Free trade and globalisation have hollowed out the middle class of developed western countries, suppressing wages and living standards below those experienced before these two forces reshaped economies. Re-patriating key industries, particularly in manufacturing, will reverse this trend and reinvigorate our economies while buttressing them from future COVID-like shocks.

Or so goes the narrative driven by the political left and, more recently, the populist right emboldened by Trump, Farage and others. However, this thesis is false, in an era where burdensome government spending and regulation have increased the cost of essential goods and services, free trade and globalisation have been among the forces improving our living standards over the past 40 years.

The cure to sluggish growth and falling real incomes in Australia and the rest of the western world isn’t a retreat from globalisation, but an embrace of the power of markets and incentives to reduce the cost of essential goods and services, while improving their quality.

The macro environment

The world economy has been dealing with two deflationary forces over the last 40 years. First, increases in the effective working age population, due to increased female workforce participation and populations in Asia and Eastern Europe entering the global workforce. Second, technological and digital innovations have produced significantly cheaper consumer surplus. The smartphone, for example, is a remarkably deflationary innovation, replacing thousands of services at a much cheaper price in a more portable and usable format.

These deflationary forces have been enormously positive for our lifestyles in advanced economies and lifted billions out of poverty in the developing world. However, central bankers have been pushed to the brink in efforts to keep inflation in their target range, or at least positive. By dropping interest rates to record lows, central bankers ignited a 15-year asset price boom. Homeowners and those exposed to share markets enjoyed record returns. Those outside of the housing market had to work harder to break in. This, combined with regulatory environments that have artificially inflated the price of other essentials, has increased wealth inequality and budget pressure on households, driving political dislocation.

Today, we are reaching the limits of the working-age population expansion of the past 40 years. Women are largely integrated into the workforce while baby boomers are aging out, the migration of populations in developing countries from regions to cities has passed its peak and developed countries are attempting to wind back globalisation. Covid-related supply chain issues initiated the current inflationary spikes, but more permanent forces will entrench inflation in the years to come.

Worse, this transition has arrived with government balance sheets in historically bad shape and economic dynamism, measured by productivity growth, at anemic levels. Three main drivers have contributed to this malaise.

The professionalisation of politics

The rise of sectional interests, abetted by the 24-hour news cycle, social media and the professional political class are driving risk aversion in policy design. The cost of adversely affecting one section of society has multiplied with their increased ability to vocalise their displeasure.

At the same time, the proliferation of professional politicians has reduced the risk tolerance of our decision-makers.

Politicians with substantial prior experience have a greater opportunity cost for service. If they lose an election they can return to their previously challenging and rewarding jobs. However, for those with limited prior experience outside of politics, returning to staffing or an adjacent field after being a Member of Parliament is a fate too embarrassing for most to comprehend. As a result, survival instincts kick in, and re-election and preservation are prioritised over policy achievement and the public interest.

In the commercial world, competing products and services vying for the same group of customers often trend towards similar features and designs. This process has occurred in Australian politics. After years of polling and focus-grouping the same voters, the two major parties have stripped any potentially unpopular policies, trending towards a mutually-inoffensive position. This peaked at the 2022 federal election, where the two parties were distinguishable by the colour of their shirts, their skill at pork-barreling and little else.

The incentives for our best and brightest to enter politics today are minimal. Trying to convince someone to take a role with low job security, intense media scrutiny and promotion prospects tied to political patronage/loyalty, instead of hard work and ability, is challenging. Anyone with a substantial career would be hard-pressed to pursue such an option, leaving a collection of careerists, egoists, and the occasional quixotic true believer as the stewards of our national interest.

Global realignment of centre-right politics

Over the past decade, centre-right parties in the western world have abandoned commitments to lower taxes and smaller government, transforming themselves into free-spending, protectionist/nationalist movements. In the aftermath of World War Two, centre-right parties brought disparate sections of the population together in opposition to trade-union socialism. This included capital owners, salary earners, farmers and trade contractors. This is particularly true in Australia, where the political system has been defined by the union movement, and those in opposition to the union movement, since federation. This divide makes little sense in a 21st century economy where trade union membership has dwindled below 10% of private sector employees.

