Challenges of Structural Reform: Reflections on Australia's Experience
Prof Gary Banks AO, Dean and CEO of the Australia and New Zealand School of Government. The views expressed are his own.
Sir John Crawford Lecture
New Delhi, 10 March 2014
It is a privilege to have been invited to this remarkable city to deliver a lecture, in these beautiful surroundings at the Australian High Commission, in honour of a man who holds such a distinguished place in Australia's policy history.
Sir John Crawford made a major contribution to his country as public servant and academic in the course of a long and impressive career, informing key decisions of governments of different political persuasions.
As Professor Ross Garnaut has observed, in his own Lecture in this series, Crawford had "a strong belief in sound analysis and research as the foundations of good public policy". Moreover, he did much to demonstrate his attachment to that principle and put it into practice: first, as founding Director of the Bureau of Agricultural Economics—which soon won a pre-eminent place as the policy research base for our rural economy—then as Secretary of the Departments of Commerce and Trade and, finally, at the Australian National University, where he headed a key research school before rising to the highest levels of leadership there.
In the latter phase of his career, he was also the architect of the Industries Assistance Commission, an independent policy advisory and research body established within the Australian Government to replace the Tariff Board. This followed a request by the then Prime Minister, who wished to provide a stronger statutory foundation for the recent shift in direction of the Board, under Chairman G.A. Rattigan, towards economic rationality in the public interest.
The 'Commission', as it has come to be known through several changes of name and configuration, is generally recognised in Australia as having been a powerful force for reform. It has developed since Crawford's day in scope (if not size) to encompass an increasingly wide range of areas of public policy. And, as I will relate, the market-based reforms it has advocated have yielded considerable benefits to the Australian community. Indeed, there are grounds for seeing the Commission as Crawford's most enduring legacy.
In crafting that institution, he had the wise counsel and active assistance of W.B. Carmichael, a senior official at the Tariff Board, who later rose to the top of the new organisation. Their report to the Prime Minister makes it clear that they saw the settings for research-based policy advice—where, how and by whom it is done—as crucial both to its robustness and its influence. They also demonstrated an understanding that research and analysis, in the right institutional setting, can play complementary 'technical' and 'political' roles in advancing reform and, indeed, in supporting good public policy generally.
These are themes that are close to my own heart, as someone who got his first professional job at the old Tariff Board in its final days and, two decades later, was to become the head of its institutional successor. They are themes that I have addressed before. However I believe their importance and wider relevance is such that they invite further reflection on such an occasion. In doing so, I am pleased that the co-sponsor of this Crawford Lecture is CUTS International, an organisation in India that has long advocated on behalf of consumers—the welfare of whom, as Adam Smith first clarified, precedes that of producers as the end purpose of public policy.
The reform conundrum
The challenges confronting good public policy are essentially of two kinds: determining what to do, and getting it done.
The former task is rarely as straightforward as some imagine, being specific to time and circumstance in each country, and contingent on behavioural responses that can be hard to anticipate. That said, in many cases it is more tractable than the latter. Research, analysis and consultation can generally get the decision-maker most of the way. And, where significant doubts or uncertainties remain, monitoring a policy’s impacts can help ensure that it ends up being fit for purpose even if it didn’t start out that way. (Tax policy is the pre-eminent example. Tax regimes generally evolve through a process of learning-by-doing or, more crudely, trial-and-error. The excessive compliance costs to which small businesses were unintentionally subjected when the GST was first introduced provide one case in point; the fiasco of Australia’s recent attempt to tax economic rent in the mining sector another, though one apparently less amenable to correction.)
The second challenge—getting a policy implemented—can be a lot tougher, to the extent that the policy in question involves changes to the status quo that are perceived to disadvantage certain sections of society or business, even if yielding gains to the community overall. More to the point, getting changes through can prove particularly difficult where they would essentially withdraw sectional advantages previously conferred by government.
Asymmetry of political pressure
The political challenges confronting structural reforms of this kind are most evident in democracies. But, recalling Winston Churchill’s aphorism, other political systems are not immune. Indeed, the earliest and best summary of the reformer’s conundrum is to be found in that famous little book of advice to Italian despots of the early sixteenth century. Machiavelli observed in The Prince that in initiating a ‘new order of things’, the reformer ‘has enemies in all who profit from the old order and only lukewarm defenders in those who would benefit from the new’.
