Address to the 16th Asialink Lecture

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September 14, 1999
Review of Business Taxation
September 17, 1999

Address to the 16th Asialink Lecture





Over the last two weeks Australia has airlifted almost 2,500 people from Dili. This includes Australians, U.N. staff and almost 2000 East Timorese seeking safe haven. Yesterday the U.N. Security Council unanimously authorised the establishment of a multi-national force, under unified command, to restore peace and security in East Timor. Australia will lead a multi-national force initially landing 2000 troops. It has pledged up to 4,500 troops as part of this operation – our largest military commitment since Vietnam, an engagement which ended almost 30 years ago. Apart from its military commitment Australia has already committed more than $20 million of in-kind and cash assistance for the UNAMET (United Nations Mission in East Timor) operation, the largest single donor country to the process. Australia also stationed civilian police including the leadership of the police contingent, in East Timor as part of the UNAMET operation. Plainly our humanitarian assistance will dramatically escalate in the forthcoming period.

Leading a peacekeeping operation with support from New Zealand, Malaysia, Canada, Britain, U.S., the Philippines, Thailand, Korea and other countries is clearly a substantial military engagement. The level of aid which we will be required to commit will be one of our most significant financial commitments to the region. And the events of recent weeks will clearly have a major influence on the nature of our relationship with Indonesia.

Let us not forget that in the 30 August ballot 78 per cent of the East Timorese people effectively voted for independence. The high hopes for the ballot, a remarkably smooth operation, gave way to the despair of the mayhem, killing, looting and suffering we have seen in East Timor in the last two weeks. It is not my purpose today to give a speech on East Timor. The Government has left no stone unturned in its efforts to obtain and implement international support for a peacekeeping operation, a peacekeeping operation designed to bring an end to the lawlessness and suffering. But I cannot discuss Australia’s relations with the region without referring to East Timor. Clearly this commitment, clearly public perceptions and reactions to the events of the last two weeks, are going to bear dramatically on our regional relationships in the future.

Today I want to take a broader look at the region and take a longer time scale. In particular I want to look at the Asian economic and financial crisis which began a little over two years ago and has a direct link to events in East Timor. We may be able to draw some conclusions about the events of the last two years now that the worst is over. If I sound tentative on declaring the end of this crisis it is because the economic and financial crisis erupted so quickly and without warning. This crisis was not predicted – not by the IMF, the World Bank, Australia or any of the countries affected. It illustrates how the unexpected can happen; and quickly. As a result I’m going to be cautious about declaring recovery.

I well remember attending the annual meetings of the IMF in Hong Kong in September 1997. Although the Thai crisis had emerged and problems were occurring in Korea, the general mood was one of economic triumphalism. The handover of Hong Kong had gone as well as anyone expected. There was a general expectation that with a few hiccups the region could be expected to drive world growth, much as it had throughout the course of the eighties and nineties. At the time, one of the senior IMF officials confided to me that the best thing about Asia was that there were no problems – unlike Latin America or Europe. We were then only two months away from near total financial collapse in Korea which, in December 1997, more or less ran out of foreign reserves.

And as the economic fortunes of the region have wildly oscillated, so too has sentiment.

It was really the growth of Japan that first gave rise to talk of the Asian economic miracle. Later the rise of the so called “Tiger economies” – Singapore, Taiwan, Korea and Hong Kong – led to a lot of serious analysis on the “Asian model” for economic growth. The “Asian model” was quite different from the open-market model. It was private enterprise but not so much the open-market. It involved quite a deal of government intervention and quite a deal of government support for the private sector. This was popular with western businessmen who imagined that if this model were adopted in their own economies they would be in the industries that received government support as a way of boosting economic development.

In addition those countries which were untroubled by elections or frequent changes of government had a strong continuity of purpose and policy which appealed to those who did, or imagined they would, enjoy good relations with the governing authorities.