This has produced an identity crisis for centre-right political movements that peaked with the election of Donald Trump as President of the United States in 2016. Trump's election carved out a new pathway to victory for centre-right political parties, winning the votes of previously reliably Democratic white working-class voters in outer-metropolitan areas who felt left behind by globalisation. This dynamic was replicated in the United Kingdom at the Brexit referendum, and Boris Johnson's 2019 election victory that dismantled the Labor Party’s so-called ‘Red Wall’.

The Trump victory and the Brexit election were shock results that went against the grain of mainstream media predictions and preferences. The emerging thesis was that centre-right parties could secure working-class voters and lasting majorities by eschewing pitches for smaller government and rejecting the ‘woke’ consensus. The angry white silent majority.

Social conservatives were buoyed by the idea that their pet interests could be secured, and economic ‘conservatives’ or rationalists could be taken for granted. It's not like they could vote with the trade-union movement.

In Australia, this emboldened the Coalition Government to reject action on climate change, confident that it had a ‘silent majority’ behind it. The Morrison Government deferred efforts to implement productivity reform, focusing instead on ‘sovereign industry development’: code for direct subsidies to manufacturing businesses in marginal seats. Scomonomics was the distribution of economic resources via the Mackerras pendulum. Economic resources were supplied to business owners based on how critical their electorate was likely to be for the outcome of the next federal election, not its proximity to customers, suppliers, infrastructure or the commercial acumen of the business owner.

Meanwhile, the right flank of the Coalition went as far as demanding large-scale subsidies for coal and gas power generation. Scarred by the 2007 WorkChoices election loss, and the political debacle of the 2014 federal budget’s attempted fiscal repair, conservatives decided that economic rationalism was no longer palatable, regardless of its merit. Former Prime Minister Tony Abbott said there were “no votes in corporate tax cuts”, while then Home Affairs Minister Peter Dutton called for the removal of GST from electricity bills as part of an ill-fated leadership pitch in 2018.

This backfired badly at the 2022 federal election, as the lack of contrast on economic policy between the Liberal Party and the Labor Party, combined with the Party’s perceived shift to the right on social issues, drove high-income Liberal voters to ‘Teal’ independents in six formally safe seats. This gutted the Liberal Party of future leadership talent, fundraising capacity and ideological diversity. Stronger economic management had long been the core equity of the Liberal brand, something that was whittled down by a profligate administration more focused on wedge politics than on making people's lives better.

Economically conservative, socially progressive voters in Teal seats were unwilling to vote for a Liberal Party that represented neither of those traditions when Independent candidates offered them both.

Sequential Tail Events - GFC, China, COVID

Over the past 15 years, the Global Financial Crisis, the rise of China, and the COVID-19 pandemic have placed successive nails in the coffin of market-based policymaking.

The GFC triggered unprecedented waves of economic stimulus from central banks and federal governments. The resulting re-regulation of the financial markets placed new constraints on innovation and risk. Central banks initiated quantitative easing distorting capital flows, inflating asset values and widening income disparity.

The rise of China as a global superpower has raised alarm bells over the integration of global supply chains with a potentially aggressive trading partner. This led to calls for the winding back of 40 years of globalisation and the re-shoring of major industries.

The COVID-19 pandemic doubled down on both movements. The ensuing economic shutdown initiated economic stimulus on a scale few had imagined possible. While the disruptions to global supply chains have encouraged politicians to demand a return to ‘just-in-case’ inventory management and the manufacture of essential goods at home, with little understanding of the potential impact on business profitability and the business cycle.

The lessons taken from each of these episodes are fundamentally flawed, and a symptom of the extent to which vested interests and risk-averse politicians are crippling our economy.

These three trends are undermining living standards across three key dimensions.