That popular support for reform is generally so weak can be explained as a rational stance for the public to take, summarised in the phrase ‘concentrated costs, diffuse benefits’. The potential winners from reform individually gain little relative to the losers, even though their gains in aggregate may greatly exceed the smaller group’s losses. Moreover any such gains may seem uncertain and often come about only after any losses have been incurred. The old saying ‘a bird in the hand is worth two in the bush’ is thus highly relevant to the reform endeavour. Further, the winners from reform will often be ignorant or deceived about the existence of any gains, as the losers have every incentive to portray the losses they would suffer as a loss to society. Ironically, therefore, the sympathy of the crowd will often lie with those seeking to retain what could properly be described as anti-social privileges.
Governments therefore need good evidence of the wider benefits of reform if they are to turn this situation round. However the structure of public administration is generally not well suited to providing the necessary information. Within most governments, these structures are configured to promote communication with parts of the economy or community that are seen as politically important. This is a natural development in democratic polities. Its inevitable consequence is fragmented information systems and a tendency for decision-makers to be preoccupied with the ‘parts’ rather than the ‘whole’. This can in turn lead to an almost symbiotic relationship between a ‘sponsoring’ department and its ‘client’ groups or, worse, the capture by the latter of the former.
Central agencies – first ministry and finance ministry departments − constitute a potential structural antidote to the phenomenon of bureaucratic sponsorship and partial assessment, but they may not be well equipped for the task, or given the opportunity.
These problems are compounded in countries such as ours with federal systems, which give rise to jurisdictional fragmentation overlaying that sectorally. And jurisdictional interests themselves generally differ on some key policy issues. This makes it harder to get agreement than in unitary states and harder to implement national reforms that require it.
These uneven political pressures on governments, mean that the dice are generally loaded against reform, to the point where I sometimes feel it is remarkable to see any being implemented at all! (True, we do see lots of policy initiatives called ‘reform’, but they don’t always pass the essential test—namely producing ‘change for the better’.) Yet, as acknowledged by the OECD and other international agencies, Australia has been very successful in times past, both in devising and securing important structural reforms.
My main purpose in this Lecture is not to dwell on the reforms themselves. These are well documented in OECD Surveys and in many Australian sources, including reports by the Productivity Commission. (See, for example, Review of National Competition Policy, 2005.) Rather, I want to focus on how the underlying obstacles to reform, those that all governments face, were overcome in Australia during what has come to be known as its ‘Reform Era’—the period from say 1983 to about 2005.
An ambitious agenda of ‘microeconomic reform’
First, to assure you that the reform program has indeed been a substantial one, let me briefly sketch its key elements. In the period in question:
- import tariffs, which had exceeded 100 per cent in effective rate terms for some industries, were reduced to negligible levels;
- financial markets, which had long been bound up in entry barriers, price controls and quotas of various kinds, were liberalised;
- government statutory monopolies in energy, communications, transport and energy were commercialised, corporatized, broken up structurally, exposed to competition and in many cases privatised;
- labour markets were freed from much centralised and prescriptive regulation, allowing enterprises to negotiate directly with their workforces on wages and work practices more attuned to their circumstances; and
- restrictions on competition were systematically reviewed, reduced or removed throughout the economy, with the onus placed on those seeking to retain them to demonstrate that they were in the public interest. (The list of reforms here is extensive, including agricultural marketing cartels, domestic aviation duopoly, retail trading restrictions (where, when, how), entry restrictions on the professions and price and quantity controls in a host of areas.)
Many of these restrictions and privileges were of long standing and had come to be seen as ‘entitlements’. This was despite the fact that, when introduced, most could never have been justified in the public interest. Moreover, they were in many cases designed to obscure the costs and their true incidence.
I suspect you will appreciate from observing events in your own country, that those groups benefitting from such policies were not about to give them up without a fight. And this threat could not be taken lightly, as they had already demonstrated their political influence in obtaining the anti-competitive privileges in the first place.
So what were the strategies adopted? And have these stood the test of time?
The gains to the community have been large
If I can maintain the suspense a bit longer, I should again assure you that the battle was one worth having, with gains from selected microeconomic reforms projected at the time to exceed 5 per cent of GDP. The very availability of such estimates, and more detailed information about how the potential economy-wide gains would be distributed, in itself played a key role in concentrating minds and building wider political support for the reforms.
The estimated gains were more than realised in practice, with benefits to the community (through lower prices, more choice and higher incomes) that greatly exceeded any losses and adjustment costs. We could convey the overall story in a single chart. This would show on the left hand side a seemingly inexorable decline in Australia’s per capita GDP ranking internationally − from 5th in 1950 to 18th in 1985 − whereas the right hand side would reveal an almost symmetric reversal over the next decade and a half.
