Leaders must restore our freedom to improve productivity

IT'S not good enough for our leaders to just preach the benefits of an open economy.

IN 2007, I participated with an international group of chief executives brought together by the Harvard Business School to mark its centenary. The result of the interviews by the three professors involved was their book Capitalism at Risk: Rethinking the Role of Business.

Harvard's publication sets up a working definition of market capitalism as a sub-system within and dependent upon a larger system which features private property rights, security, sanctity of private contracts, a sound currency and banking system, prices set by independent enterprise and free trade among nations.

The definition also set important facilitating conditions such as education, health, rule of law and effective and accountable government, (although I believe security is a facilitating condition whereas the rule of law is mandatory).

This definition supports the notion that people who are free are more likely to innovate, invest, adapt and become more prosperous. Interestingly, the Harvard professors concluded that "there is a series of publicly valued goods that the market system requires for it to function properly. But democratic governments around the world seem unable to buy or produce them".

The global financial crisis resulted in heavy criticism of market capitalism but, as the Harvard study showed, not many, if any, developed market governments were either supporting it or practising it.

Perhaps the most important learning from my work experience is that human systems come before work, business or technical systems.

This has led me to the conclusion that the real issue facing Europe is a cultural one with a crisis of leadership, a problem also faced by other so-called "advanced" economies.

By examining systems too narrowly, we can be led to credible but unhelpful conclusions because those systems sit within a broader human system. For example, market capitalism is often cited as a system contributing to economic stress, even though it can only operate as part of a larger system dependent on a nation's culture.

The seemingly intractable problems of the eurozone countries best highlight this larger systemic failure. Adoption of a single currency across very diverse economies, and unbacked by a single rule of law, was never going to work.

Yet learned people in Europe predicted reserve currency status for the euro, like the US dollar, which they saw as giving the US an unfair advantage, presumably because the US could gorge more debt than they could -- with relative impunity.

The truth is that the US never set out, at independence, with a specific objective of having the world's reserve currency. By conducting a system which supported market capitalism, they have, until recently, built prosperity and a currency backed by their rule of law, which the rest of the world respects.

Other features of Europe's malaise stem from a socialist system, which attracts votes by offering debt-funded entitlements or adopting causes which infer protection from myriad future threats and open the way to more interventionist, unproductive uses of public money. This interventionist approach seeks to centralise decision making and legislate for everything.

At the same time, politicians pursue the now well-drilled system of 24/7 spin to "manage" public information, avoiding hard decisions which, generally, require a more prudent approach to public financing. The appearance of progress is given by making pronouncements about growth and stability, secure banking, free trade and multilateral co-operation. In reality the debt is still rising as is trade protectionism. Central banks are left to avert successive crises of confidence, essentially by changing the names on IOUs -- a response that ultimately does little to add credibility to bond holders. This condition, the "eurovirus", is not limited to the eurozone. Britain, the US and Australia have caught it and continue to conduct systems that limit freedoms, overcommit public finances and/or are unsupportive of market capitalism while leaders preach the benefits of an open economy.

If leaders promote human systems based more on power than merit and freedom, they are essentially closing down the creativity, diversity, specialisation, capacity to trade and ambition that produces productivity and prosperity.

Leadership is about organising work to turn intention into reality, a reality of value to those they lead.

For this to occur, there has to be an alignment between that reality, the behaviour of leaders, the systems they govern and the symbolism and signals transmitted by them, all of which nurture a culture of freedom. Unfortunately there are many examples of misalignment.

Few people understand the process by which a government makes financial commitments and issues bonds to fund them. Because this appears to happen without fuss, voters believe their commitments are affordable. The reality is that governments either encourage or mandate that banks, funded largely by voters' deposits, should hold their bonds. Not only that, through their agencies they create rules that make it more attractive to continue to hold their bonds. Thus we see in Europe and the US a situation where countries have government debt of 50 per cent to 100 per cent of GDP but total liabilities of 150 per cent to 300 per cent of GDP.

The point is that the culture of their citizens includes a belief that this is all right. But many of the bond holders are foreigners who can either sell their bonds or choose not to renew them.

Politicians perpetuate this culture by relying on their agencies, central banks, to create more government obligations by buying their own bonds, a process that creates an unhealthy interdependency between governments and banks with even greater systemic risk. Is this modern economics or a Ponzi scheme?

