to determine the circumstances that will cause its revival.

Changes in monetary settings are now thus largely based on pragmatic judgements about likely rates of economic growth and their effects on inflation. My discussions at the Fed and the Bank of England suggested that they are effectively making such judgements by reference to a "check-list" of economic indicators similar to the list which the Reserve Bank used in the 1980s in Australia. Discussions with economists in US financial institutions suggested that they are trying to second-guess the Fed by compiling their own check-list of what they think the Fed thinks is important!

The potential implications of this development are considerable. It certainly raises a serious question about the pre-emptive strategies which central banks have adopted - even allowing for the time taken for interest rate changes to have effect (about twelve months according to the Fed), if you can't forecast inflation, how can you justify changing monetary settings in advance of price changes? In the absence of any significant signs of increasing inflation in the US (at least prior to the latest Employment Cost index), it is evident, for example, that Greenspan has been really struggling to justify interest rate hikes, though that appears to be his inclination. More generally, if markets are now (better) "educated" to respond to inflation, perhaps central banks should be making of less frequent policy changes.

The debate about the need for and effects of labour market deregulation continues apace. I arrived at the OECD in the midst of an internal "brawl" caused by the statement in the June 1999 OECD Employment Outlook (EO) that employment protection legislation "has little or no effect on overall unemployment". This statement clearly contradicted OECD publications in the Jobs Strategy series and the wording apparently reflected changes made by the Employment and Social Affairs directorate after a draft of the EO had been cleared for publication by the relevant OECD committee and without any reference back to it or the Economic directorate.

In the end, a (rather weak) statement was issued to the effect that, for countries with a serious problem of long term unemployment and/or relatively low overall employment rates (which would surely include Australia), the OECD will continue to recommend "consideration" be given to relaxing employment protection as part of a comprehensive policy to improve labour market outcomes. In addition, however, I understand that further Jobs Strategy papers to be published in September in connection with a workshop will confirm the link between employment protection legislation and unemployment. These will also show that, in countries with low employment rates, those who are "missing out" on jobs are women, youths and older workers - employment rates for prime age males are similar in all OECD countries.

The 1999 Employment Outlook does publish, for the first time, the overall employment rates for 1998 for OECD countries. Although these show a slight improvement in Australia's position relative to comparable less regulated labour markets, they basically confirm the thesis in my Nov 1998 report on The Case for Further Deregulation of the Labour Market (on which one senior OECD official complimented me and which seemed to generate some interest at the IMF) that deregulation would likely result in a major increase in employment. The 1998 figures show that, if Australia had had the same proportion of its working age population (15-64 year olds) employed as the US, the UK and New Zealand, our employment would have been higher by the following:

USA - 755,000;

UK * - 430,000;

NZ * - 218,000.

*The UK experienced a marked slow-down in growth in 1998 and New Zealand experienced a fall in GDP.

While some of the Nordic countries with more regulated labour markets also have relatively high employment rates, discussions overseas suggested a number of possible reasons as to why their experience may not be relevant to Australia - their "culture" of greater involvement of both employers and employees in social partnership; their less detailed regulation of employment conditions and less intervention by third parties; and, with export-oriented manufacturing industries, their regulation of wages and employment conditions based to a greater extent on the need to be internationally competitive.

The performance of the US labour market continues to improve, with labour "shortages" leading to employers offering increased training so as to suck in people not previously in the work force. (The Wall St Journal ran an amusing article entitled "Even Leftists Have Servants Now" which highlighted the 8 per cent expansion in domestic service-type jobs last year - even at $US12-15 per hour plus board - including the growing employment of nannies, gardeners, cleaners, cooks, maids, housekeepers, etc - "the dirty secret of a lot of middle-class Californians"). The Fed attributes the improvement compared with the 1950s and 1960s to a whole range of small changes over the past twenty years and points out that, contrary to "theory", low inflation has not reduced the potential for flexibility in labour costs: the use of stock options, for example, is rapidly spreading down the wage spectrum.

Contrary to majority academic opinion in Australia, the Fed also takes the view that increased inequality in the US is not a serious problem because of the mobility of labour. This is supported by a recent OECD Working Paper on Poverty Dynamics in Four OECD Countries, which shows that the majority of people who are "touched" by poverty are affected for only a short period. The study shows that, in the US, only 4.6 per cent of the population were poor throughout the six year period 1988-93. Importantly, it also concludes (unsurprisingly except for the academic majority here) that "obtaining or losing employment is particularly important for transitions into and out of poverty". In short, as argued in my report, it is much better to have working poor than unemployed poor, who can be looked after by social security. (Incidentally, viewed from another perspective the US labor market is a not unimportant equalising force: the continued large influx of illegal immigrants -now estimated at 12mn - is provided with employment at wages well above those obtainable at home).

