Dr Pradeep Philip: Reform in the context of structural change

Deloitte Access Economics' Pradeep Philip.

This is the text of the speech Deloitte Access Economics lead partner Dr Pradeep Philip delivered at The Australian‘s Economic and Social Outlook Conference in Melbourne today.

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It is wonderful to be here and let me begin by acknowledging our gathering today on the lands of the Wurundjeri People of the Kulin Nation and I pay my respects to elders past and present and may we learn the value of collective wisdom over proprietorial rights as we seek to solve our greatest economic and social challenges together.

Because our future is not preordained.

1. Today, I want to explore this as a question of agency and focus on two domains for discourse:
2. The political economy of reform; and
3. The importance of dynamism and competition to drive structural change.

Ask any pundit, including the esteemed journalist Paul Kelly, and you hear the refrains on how difficult it is to get reforms up; that the task seems harder; that the appetite for reform is weak; that political will and ambition is diminished; that the 24 hour media cycle too difficult to navigate. The political economy for reform must be better understood and bent to purposeful and meaningful change.

As an economist, my intentions today are to reinforce and place competition policy at the core of a renovated industrial policy.

Let me begin with some contextual remarks – not the day-to-day commentary on movements in interest rates or the latest budget speculation – but the arc of disruption which lies beneath.

The context: the arc of disruption

To steal the title from Slim Dusty’s 100th album Looking Forward; Looking Back, if we look back at our economic performance, after that spurt of Keynesian inspired growth of global Post War reconstruction, trend economic growth rates, over the last 50 years, have kept coming down.

Each cycle, each decade, trend growth rates have slowly declined – notwithstanding the great leap forward in terms of lifting people out of poverty, curing illness, increasing life spans, and generally a massive dose of income improvements for a large swathe of the population, globally and here at home.

And yet, today we find ourselves with productivity in the doldrums, the debates about methodology of productivity aside, a world retreating from globalisation, geopolitical architecture being refashioned, in part along global equity lines, and an unhealthy distrust and apathy brewing in the West with hitherto successful institutional architecture which have promoted liberty and wealth creation.

My first provocation to you this: the things that drove growth and productivity over the last 80 years are petering out and the hunt is on for new sources of productivity and growth to lift economies on to a new and higher wave of economic growth. But one where growth and distribution have to be countenanced simultaneously.

This leads to my second provocation: that we are in a period of structural, not incremental change. And when you take these two provocations together the landscape we see before us is one characterised by the tryptic of uncertainty, volatility and fragility.

Today, we stand at the intersection of two major disruptions – technology and climate change – major disruptions which can be a catalyst to what we hold dear about being human, and to secure a future which is better and safer than the past.

• First, raising questions on our very identity and our place in the future like never before – deeply existential – from the perspective of climate change but also a humanistic one as we stand on the verge of the transhuman era of the fusion of technologies with our physical and cognitive human capabilities;
• Second, deeply enmeshed in solutions which can only be derived from our creativity and innovation – the antidote to uncertainty being innovation, and
• Third, which calls for the elevation of co-operation to the same dizzy heights of competition which we are all too familiar with.

Change, though, is never easy; never comfortable; never costless; but always inevitable. This is no period of stasis; on the contrary.

It is tempting to think of change and progress as mostly linear – orderly and incremental.

And as humans, we want to believe, often despite the evidence, that when change occurs things can just return to normal.

But there are competing theories of change or progress:

One posits that progress occurs where long periods of stasis or stability are punctuated by short periods of upheaval.

• Equilibrium is the norm; instability the exception
• While other theories posit the opposite. With instability the norm.
• Here we operate more out of instability, where true uncertainty pervades, or far from equilibrium for the economists in the room.

Today, we find ourselves not at an inflection point, but at a point of bifurcation that seems to be taking place in real time before us.

This is the Schumpeterian world of creative destruction – where value destruction will take place in order for value creation to establish new economic structure.

My third provocation today is that I want to posit 4 characteristics of structural change to frame and guide our discussions:

One, the nature of change we must comprehend is dynamic not static, and that change is fundamentally nonlinear

Two, it is governed by the interdependencies across systems

These two mean that there are tipping points and points of bifurcation.

Three, the system is not purely deterministic but resembles complexity. That is, there are interrelated parts which mean an action in one area can have consequences in another, in unpredictable ways, and where time is irreversible.

Four, speed and scale matters critically, else the overall economic system won’t shift. Understanding these four characteristics points to the method for solving this.

But solving this starts from the following: Our future is not preordained. Indeed, humanity is not dictated solely by Darwinian factors, but because we are intentional and purposeful. Because we can dream; and we can dream, collectively.

This, is the story of the human race – individual actions and dreams nested in collective purpose.

This is the time to write our future; to bend transformative change to our collective purpose – and benefit.

This is how today’s Conference can navigate the arc of disruption we face. Together, or not at all.

The political economy of reform

It is not without good reason that we may ponder that with the macroeconomic challenges we face; as the world has moved from deflation to inflation; as geopolitical architecture undergoes fundamental revision, are we able to navigate the future?