The central banks are not to blame because they are only doing what they must to preserve stability. It is their governments that created the underlying problem.

Because citizens believe their entitlements are affordable they will oppose vigorously any attempt to reduce them. At each new development in the crisis leaders point to the new regulatory developments initiated by them so that the crisis will not happen again. The appearance of hastily convened summits, more regulatory intervention and the usual set of diversions, all managed in the 24/7 media spin system, is keeping the culture well removed from any new and better reality.

The tragedy for Australia is that we are witness to this leadership crisis in Europe and the US, but our leaders do not want to inculcate a culture able to avoid the same malaise. Many commentators and our political leadership point to the need to raise productivity to address future prosperity.

But our leaders are not allowing our free-market economy to be more productive. They point, quite rightly, to the highly successful opening up reforms of the Hawke and Keating. So what is the problem? Any human system, whether in the home, in business or in government has to be based on freedom and bound by some rules if it is to be productive. This is why unbridled capitalism has never been an option -- it must be circumscribed by the rule of law.

We know in business that the equivalent of freedom for employees is a system built on merit (not power) and clarity of authority. Similarly a nation needs clarity in its rule of law. Yet we have reached the point where a set of easily recognised principles is insufficient to guide behaviour.

We boast that the federal parliament got through 250 pieces of legislation in one set of sittings. Statutes are increasingly larger, more complex and incapable of understanding without expert advice. Even then the risk of court action remains, and not even the experts or those who wrote the law can predict how the justices will interpret the words.

For business, the cost of legal complexity is much higher than the dollar cost of compliance. Company directors are the subject of hundreds of statues, many of which deem them criminals before they meet. Commonly in employment law, safety legislation, environment law and tax and competition law they, as Australian citizens, suffer the ignominy of reversion of the onus of proof under the law. They are guilty until proven innocent, sometimes without proper application of the rules of evidence in a proper court. Other office holders such as union officials can have protection from the law, limiting their accountability.

Our right to property as Australians also lacks clarity. What is predictable about a residential development approval for an existing dwelling which contains over 80 conditions and requires layers of consultants to interpret environmental and other planning laws or a court hearing with highly uncertain outcomes? The value of business goodwill can be bullied away by regulatory threat.

We claim to believe in free trade but override that freedom with systems of licensing and government approvals which stifle competition by giving advantage to larger entrenched players, and raise the cost of doing business. Worse, government approvals to contract and trade always leave open the prospect of corruption.

Australia's public finances are far more vulnerable than the political rhetoric would have us believe. If we combine the high operating leverage in the federal budget (recently alluded to by Don Argus) with high net foreign liabilities and a seemingly permanent current account deficit, Australia's public finances are very vulnerable to global shocks. It was this vulnerability that required the government to guarantee the banks, not weakness of the banks.

The issue is that as a commodity exporter, Australia is a price-taker whereas the high welfare bill is a fixed cost. Such a structure does not normally allow for much debt at all.

Notwithstanding these vulnerabilities, the signals from politics seek to preserve the status quo or even weaken it. For example, attacks on successful mining entrepreneurs influence a culture opposed to success, productivity and prosperity by outing successful people, thereby limiting their capacity to participate in society on an equal basis with everybody else.

Moving the national debate to live RBA meeting broadcasts or jawboning bank interest rates diverts the community from the substance of the economic issue.

Market capitalism is not of itself a problem, but crony capitalism, best practised in the US through the lobbying industry, is destructive, because those that do not benefit lose confidence in the system.

Similarly debt financing of entitlements creates a rising tax burden on a shrinking number of taxpayers who lose confidence. When this happens the public no longer holds the government accountable and the government does not have to be accountable.

Leaders, of any political persuasion, by their action or inaction, condone behaviour, whether it is productive or unproductive, and what they condone they authorise. One constant signal we get is that Australia's greatness stems from its rule of law and freedom. Both in fact are weakened by political leadership not facing reality.

If higher productivity is needed to manage in a more volatile world, then our leaders need to give us back our freedom.

To do this they must act to show they believe in it, govern systems that reflect it and send signals that support it. In this way, the Australian culture will become highly productive and the majority of our citizens, so many of whom have come from turmoil in other parts of the world and will relish this additional freedom, will help make this the place to be.

David Murray is former chief executive of Commonwealth Bank and former chairman of the Future Fund