It is true that not all analysts were taken with the “Asian model”. The internationally respected economist, Paul Krugman being one, who published his famous paper: “The Myth of Asia’s Miracle” arguing essentially that growth had been achieved by new industrialisation with rapidly growing inputs rather than gains in efficiency. This led to the conclusion that if the growth was masking bad productivity performance, it would be a one-off development stage that would come to an end sooner or later.

Belief in the “Asian model” was quite strong in Australia, particularly in some industry organisations. For example, as late as 1997 the Australian franchise of the Economist Intelligence Unit (on retainer to an industry group) was reporting on the successful investment promotion incentives of Malaysia which could be followed by the Australian Government. This was the lead up to the Government’s “Investing for Growth” statement. Since the statement came out at the end of 1997 after considerable difficulty in Malaysia, some of the wind was going out of the argument for economic interventionism.

The bubble economy burst in Japan in 1991 and its economy started limping at less than 1 per cent average growth over the following four years. The Tiger economies continued to boom however. In many respects the Japanese slow-down continued and added to growth in other Asian economies who benefited from a huge surge of capital investment, much of it Japanese as a result of high savings, a high Yen and Japanese investors looking for better opportunities outside Japan.

These huge capital in-flows came to an end, beginning in Thailand in July of 1997 and flowing on to Malaysia, the Philippines, Korea, Indonesia and other economies as well. In 1998 Korea contracted 5.8 per cent, Hong Kong 5.0 per cent, Indonesia 13.2 per cent, Malaysia 7.4 per cent, Thailand 9.4 per cent, and the Philippines 0.5 per cent. Japan itself contracted 2.8 per cent in 1998. To the end of 1998 it had five quarters of negative growth.

The Asian financial crisis became the Asian economic crisis.

In the last two years few have been extolling the virtues of the “Asian model”. In fact, most of the prescriptions, prescriptions widely accepted by the crisis affected nations themselves, have involved moving the “Asian model” much more along the lines of the open-market model: reducing the interconnectedness of financial institutions and corporations, purging bad loans from the books of financial institutions, allowing insolvent corporations to fail, instituting insolvency regimes, as well as improving corporate regulation, prudential regulation, financial regulation, promoting transparency and proper pricing of risk.

New Zealand, another market economy in the region, also experienced recession through 1998 although I would argue this was worsened by inappropriate monetary policy (under a system now abandoned) which compounded the external situation.

Now, I do not want to understate the extent of the crisis and the adverse conditions that Australia faced throughout this period. There were periods of extreme stress, high uncertainty, and dangerous strain. But the Australian economy did not go into recession. It grew, and it grew faster than practically any developed economy in the world.

In preparing this speech today I read some previous Asialink lectures. One was given by the Leader of the Opposition in July 1998. Mr Beazley noted that the Government was forecasting growth at 3 per cent in 1998-99 and that most forecasters were more bearish. He suggested the Government’s forecast would be overrun by reality and that statements that Australia had been fire-proofed were “at the very least misleading” and simultaneously “politically imprudent”.

The Opposition was taking great delight at the time in predicting a severe downturn in the Australian economy. Talking of growth during an Asian recession was, they said, “misleading”. As it turned out the 3 per cent growth forecast was wrong. The Australian economy grew at 4.5 per cent in 1998-99. This of course was higher than the US, UK, France, Germany, OECD and G7.

The financial and economic crisis of Asia has had profound political consequences as well. The three worst affected countries which sought IMF assistance packages, were Thailand, Korea and Indonesia. All three countries experienced a change of leadership arising out of the economic crisis.

A change of government in Thailand was not such an unusual thing. The election of opposition leader, President Kim Dae-jung, was a substantial political shift in Korea. And in Indonesia the end of the 30 year rule of President Soeharto led to the appointment of President Habibie, subsequent elections, and eventually opened the way for the ballot in East Timor.

Each of these three countries sought assistance from the IMF, the World Bank and individual countries. Make no mistake:- the purpose of the financing programmes was to restore confidence, rescue exchange rates, soften economic collapse and stabilise social conditions. The financing is one aspect of restoring confidence, but it is provided in return for a programme equally, perhaps more, important in restoring confidence. These programmes focus on providing transparency in budget policy, a more open market economy framework, re-capitalising financial institutions, purging bad loans, establishing independent corporate regulation and withdrawing distorting subsidies. The change in policy to some degree undermined the political incumbents – it was their policies which were being repudiated. And at the same time new policy required new political leadership as evidence of the government’s bona fide intention to change economic direction.