Relative cost of living

Over the last four decades technology and globalisation have placed downward pressure on the price of production. The cost of goods and services exposed to those forces has plummeted, while the quality of those goods has increased dramatically. Would you rather have a high-end television available 20 years ago, or a $200 television available in Aldi today?

Despite this enormous transformation, the cost of goods and services not exposed to these forces, and largely regulated, distributed, or subsidised by the government have grown substantially.  

The cost of housing, education, healthcare, energy and childcare have all grown relative to the rest of the economy, largely due to the government's inability to set effective consumer-focused policies. Childcare is a clear example of how well-intentioned government policy can have far-reaching and catastrophic economic impacts.

Affordable and available childcare is a critical element of any 21st-century economy. It allows both parents to return to work earlier than they otherwise would have, primarily increasing female workforce participation. Additionally, expensive childcare increases the overall cost of childrearing, lowering the birthrate. More importantly, affordable and available childcare is an essential enabler of gender equity and opportunity in modern society. The burden of child-rearing falls disproportionately on women, and access to childcare can ease that burden.

In Australia, childcare is managed by a complicated combination of local, state and federal governments with support from not-for-profit, and for-profit, providers. In 2012, the Gillard Labor Government introduced the National Quality Framework. A set of regulations designed to baseline childcare quality to increase educational outcomes. Critically, these regulations halved the minimum child-to-teacher ratio from one per 20 to one per 10. As Senator Gerard Rennick points out in his essay, this has substantially increased the number of childcare professionals, many of whom choose to join the United Voice Union, and doubled the labour-input cost of providing childcare. Research has been unable to identify any discernable increase in educational outcomes because of these changes. However, it is simple to identify the enormous cost of these changes in overall price increases for consumers and additional subsidies paid by the taxpayer.

The productivity benefit of childcare comes from allowing multiple parents to deploy an economically valuable skillset in the marketplace, while one trained professional looks after their child for the day. The National Quality Framework halved that productivity benefit, at an enormous cost to the country.

The social benefit of childcare, in the form of improved gender equity, is accrued by allowing a second parent to work full-time. To do so they will likely want to earn significantly more money than is paid in tax, the cost of childcare and foregone tax benefits, like Family Tax Benefit A and Family Tax Benefit B. However, this is not the case for a large portion of our population.

Liberal and Labor governments have been unwilling to take on the United Voice union and the major childcare providers who profit enormously from the additional barriers to entry provided by the National Quality Framework, choosing instead to further subsidise childcare at the expense of the taxpayer and to the benefit of private providers. These subsidies are quickly chewed up by providers who have little incentive to keep a lid on prices.

If government regulation and subsidies were channelled effectively to provide access to essential public services like childcare while leveraging the benefits of competition and technological advances, these sections of the economy could have avoided the cost increases of recent decades. This would improve living standards. A prosperous country must leverage these forces to avoid falling under its weight.

Security

The tragedy of this situation is that our economic capacity is being worn down just as our geo-political security is deteriorating. The war in Ukraine and the rise of China present the most substantial threats to the stability that has underpinned our national security since World War Two.

Our ability to respond to these threats is a direct function of the productivity and size of our population. It's not hard to understand that larger, more prosperous societies are better able to defend themselves than smaller, poorer ones. Assuming defence spending as a proportion of GDP remains at ~2% and Australia's GDP grows at 4% over the next 20 years our annual defence budget will be ~$80bn. If it grows at 2% it will be $53bn. The difference, $27bn, is roughly double the annual Ukrainian defence budget. That's an enormous amount of additional capability that could buttress our national security in these increasingly unstable times.

Geo-political uncertainty, as outlined above, is likely to stiffen our economic headwinds, rewire supply chains and close previously open markets. It is no longer guaranteed that Australia can simply ride on China's economic coattails for sustained growth. We will have to look internally and generate increased productivity to continue to raise our living standards.