The problem is that years of short-term thinking on the economic and social policy fronts has left us with an economy that is not fully optimised to deal with disruption and governments that feel unable to use all of the tools at its disposal to manage change and retain civic trust.

So, how did we ever get here?

We are, in some ways, all to blame – politicians, policymakers, economists, business groups and even taxpayers.

While Australia has a proud history of economic reforms – such as tariff reform, floating the dollar, and tax reform such as the GST, what marks this recent debate is the fact that we had bold policy ideas, such as a carbon price, which were then sacrificed at the altar of political opportunism – by political actors as well as business and taxpayers.

Political short-termism has driven short-term policy making – always kicking the can down the road; avoiding the hard decisions; putting off the inevitable; beholden to the vested interest.

Good policy and good politics should be inseparable, but short-termism is distorting this relationship. Short-termism has allowed bad politics to generate bad policy.

And in the process – from bad policy to oversold benefits to an inability to articulate long term policy transitions – the public keep getting sold a pup. Is it no wonder then that it is increasingly proving hard ‘to take the mob with you’?

The conversations our body politic yearns for, and for which our public institutions should be responsible for providing, have been short-changed.

1. A first order condition for reform is the articulation of the social welfare function, or vision;
2. The second order condition for reform is good, sound, policy analysis across the time horizons for reform, and
3. And third, a transparent communication of this to the citizenry.

And while it is easy to dismiss the distorted medium of communication to the trend to make news entertainment, it is nevertheless true that the good and great journalists seek this reasoned and rational analysis to comment, opine, and report on.

A disorderly transition in times of structural change is not costless, as we are experiencing with climate and energy policy, social reforms, and tax reform, but we still have choices we can make to build a better economic future for Australians with more rational debate and much needed economic reforms.

Dynamism and competition as drivers of structural change

As we consider the two major drivers of structural change – technology including generative Ai, and climate change, we recognise the ubiquitous nature of these drivers – every market, every sector, every economy, every domain of life – affected simultaneously and fundamentally.

The scale and pace of change is what is curious about this period of economic history.

Take climate change, for example.

Australia’s debate on climate change, like elsewhere around the world, has been anything but productive.

• It’s been piecemeal.
• It’s been ideological.
• It’s been sector focused, or a narrow debate about the environment, or the NEG, or simply about lower energy prices.

This is not to dismiss these debates – after all they have seen off too many a Prime Minister, no less, and corporate leaders in recent times.

But this debate has missed the real picture – what’s really at stake.

While this issue has variously been described in moral terms, in environmental terms, in energy terms, what’s been missing is climate change as an economic issue.

• It is about the underlying production system of the economy.
• It is about the decoupling of our production of goods and services that we need and want from emissions intensity.

So, it is all pervasive, affecting all parts of the economy, all economic actors, and can only be addressed collectively.

Unlike other disruptions, a core phenomenon of climate change, is that of the Commons.

It refers to how the self-interest of individuals can breach the carrying capacity of a common resource.

Whatever one believes on climate change, the effects of a warming world represents a shared problem.

No one person can solve for it; yet it needs every person.

So too the arguments when we consider rampant technological change and the power of analytics and the birth of new tools such as generative Ai.

Indeed, a few weeks ago, we published a report that estimated more than one-quarter of Australia’s economy representing $600bn of economic activity will be imminently disrupted by this new technology of generative Ai.

Particularly affected will be the industries of finance, ICT, media, professional services, education, and wholesale trade. The productivity upside is huge. These are global markets, and you can be sure overseas competitors are embracing AI – yet our research shows that just 9.5 per cent of large Australian businesses are currently utilising AI, making us one of the poorest performers in terms of AI deployment out of the leading world economies.

This is powerful and all pervasive stuff.

Disruption of the scale of the industrial revolution is underway and taking place in a fraction of the time.

And our collective domestic and global dithering has meant that structural change and the transition paths will be more disruptive and more expensive than it should be.

Transitions are about navigating the uncertainties of that which is yet to unfold and the decline of what we know. It’s a process the great Austrian economist, Joseph Schumpeter, described as the process of creative destruction.

So, speed to avoid economic atrophy and speed to realise the new; scale because it is about every business, every sector, every region.

So, the arc of disruption is well and truly upon us.

The crunch time for technology and crunch time for the climate is now.

Inaction and uncoordinated action comes with a price – more volatility: markets will react more savagely, and markets are already pricing in technological and climate risk faster than we realise – these are not black swans; but their interactions and our unpreparedness for change and adaptability might just create one.

The features of technological change and climate change – nonlinearity, dynamics, complexity, speed and scale – are becoming all too apparent and real.

Climate change is now no longer invisible; and technological change is personal. So, if the future is not preordained, but change is inevitable, what course of action for us?

The answer lies in going back into our economic history books and understanding the nature of markets.

If you read the economic historian Bradford DeLong, you learn how the Industrial revolution drove growth as a function of three great developments – globalisation, the industrial research lab, and the birth of the modern corporation.