At the request of the international agencies Australia agreed to provide additional funding, if called upon, as part of each of these restructuring packages. Along with Japan we were the only other country that agreed to contribute to all three packages in Asia in Thailand, Korea and Indonesia – pledging loan support of U.S. $1 billion to each. This bilateral funding is drawn down after the first tier financing of the international agencies, if required, and when required.

US$800 million of the $1 billion has been disbursed by Australia to Thailand. We have not been requested to disburse any funds to Korea. We have not disbursed any of the funds to Indonesia.

Australia’s involvement in the multilateral restructuring packages included the provision of technical assistance to bank regulators and training for corporate regulators. Our recent reforms to financial and prudential regulation, arising from the Wallis report to the Government of March 1997, are recognised as leading the world. In fact, in November 1998 the International Monetary Fund described them as “. . . a package of path-breaking reforms, which puts Australia at the forefront of international practice”. This gave Australia credibility as it shared its experience and lent its technical assistance to regional neighbours.

One of the most practical regional arrangements to come from the economic and financial crisis was the Manila Framework Group. This Group provides a regular meeting of finance and central bank deputies of the region to work together promoting surveillance, best practice and improving governance. Australia has taken a strong role in this and hosted this group in Melbourne earlier this year.

Australia’s role in regional financing packages, in assisting on governance and regulatory reform in the region, has also lead to a strong involvement in the world forums on financial architecture. We have pressed the case for reform in the APEC forum and the IMF and World Bank. A Financial Stability Forum has been set up under the Bank of International Settlements to work on the international financial architecture. The Forum consists of the G7, Hong Kong, Singapore, Netherlands and Australia.

The G7 is also convening a group of nations (G-X) that are either important as financial centres or have been adversely affected by recent financial crisis to continue on-going work on financial stability. Australia will seek to work as part of this group.

Australia has a world class system of prudential regulation, we have cleaned up our corporate regulation, our insolvency regime is strong, our Charter of Budget Honesty is used as an international model for promoting budget transparency, our competition law is very advanced. In the midst of a regional crisis in the last two years we have had strong growth with low inflation. Our Budget is in its third year of surplus.

We are retiring debt. Our engagement with the region is enhanced by the strength our economy has shown during the regional crisis.

Australian GDP is almost equal to the combined GDP of Malaysia, Thailand, Indonesia, Singapore and the Philippines. We are around the same size as Korea. Our economy is around a tenth the size of Japan. We have been able to play a strong and helpful role during the economic and financial crisis of the last two years. We have been a significant aid donor. We have reached out to other countries in the region where our assistance has been sought. We are about to play a significant regional role in humanitarian assistance to the troubled area of East Timor.

Make no mistake this has significant risks for the safety of Australian personnel. It will have significant economic costs. We will only be able to afford this commitment and these costs in the future if we continue to keep our economy strong. All of the economic restructuring of the last years paid dividends during the Asian economic and financial crisis. It is the restructuring which we do now, particularly in relation to tax reform, which will provide our economy with the strength to meet the challenges in the years ahead.

And hopefully in the years ahead the external environment will be working with us or at least not working against us to the extent that it has in the last two years. We can’t go through the worst economic and financial crisis in 50 years on a regular basis!

There are signs of recovery in Japan after some five quarters of negative growth to the end of 1998. The Korean economy has rebounded and expanded by around 3.5 per cent in the June quarter, 9.8 per cent above year earlier levels. Whilst economic growth is coming off very low levels, the outlook is generally positive for growth through 1999 and 2000. Malaysia, Hong Kong, Singapore, Thailand and the Philippines are all expected to grow through 1999 and into 2000. Many of these economies had severe contractions and are coming off a low base. It will take a period before growth reverses the lost production of 1997 and 1998. But these economies have turned.

