Poised for the storm

WHAT'S wrong with Australia? Kevin Rudd, Wayne Swan and Lindsay Tanner insist that market-based reforms will continue, deregulation is still alive and the post-1983 reform age will be renewed, not buried.

The message from Australia about the meaning of the global financial crisis is utterly different from the US. We should not be surprised. The origins of the crisis are different in both nations and the consequences of the crisis will also be different.

The US is swamped with hyperbole about the end of the Reagan age, the termination of the deregulation era, the evils of free markets and a new dawn of big government overlaid with an emotional transition to the expected Barack Obama political era.

In Newsweek, Francis Fukuyama warned that the American brand of capitalism was being greatly damaged. British philosopher John Gray dispensed with such temporising and said "the American free market creed had self-destructed" in a transformation "as far-reaching in its implications as the fall of the Soviet Union".

A vast new literature is coming, based on such false comparisons. But it will gain traction because the crisis reflects a systemic failure of American institutions, ideas and leadership: witness poor prudential regulation, failed policy from the Bush administration and the US Congress, unsustainable bank lending practices, misdirected financial incentives and craven appeasement in the cheap money stance of the Federal Reserve.

The financial, intellectual and political watershed for Australia is that the crisis is almost entirely externally induced. Australia has not followed the American model. Indeed, it has sharply separated itself from the US at virtually every point.

The Howard government ran strong budget surpluses, the Reserve Bank ran a tight monetary policy, the Australian Prudential Regulation Authority imposed the required prudential standards, Australian banks essentially avoided sub-prime loans, while Australia, in recent times, has been less dependent on the US as a growth locomotive as the commodity trade with China leapt forward.

In this context, Rudd, Swan and Tanner are right to reject the notion that Australia, like the US, needs a fundamental recasting of ideas and institutions.

"We're continuing on with the reform agenda," Swan said in a speech this week. "We're not taking our eyes off the long term, not for one moment."

Swan drew a distinction between the Australian and US models. The Government believed in markets, he said, but not the poorly regulated markets upheld by former US Federal Reserve chairman Alan Greenspan. Poor quality regulation in the US had fanned greed, abuses and inefficiency.

Swan said he drew two lessons from the crisis: markets remain a valuable tool provided they are properly regulated, and the Rudd Government must proceed with its existing reform agenda.

Tanner was emphatic when he told The Australian this week: "There is no case for returning to the regulatory arrangements of the past. It would be a mistake to think increasing the quantity of regulation is asolution."

Such comments would be inconceivable in the US and they highlight, again, the differences between Australia and America in this crisis. Tanner doesn't think Australian capitalism is facing its Soviet moment.

The significance of Rudd's declaration that the Government still intends for its emissions trading scheme to be launched in 2010 is, again, the imperative to maintain its reform momentum. Rudd argues that the ETS will be a net gain for Australia's economy. The Treasury modelling, in effect, locks in the Government because it is a compelling case for action. In addition, Rudd knows that his political credibility is at risk from any retreat on climate change action. He would be seen as a prime minister abandoning his convictions under pressure.

In his speech to the Business Council of Australia this week, Rudd pledged to "continue to prosecute a long-term economic reform agenda to boost productivity growth". This is a political declaration that the agenda on which Rudd won the 2007 election remains relevant.

Rudd, in effect, is saying he won't cut and run. Sanctioning a long-term policy retreat would be a political and economic blunder, which is another demonstration of the different situations of Australia and the US. In the US, presumably, a new president Barack Obama will dramatise a fundamental change in policies and ideas. Rudd said he would continue the Education Revolution agenda, long-term tax reform and the federal-state reform and deregulation program.

In public, Rudd is optimistic a recession can be avoided, while saying it will be tough. Reserve Bank deputy governor Ric Battellino says that while the impact of the crisis is unclear, the data so far has Australia tracking to avoid recession. Its armoury is hefty: fiscal stimulus, interest rate cuts and the gains from a sharp currency depreciation.

In private, senior ministers rate the chances of avoiding recession as 50-50. Swan and Tanner know the revenue is about to collapse. The budget will go into deficit. The budget process next year will be a bloodbath, with spending agendas abandoned, deferred or modified. No budget has been prepared in such a brutal setting for more than 16 years.

There will be a risk to Labor's unity and tensions will rise among ministers competing for scarce funds. Education, health, welfare and defence outlays will be under pressure, and Rudd will have to decide what is expendable. Once unemployment rises, there will be populist demands for special deals andbailouts.

Figures released by Battellino show that Australians face a severe shock. After Rudd became ALP leader in late 2006, he launched a crusade against John Howard on the cost-of-living squeeze on families. Would you like to know the facts?

The Reserve Bank says the past five years have been "an extraordinarily favourable period" for household income. Real disposable household income rose on average by 6.1per cent a year, with a cumulative increase over five years of more than 30 per cent, the greatest lift for more than 30 years and "very strong" by world standards.

Even after accounting for higher interest rates, real disposable income rose by more than 25 per cent, the result of higher wages, investment income, tax cuts and low inflation. The benefits were spread "fairly evenly" across all income quintiles, contrary to the propaganda and repeated phony surveys about income inequality.

This was the opposite to the US, where income gains were concentrated at the top, not spread through the working population, and real wage increases were weak. The Howard government delivered on the "fair go". The implication is obvious: if households think recent years were tough, they are about to discover what tough actually means.

Meanwhile, the big structural improvement Australia can make from the crisis was foreshadowed by Reserve Bank governor Glenn Stevens in his October 21 speech, saying the finance sector globally should return to its historical role of being "the handmaiden of industry" and allowing a renewed focus on the real economy.

That demands serious policy review in many nations, including Australia. This Stevens homily was endorsed by Rudd on Thursday night. That was symbolic, coming as the Government has deliberately overlooked the views of the Reserve Bank on the sustained confusion caused by its deposit guarantee policy.