The enhanced performance of Australia’s economy—its greater flexibility, innovativeness and resilience—also positioned it well to meet the challenges and opportunities of the opening and consequent rise of Asian economies, including notably China—by far the dominant influence so far this century − and India. (The former has since the year 2000 become our largest source of imports and destination for exports; India has in the same period risen from being our 13th to 7th largest trading partner.)
Higher incomes, more jobs
As a result, Australia has experienced 22 consecutive years of positive economic growth, including through the Asian and Global Financial Crises—something unprecedented in our economic history and unique among OECD countries over this period. More importantly, per capita incomes have also increased in most years, and all income groups have generally shared in the benefits (even if not equally). Again, research has confirmed this, including analysis by the Productivity Commission of the distribution of the aggregate gains from infrastructure reforms (amounting to some 2.5 per cent of GDP) both regionally and across the income spectrum.
And, notwithstanding the considerable structural changes in the economy wrought by the reform program—and notably a further significant decline in manufacturing’s share of the economy, especially in labour intensive activities such as textiles and clothing—unemployment steadily fell, reaching record lows by the year 2000, while labour-force participation steadily rose, reaching record highs. (If there were ever a case study of structural reform as a force for net job creation rather than, as commonly thought, job losses, it is to be found in Australia’s experience since the 1980s.)
Underlying these gains was a surge in productivity throughout much of Australia’s economy, at a rate that was not only historically unprecedented, but that exceeded the much-vaunted contemporary experience of the USA, the productivity leader globally. This was of central importance, because, as Professor Paul Krugman at MIT has famously put it, “productivity isn’t everything, but in the long run it is almost everything”. It is the principal enduring source of rising per capita incomes in an economy, again illustrated well by the Australian experience. (Terms of trade gains took over subsequently, with a related surge in mining and other investment that served to deflate measured productivity; but, as in the past, this has been a temporary experience, marked though it was.)
This experience earned Australia the label ‘miracle economy’ in an IMF report at the end of the 1990s. But if interpreted to mean that the changes were unexpected, or unrelated to policy effort, this term was seriously misleading! Indeed, as indicated, if anything the Australian experience demonstrates how a country can shape its own economic destiny if it pursues the right policy course with sufficient skill and conviction.
The policy ‘drivers and enablers’ of productivity growth
The policy insight crucial to such a transformation is that national gains in per capita output and incomes—in other words increases in average living standards − depend on the performance of individual enterprises and industries throughout an economy.
It follows that there are really only two mechanisms through which improvements can occur. One is that firms individually perform better, which means doing more valuable new things, or doing the same things in better ways (loosely, ‘innovation’); the other is through better performing firms displacing or replacing weaker performers (which economists since Schumpeter have labelled ‘creative destruction’) such that industries perform better. International experience as well as that for Australia suggests that the latter can be as important as the former in raising the growth performance of an economy.
The reforms of the 1980s and 90s, outlined earlier, were directed at both mechanisms for overall improvement. On the one hand, they increased the incentives (pressures) on firms to be more cost-conscious and attuned to market wants; on the other, they enhanced their capacity to do so via improved infrastructural capability and regulatory flexibility. All three channels are important to a firm’s and indeed an economy’s performance, and governments influence each of them.
The most important common ingredient was greater market competition and contestability, particularly through the removal of policy-related measures from the past that had served to reduce these drivers of performance. Introducing such measures had arguably been a major preoccupation of policy in the 1950s to 1970s, so that our governments’ role in this period could be said to have been anti-growth; in the 1980s-1990s, however, government played a more ‘positive’ role. It is therefore not really surprising that our performance responded.
Success factors in the reform program
Having completed these brief excursions through the ‘what’ of Australia’s structural reforms, let me at last turn to the ‘how’. Given the undoubted political obstacles, what were the ingredients that made Australia’s extensive structural reforms possible? And might these be translatable in some way to other countries, including your own?
Sequencing was important
Looking back, one important factor in the Australian ‘success story’ was how the reforms were sequenced and paced. The major reforms took place roughly in a sequence that yielded some early gains (lower consumer prices and producer input costs) while preparing the way for the reforms that followed. Each of the major reforms also had its own ‘space’ in the unfolding agenda.
This approach had two important benefits: it enabled sufficient skilled resources within our government administration (always in short supply) to be brought to bear; secondly, it ensured that there could be a focussed discussion about the problems and the solutions, in which the public had time to participate.