They disrupted the previous mode of getting rich by simply taking things of others, and facilitated the dissemination of ideas at a pace and scale which allowed the modern corporation to solve for economic problems locally.

Hayek described all this in terms of the market catallaxy.

And, of course, Schumpeter drove home the dynamics of structural change in talking about creative destruction.

This is a powerful educative point for us all – understanding the dynamics of structural change.

At its core is a rethinking of dynamism in economies – their ability to renovate, innovate, and renew.

So, to my last provocation: If you want a dynamic economy that evolves, then openness, inventiveness, and competition are the crucial ingredients.

A small open economy must push for globalisation and openness of trade; embrace skilled migration, and ensure its domestic economy is competitive and invested in skills and research to remain at the knowledge frontier. Even being a follower is neither cheap or easy.

But dynamism is a cultural shift as much as it is about investment.

The burden of enhancing the productivity and innovative capacity of our economy does not rest solely on the shoulders of policy makers and bureaucrats. The private sector must play its part too and be willing to lean into the uncertainty, realising there is no value creation without value destruction.

This is, of course, deeply antithetical to many Australian firms, which are defined by a cultural conservatism that prioritises growing market share in safe and predictable industries in order to return a steady stream of dividends to shareholders. There is nothing wrong with this of course, but as Joseph Schumpeter’s theory of creative destruction tells us, an “essential fact” of capitalism is that the old will be swept away by the new.

When Australian businesses are entrepreneurial and bold and able to take disciplined and calculated risks, within regulatory frameworks which facilitate this, then, and only then, can our businesses embrace these new, economy-revolutionising ideas before the opportunity is seized on by companies from more culturally dynamic and innovative countries.

For example, the most valuable three companies in the USA’s S&P500 – Apple, Microsoft, and Alphabet – either did not exist or were not even close to the top of the index 30 years ago. On Australia’s bourse, miners and the big banks dominate now as they did then, with CSL perhaps being the most notable new entrant to the list of top ASX companies.

As a high-income, globalised and highly-educated nation, there is no reason to be lagging so much on the innovation front. Recently the Committee for the Economic Development of Australia produced a very strong report on just how to enhance the dynamic capability of Australian firms.

There were several key findings, with one being that most Australian firms prioritised efficiency over innovation. In other words, the ordinary capabilities of Australian companies are typically great but their dynamic capabilities, their ability to be forward-looking and strategic in volatile and complex environments, are lacking.

Given the megatrends of today’s economy – technological change, demographic change, climate change and the impact of the pandemic, dynamic capabilities are crucial. The report surveyed several companies and found that during Covid, the best performers were the ones that were quick off the bat to make moves like overhauling their management processes or shaking up how they marketed to customers.

Second, Australian businesses are hesitant to cannibalise or to sacrifice sales or revenue from one part of the business to help build another – the classic strategic dilemma.

Third, the report found that increasing the diversity of leadership at executive and board level helped build dynamic capabilities. This isn’t just virtue signalling or woke moralism – it’s about the benefits that a genuine diversity of experience, not just identity, can bring to a company.

And in this context, the role of government and industry policy needs renovation.

Renovation from a handout mentality to the shaping of markets which facilitate structural change at pace and scale.

Just as competitive markets and the rise of the modern corporation drove the diffusion of the growth potential of the Industrial Revolution, so, too, must we think about competition – in the service of structural change not vested interests, as an economic driver.

For too long we have thought of competition policy only in narrow markets and some brief to the ACCC about market access or conduct in narrow fields.

But in the context of structural change, competition policy should encourage industrial renovation – renovation of the structure of markets.

Too often, the edifice of market rules and government decisions start with good intentions but then ends up as a protection racket for vested interests.

When structural change needs economic destruction and value creation to both take place at pace and scale, and in a co-ordinated manner, then competition policy should service this.

In this regard, the ACCC commissioner who will speak later today has made some major in roads in shifting this debate. My intentions today are to reinforce that and place competition policy at the core of a renovated industry policy – as a lever that makes markets more dynamic – that facilitates innovation and disruption – not protecting sectoral interests.

Final observations

So let me bring my remarks to a close.

Our Conference today is timely and is not a trivial exercise. The topics today canvass decisions that must be made – over the course of the next few years.

Already the task is difficult – the price of dithering and obfuscation are now playing out in terms of declining standards of living, perilously low rates of investment and innovation, and productivity is in free fall.

Globally, we are witnessing volatility and a shifting to more complex geopolitical environment.

Everywhere you turn, structural change is staring us in the face.

The short-termism card holds no tricks any more.

Discontent and economic failure is the end game if we don’t shift gears soon.

It’s time to lift our horizons, rethink our reform architecture, and hasten at speed into shaping the arc of disruption that is upon us.

This is an economic choice we can make, in our favour.

The arc of disruption picks no sides; that is our choice to how we bend that arc of disruption to the positive purposes of human endeavour.

And remember, whenever you solve for a problem of structural change, you solve for it together or not at all.