In the UK, notwithstanding the introduction of a minimum wage (providing "gains" for 2 million), and the introduction of basic minimum standards and new regulations under the European Union Social Charter, as well as a slow down in growth in 1998, the performance of its (hitherto) less regulated labour market has also continued to improve, with unemployment down to 6.2 per cent. Features of labour market developments in recent years have included marked increases in fixed-term contracts (notably in the employment of professionals) and part-time and temporary workers.

Blair is claiming that EU regulations (such as the 48 hour maximum working week and the requirement for part-time and casual workers to receive paid holidays!) are being introduced in ways that will not undermine "flexibility". Certainly, extensive use does appear to have been made by the UK of the derogations and exceptions allowed for in the EU Directive. However, as the minimum wage and the EU Directive have only just become operative, the next year or so will be a testing period. The Confederation of British Industries certainly seems to have accepted all these changes with little protest - but it is widely perceived as part of the corporate state. By contrast, the Centre for Policy Studies has published a paper which estimates that the various measures taken by Blair (including increased "recognition" rights for trade unions) will increase unemployment by 3 percentage points.

While this estimate seems rather high, the UK's slow progress in reducing unemployment may be coming to an end: indeed, the OECD argues that unemployment is below the structural rate and will increase this year. Discussions at the UK Treasury indicated that the primary focus at the official and government level is on improving the supply side of the labour market, such as trying to make work more attractive to workless households and providing "personal" advisers for all benefit claimants. The vital importance of having minimalist regulatory arrangements to encourage demand is seemingly neglected.

However, even though he has made some bows to meet trade union wishes, Blair remains careful, politically, to keep them at arms length. He apparently declines to have his photo taken with a leading trade unionist and, notwithstanding his Anglo-German "Third Way" accord with German Chancellor Schroder, he has refused to enter any social pact involving trade unions (as Schroder has done in his "alliance for jobs" with representatives of unions and employers). UK unionism is continuing to decline under Blair and is now down to 19 per cent in the private sector and 30 per cent overall; and workplaces with no union members have increased from 36 to 47 per cent since 1990.

Schroder, incidentally, appears in serious political trouble in Germany with unemployment higher than when he assumed office, the resignation of his chief of staff (who reputedly masterminded the Social Democrats' victory last September) and "warnings" to Green coalition partners that they have to scale back their demands for closing the country's 19 nuclear power stations. German employment in retail, wholesale and catering fell 6 per cent in June after increased controls were introduced. As with the UK, the increased regulation of European labour markets generally is going to provide an interesting test case of the effects of regulation.

There is no doubt that Blair's attitude to unions and his attempts to "make the public sector work" is causing considerable angst amongst the Labour left. This was illustrated when Blair made a speech while I was in London complaining about the difficulties of effecting change in the public sector (more resistant to change, he asserted, "than any group of people I have come across") and about the scars he has accumulated from trying. Deputy Leader Prescott exploded, lavishing praise on the public sector which (he claimed) has "done much to civilise this century". Prescott followed up with an attack on the "faceless wonders" in 10 Downing St, which (he "explained") was a reference to some elements in Blair's staff.

It may be that Blair has "peaked": although his ratings remain high, Conservative leader Hague is consistently outperforming him in the Commons and Blair's strategy of trying to make the public sector operate efficiently is in difficulties (not unexpectedly when the right incentive structures are not there). One example which emerged during my visit was the Home Secretary's threat to privatise some public sector prisons because of their poor performance - so much for Victoria's problems with its privatised ones!

In London I made a special point of visiting the Advisory Conciliation and Arbitration Service (ACAS), the UK quango which provides voluntary conciliation, mediation and arbitration in relation to both collective and individual employment disputes. I have already suggested in my Deregulation report that ACAS provides a model for a deregulated system in Australia, with the AIRC being converted into a similar body.

ACAS is soon to celebrate its 25^th anniversary, in which Blair will participate. The Blair Government has, indeed, recently expanded ACAS' role by providing for it to operate an arbitration scheme for unfair dismissal cases as a voluntary alternative to employment tribunal hearings, which have become clogged in legalistic practices. (ACAS already settles through conciliation nearly half of individual disputes).

The role of ACAS highlights the voluntaristic approach of the UK in relation to both collective and individual disputes (indeed, it was suggested to me that the UK has always been more voluntaristic than Australia across the whole area of industrial relations regulation). ACAS' emphasis is on encouraging internal resolution of disputes by having appropriate dispute settling procedures at the enterprise level. Failing internal resolution, ACAS then, potentially, comes into the picture in fulfilling its main role as the provider of a voluntary conciliation service.

In providing that service, however, no pre-conditions are imposed requiring the parties to accept any particular outcome and ACAS has no right to compel the parties to come to it, no right to impose solutions and the solutions are generally not binding. Most importantly, ACAS emphasises its complete impartiality as between the parties and (by contrast with our industrial tribunals) that appears to be universally accepted.

Apart from publications, there is no charge for any of ACAS' service and the annual cost of its operations is only 26 million pounds a year. That includes the provision of extensive advisory services to both employers and employees, including the handling of over 500,000 phone calls in 1998. In that year, ACAS handled 1313 collective conciliations (with a success rate of over 90 per cent), 114,000 individual conciliations, and 530 advisory mediation projects (mainly covering improvements in dispute settling procedures).