The value of this has been reaffirmed in my country by the generally acknowledged failure to bring about enduring policy changes in such important areas as broadband communications, mining taxation and carbon policy. This involved much ‘reform’ effort that would have been more productive if directed at those and other complex areas one at a time, particularly at the design and implementation phases. Instead, the scatter of ‘reform’ activity merely succeeded in confusing or dividing the public about what was important and why, and has led to setbacks in nearly all of the areas concerned.
The particular sequence chosen during the Reform Era—beginning with the opening of our borders to foreign capital, currency and goods—in itself created pressure for further reforms, especially in key markets ‘behind the border’, where there were major cost impediments to firms withstanding exposure to global competition. Infrastructure and labour market reforms may not have been pursued with sufficient vigour without this (as seen in other countries that have sought to tackle domestic distortions first).
The various reforms accumulated into a program that ultimately had considerable breadth, bringing the further advantage that those who lost out from some reforms were able to gain from others.
The pace of reform in the different streams varied, however, depending on the nature of the market and the impediments to efficiency. For example, the floating of the currency happened overnight, whereas tariff reform was a graduated process lasting over a decade (and is still not complete). Together with some support programs to ease labour adjustment in key areas or regions, this served to reduce the costs of adjustment—both economic and political.
Information on the ‘why’ of reform was crucial
These design features, while important, were nevertheless only part of the story. More fundamental to the success of the overall reform program were the efforts to secure general recognition that reform was actually needed. This did not happen overnight, however, and involved an extended process of public education about what was at stake for different groups and society as a whole. This in turn drew on research and evidence that demonstrated the deficiencies of existing policies and the payoffs to be expected from remedying these.
For example, Australia is one of few developed countries to have substantially liberalised its import protection regime unilaterally, without seeking prior concessions from its trading partners in WTO or other international negotiations. This arguably only became possible through credible, publicly available analysis of the costs many Australian firms and industries were bearing as a consequence of the protection afforded others. In particular, as farmers and miners came to appreciate that the tax on imports of manufactures was actually borne by them, not just foreign exporters, they soon became a well-organised countervailing political force for liberalisation.
Similarly, the National Competition Policy reforms depended on the central government’s ability to demonstrate that the gains would exceed the costs, and generate sufficient tax revenue to ‘compensate’ those jurisdictions which gained least or lost out. The costs to businesses of inefficient public utilities became known well ahead of any specific reforms being mooted. And the costs to the economy of hitherto using utilities essentially as an income redistribution vehicle became manifest, disarming interests seeking to maintain this (surreptitious) de facto social policy and alerting those ultimately paying the bill.
Industrial relations (labour market) reform has been a more mixed story. The initial deregulatory moves were founded more on common sense than empirical verification of the costs of the status quo. Australia’s centrally planned and antiquated labour market was increasingly showing the strain of having to operate alongside competitive product and capital markets. And, as noted, the early reforms that permitted some decentralisation soon yielded positives for encumbent labour and ‘outsiders’ alike. The importance of building a case for reform in this sensitive area with its entrenched interests was nevertheless demonstrated subsequently, by the consequences of failing to do so adequately for the further deregulation that came under the rubric ‘Work Choices’. This lapse enabled public sympathy to be more readily garnered for the union movement’s resistance to the changes, and ended up contributing to the fall of the government that introduced it.
The major reforms that defined this era followed considerable research and public testing of the pros and cons of different possible reform measures. This generally occurred through review processes that made effective use of discussion papers, draft reports or ‘green papers’. In most cases, sufficient time was allotted to the consultation processes to enable proposals to be properly explained, digested and responded to, and to inform wider public debate. This was central to the industry assistance and national competition policy reform processes, as well as to the major reforms to financial regulation and taxation.
The experience has been that consultation is useful not only to develop and get acceptance for broad reform options, but also to get the detail right in the option that is finally implemented. For example, the Petroleum Resource Rent Tax took a couple of years to be developed and a couple more to be refined, through intensive consultations with industry, before it was finally implemented in 1989. This contrasts with the so-called ‘Resources Super Profit Tax’ that was announced in 2010 as a fait accompli, without those affected having been consulted on its detailed design. This too contributed to the demise of the (different) government responsible, in contrast to the experience with similar taxation reforms for offshore petroleum ventures in the earlier era.
Institutions and processes mattered
Evidence, analysis and their conditioning influence on the environment for reform did not occur in a vacuum. Institutions and processes within government were crucial to the reform successes.