The situation is more clouded in Indonesia. It is clear that even the events of the last two weeks have shaken the confidence of international investors. Economic conditions are better now than they were at the height of the economic crisis of 1997-1998, but clearly confidence is very fragile.

I said earlier, that attitudes to the “Asian Model” economies have oscillated wildly. The euphoria of the eighties and nineties tended to overlook underlying policy weaknesses. These policy weaknesses became evident in 1997-98 and led to a general despair of sentiment. As the economic situation has turned we would be wrong to think that all of the policy weaknesses have now been dealt with. We should remind ourselves that honest and realistic appraisals are likely to moderate the wild oscillations both ways. We would also be foolish to think that all the work of restructuring has been completed and since economies are now turning there is now no need for financial and economic reform.

When Australia set out to reform its financial system through the Financial System (Wallis) Inquiry, commissioned in June 1996, it was not because we then had a crisis. In fact we were regularly asked, why we should have an inquiry since there was no apparent crisis. Our attitude was to inquire into and reform arrangements before problems arose rather than after the event. The new structure of the dedicated prudential regulator, the Australian Prudential Regulatory Authority supervising all deposit taking institutions, and the Australian Securities and Investment Commission dedicated to consumer protection on investment products served us well. The focus of the Reserve Bank on monetary policy was tested, particularly through the instability in the exchange rate in 1998, and proven. Whilst it is harder to summon political will to reform institutions in good times, it does allow a freedom of action and careful decision-making which is difficult in a time of crisis. And I hope, as economic conditions pick up, momentum in this regard will not be lost in Australia, in the region, and in the world.

In concluding I wish to make a few longer term observations. There have been interesting debates in recent years about whether Australia is part of Asia, about what its role is in the region, and how it sees itself as part of the region. The recent events in East Timor have galvanised Australian public opinion in a way I have not seen before. Public response was overwhelming, and overwhelmingly in favour of Australia taking decisive steps to help with the humanitarian tragedy. The Australian public considered the events of East Timor required an Australian response. We did not ask about where our geographic responsibility started or ended. We considered it our duty. We considered it our responsibility to take a leadership role. And we are working with other countries in the region in this regard. It was a clear demonstration of how we are part of, and have responsibilities in, this region.

And it demonstrated the importance of regional groupings such as APEC. The timing was fortuitous but the fact that all major regional leaders or their representatives were in Auckland last weekend opened the way to achieve unequivocal diplomatic support for a peacekeeping operation which would have taken much longer to gather had all the leaders not been together and not focussed in this region at this time. The Prime Minister’s efforts over the weekend in gathering diplomatic support at APEC are genuinely admired by all. And they were facilitated by a regional association:- a practical demonstration of the importance of APEC for our region and for our country.

Thirdly the events of the last two weeks have brought home, I believe, how important Indonesia is to Australia and how important Australia is to Indonesia. It may be that we have not been as realistic in our relationship as we should have been. The best relationships are realistic ones. There is no getting away from the fact that we must be engaged with Indonesia. We need to understand its aims and objectives and we need it to understand our aims and objectives. We need to understand each other’s aims and objectives on a realistic, non-sentimental, and open basis. We can’t afford to misunderstand each other. And importantly this is not just a matter for elites or governments. We need our public to understand their aims and objectives, their public to understand ours. We need public engagement both ways in this process. This is an extremely important relationship for both our countries.

And from Australia’s point of view it is in our interests to have strong economies and prosperous neighbours. Just as the economic downturn amongst our neighbours had severe risks for our economic position, so too their upturn will have clear benefits. Just as economic downturn lead to social instability, so too an economic upturn is likely to promote better stability and better peace in the region. Australia unqualifiedly benefits from economic growth, open trade and economic liberalisation in the region. We are engaged in the region more now than ever before. We have very high interests. We are making substantial investments in peacekeeping and humanitarian arrangements. And we are doing this because the region is important to us. We want to see it stable, prosperous and secure. For the sake of our neighbours and ourselves.