There seems little doubt that the UK's voluntaristic approach to handling industrial disputation is far superior to ours. The main onus is put exactly where it should be -on the parties most directly involved - and there is no sense in which the responsibility for settling disputes is a matter for third parties.

Although the pace of privatisation has slowed overseas, it is continuing - even the Irish are (fully) privatising their Telecom. Faced with increased competition from a privatising (next year) Deutsche Post, Blair has corporatised the Post Office and is phasing down its mail delivery monopoly (up to 50p only). He is also pursing a form of privatisation through (large) resort to private finance to fund capital expenditure on hospitals, police stations, schools, London Underground and prisons. This is being resisted by the left (and by the BMA in the case of hospitals!) because of the (alleged) higher cost of capital. Unsurprisingly, the UK health service is subject to the same problems and complaints (particularly hospital waiting lists) as are Australian health services and, as in Australia, there seems to be no inclination by the Government to introduce cost sharing arrangements.

More interesting, perhaps, is the on-going debate about regulation of former utilities that have been privatised. The telecoms regulator in the UK is talking about withdrawing from detailed price controls as competition has developed (BT now faces competition from scores of licensed operators, there has been an explosion in products and services and phone call charges have fallen 50 per cent in the past 15 years). On the other hand, the UK energy regulator is clearly unhappy with (and threatening more intervention in) the working of the electricity trading arrangements and Transport Minister Prescott, who has been scoring political points by attacking the privatised railways, has legislated to require their compliance with tougher performance criteria. But, even though the railways' performance clearly leaves much to be desired, their patronage has increased by 25 per cent in five years and one of the main complaints is the difficulty of getting a seat even off-peak. More generally, while the requirement for privatised utilities to meet performance criteria as part of the regulatory process has brought forth increased consumer complaints, it has also highlighted the fact that their predecessors did not publish (non-financial) performance results or have a regulator to whom people could complain.

In the aftermath of the Asian crisis, there was much discussion about reforming the "international financial architecture". Proposals included some form of exchange rate "management" (such as by establishing currency zones for the $US, the euro and the yen), the regulation of international capital flows and the establishment of a world central bank. Thanks mainly to US resistance, none of this is going to happen.

The IMF has established a Contingent Credit Line with the idea that credit might be made available to countries facing capital flight, provided their policies are in order. However, discussions at the Fund indicated that it has a long way to go before it can predict such upcoming "crises". In conjunction with private sector financial institutions, work is proceeding on developing early warning indicators but "there are a lot of data problems". In fact, the main outcome of all the post Asian kerfuffle seems likely to be limited to attempts to improve data. To the extent that this succeeds, it will improve transparency and the efficiency of capital markets themselves, reducing the need for IMF credit.

With the passing of a no confidence motion in Victoria's Chief Commissioner by 2,000 police officers at a Police Association meeting, the issue of policing policy has remained in the limelight (see attached letters). Unfortunately, what should be the main issue - the wholly inadequate discretion given to police officers to protect the rights of those who are subjected to violence or threats thereof - has received little attention. The issue will be further explored at the above-mentioned HRN Conference.

It appears that we are out of line with overseas practice. During my visit to the US and UK, I observed reports of police using water canon, tear gas and even rubber bullets to control unruly crowds/protesters. Is there some (substantive) reason why none of these are available to Victoria Police?

Tidbits

• The Anglican Church seems to be recognising the power of market forces: except for attendance at services, it is charging seven pounds fifty to enter St Paul's Cathedral.

• The hedge fund, Long Term Capital Management, is paying back $US1 billion of the $3.625 billion of "rescue" loans it received last year and 5 new hedge funds started in New York while I was there.

• Alger Hiss' son has written a book claiming that Whittaker Chambers was wrong and his father did not give secrets to the USSR. However, the W.S.J review of the book pointed out that the Venona project (the release by the US from 1995 of coded cables used by US Soviet agents to report to Moscow) made it clear beyond reasonable doubt that Hiss was involved. Why don't we have an Australian Venona project?

• In its 1998-99 decisions, the US Supreme Court moved to increase the powers of the States and reduce those of the Federal Government. It has also limited the definition of "disabilities" under the Americans With Disabilities Act (which covered an estimated 43 million when passed in 1990!). People with problems that can be corrected/controlled by medicine, glasses or other measures will not qualify as disabled. This will limit the liability of businesses to accommodate disabled people, an issue which has emerged here with the astonishing HREOC decision to require a private school to accept as a pupil and make special provision for a child with spina bifida.

• Meantime, US legal decisions over the past ten years awarding damages to those claiming disease from breast implants have been shown incorrect by the National Academy of Science's Institute of Medicine report, at the behest of Congress, showing no link between such implants and various systemic or connective tissue diseases. Those decisions forced the primary manufacturer, Dow Corning, out of business. This is leading to increasing questioning of "class" actions.