What's most disappointing is that the parliamentarians who have been the first to highlight the threat of China, those on the right flank of the Liberal Party, have also been the first to abandon the productivity-enabling reforms that would place Australia in the best possible position to respond to that threat. How can our politicians be expected to stand up to large-foreign powers if they are unable to stand up to the sectional interests sapping the life out of our economy?

Growing government debt

Our state and federal government balance sheets are in historically bad shape. COVID-19, and the inability of our politicians to say 'no' has sharply increased expenses, driving up government debt.

Since 2007, federal government expenditure has grown 8% each year on average. This has increased federal government spending as a proportion of the economy from 23% to 27%. The more resources that are sucked into government the less can be deployed by the private sector. If the government is not using these resources efficiently, productivity growth will slow.

The outlook for a potential reduction in the size of government is not good. As the baby boomer generation moves out of the workforce, the structural forces underpinning the federal budget will shift. The number of workers supporting each retiree, the old-age dependency ratio, has fallen from 6.6 in 1982, to 4.0 in 2020, and is projected to fall to 2.7 by 2060. Healthcare and pension costs associated with supporting an older population will increase. While migration can partially solve this problem, the political tide has shifted against large-scale migration despite the overwhelming body of evidence suggesting that migrants have positive economic impacts. Politicians are largely uninterested in addressing this dilemma as the consequences of inaction will be felt beyond the three-year election cycle.

Skyrocketing expenses have increased government debt substantially. Since 2007, federal government net debt has grown from ~-$25 billion to ~$630 billion. After almost a decade of projecting surpluses in the forward estimates, governments of both stripes have largely abandoned the cause. This is a direct function of the inability of senior politicians to make difficult decisions. To extricate Australia from this situation will take an extraordinary period of economic growth (which could only be generated by substantial productivity reform), steadfast resolve from politicians to control the government purse strings or an extended period of high inflation. These options are either unlikely or undesirable.

Government borrowing for recurrent expenditure is a tax on the future wealth of the country. It will either be paid for by future taxation, forgone service provision or future inflation. As interest rates rise around the world, the cost of this debt will increase, reducing debt sustainability. The outlook for the government’s fiscal position is bleak, a confluence of events and inept politicians have allowed entitlement programs to proliferate and spiral out of control. Demographic changes will exacerbate these challenges.

The challenges outlined above are daunting, and our current political class has proven itself incapable of addressing them. However, there is some cause for hope. These are outlined below.

Business and technology

While politicians chase career longevity and positive media write-ups, scientists and the business community are working to overcome the challenges we face, whether it’s the rapid decrease in solar panel costs over the past decade, the productivity-enabling capabilities of cloud computing or dozens of other technologies. These forces do not need the government to flourish but can be strangled if policy settings become too restrictive.

Cure to stagflation

Our current policy settings have driven the return of inflation while economic growth sputters below the long-run trend amid the threat of recession. It was during the stagflation of the 1970s that free-market economics returned to the forefront. It is possible that a similar scenario could spark the political will required to rebuild such a narrative. The backlash against UK Prime Minister Liz Truss’ aggressive tax cuts in 2022 suggests that moment has not yet arrived.

Geo-political imperative

The short-term interests of domestic lobby groups appear increasingly petty in a world where geo-political tension turns to outright conflict. It’s hard to imagine the Rail, Tram and Bus Union going on strike, or farmers demanding new and greater subsidies in such a scenario. The geopolitical threat to Australia may become so serious that it must embrace efforts to increase productivity.

Australia’s position is not unique in the world. It has a diminished political class, substantial government debt and challenging demographics while facing geopolitical uncertainty and global economic headwinds. It is not a positive narrative. However, our country and countries like ours, have faced greater challenges in the past and overcome them. There is nothing to say we cannot do the same again.

Harry Stutchbury is a Management Consultant at Kearney. He has previously worked as an adviser for Liberal members of parliament and as Deputy Director of the Blueprint Institute.

This was originally a chapter in Markets and Prosperity (2023), edited by Harry Stutchbury and published by Connor Court.