Virtually every major reform in that period was preceded by arms-length public inquiries or reviews commissioned by government. The reviews played a central role in establishing the case for reform, and in identifying (and explaining) the best solutions.
The arms-length nature of these inquiries and reviews had a number of benefits. For one thing, it meant that the reviews were generally seen as being not only ‘expert’ but above politics—in what were often politically sensitive, as well as complex, areas of public policy. This ensured that their recommendations carried weight with the community. At the same time, the governments of the day had the advantage of ‘deniability’ and freedom to move. They also had an opportunity, at a distance, to read the public’s reaction and to evaluate more accurately the implications of adopting different courses of action.
The fact is that while most members of the public may be ignorant about policy detail, they are not oblivious to good process. Their very ignorance about complex policy matters means that they look to institutions in which they can put their trust, and those institutions and processes can therefore be politically useful in advancing reform.
To achieve this, however, they need to be well constituted and resourced, and to follow open, consultative processes. The experience in Australia is that where these qualities have been lacking, policy reviews have had little real impact. Decisions about who leads the reviews and the degree of perceived independence from the Executive are particularly important in this respect.
The ‘Commission’ had a central role
While many countries, including India, have initiated ad hoc public inquiries, Australia was for many years the only one to have in place a standing statutory body for this purpose. The Industries Assistance Commission was initially conceived as an institutional counter-weight to the power of industry groups to influence decisions about tariffs and government subsidies, but it evolved over time to discharge a much wider remit. The inquiries of its successor body today, the Productivity Commission, cover major policy development and reform issues in all sectors of the economy and across social and environmental, as well as economic, domains.
Importantly, the Commission’s independence is enshrined in its own Act of Parliament. Commissioners are appointed by the Governor General (Head of State) and have powers akin to those of the judiciary—but only an advisory role in relation to their policy findings. The Commission’s recommendations must be directed at promoting the long term interests of the Australian community and its processes and reports open to the public. Commission inquiries follow a similar procedural sequence to Royal Commissions, but with some emphasis on the exposure of its preliminary findings and recommendations in public draft reports.
As with the best of the more ad hoc inquiries and reviews, the Commission’s contribution to reform has typically been a dual one—providing evidence for specific reforms, and using it to help inform the public about the need for reform, including those sections who stood to gain the most. In this way it has served to create a more balanced (even on occasion supportive) political environment for governments to undertake real reform.
Leadership was paramount
Finally, leaders with the right vision for a better Australia and the skills to realise it, were fundamental to each of the individual success factors just described—they could be said to have been the ultimate success factor.
The Reform Era was unusual in the quality and depth of political leadership at both Federal and State levels. Moreover, the leaders of the reformist governments often had the benefit of Opposition leaders who were broadly supportive of the major reforms (a less common thing today).
Their effectiveness was further enhanced, however, by other initiatives at the political level for which they were ultimately responsible. These included effective cabinet processes and special committees to provide systematic scrutiny and debate across portfolios.
The factors I have identified as contributing to past structural reform successes in Australia have had their value reaffirmed by the more recent failures of government to heed them. That failure tells us that good process in public policy can become a casualty of perceived political imperatives. While such processes may prove ‘inconvenient’ from time to time, the revealed reality is that, without them, policy actions are more likely to fail the public credibility test and even weaken a government’s claims for re-election. That indeed is what transpired in Australia in recent times. It stands in contrast to the preceding record of good policy process yielding good outcomes all round, including under a government of the same party nearly three decades before.
The challenge we now face in Australia is to recapture the acumen exhibited by both sides of politics during the Reform Era; to embrace once again an approach to reform that involved careful preparation, good analysis, skilful public communication and the building of coalitions of support. It should therefore be noted that Australia’s incoming Federal Government attracted considerable electoral support on the basis of it restoring good policy practice. Its performance thus far shows promise in this regard, though not uniformly so, and will be closely watched in the months ahead.
Whether any of this is relevant to India’s circumstances I leave you to judge. I would only observe that while countries have their own histories, cultures and institutions—and our two countries are obviously very different − all share in common the need to overcome the same basic obstacle to reform. Sir John Crawford’s insight was that, at bottom, this is a matter of information failure. And he devoted himself to redressing it, through his own research and advice to governments and, more enduringly, the public institutions he helped create. I wish you well, therefore, in finding your own path forward. Your reform needs and challenges are obviously great. But so too are the potential rewards.