marsh

Vol. 22, No. 1 COUNTERPOINT Reply: Political Change and Economic Governance in Australia: A Response to Michael Keating by Ian Marsh † 1. Introduction White I appreciate Michael Keating’s comments and observations. His parts as architect and actor in policy development over the past decade and a half give his views especial weight. 2. Policy Making Institutions White There are two particular points I would like to take up. The first concerns the evolution of policy making institutions. Keating suggests some of my proposals might appear naive—they envisage a larger role for other actors, specifically parliament, ‘than many people would be comfortable with’. He points to present moves to orchestrate tax reform from outside the formal political system. Elsewhere he suggests bargained consensus may be the only, or best, pattern for interest intermediation. I note in passing that another former practitioner, but this time an ex-Minister and Senator, Fred Chaney, in a review in another journal (1997), did not share Keating’s concern. Present approaches are constrained by the present disposition of political forces—which is expressed institutionally in the adversarial system. The question is: how durable is this disposition? My book anticipates a new policy making order based on a new disposition of electoral forces. It assumes the electoral appeal of the major parties will erode significantly. The grounds for this judgement are in chapters 2 and 4. In summary, I believe the present coalition majority rests on an unstable electoral base. Once voters realise the substantive measures of the Howard Government barely differ from those of their predecessors, the possibilities for independents and minor parties (such as the Hansen populist fringe, but perhaps more importantly the Democrats) will multiply. Of course this ‘learning’ on the part of the electorate may take time to develop—and various intervening issues might be manipulated as diversions. Regional security issues (eg, the Suharto succession, collapse of North Korea, tensions over Hong Kong and Taiwan) may also emerge to overshadow domestic preoccupations. All of these, or other, developments may staunch electoral † Australian Graduate School of Management, The University of New South Wales, Sydney NSW 2052; E-mail: ianm@agsm.unsw.edu.au – 117 – AUSTRALIAN JOURNAL OF MANAGEMENT June 1997 fragmentation. Meantime, voting rules constrain the impact of electoral fragmentation on the House of Representatives—but not on the Senate. Thus the major parties might be expected to continue to play leading parts— but in a context in which their hold on the electorate is much diminished and in which the need to accommodate minor parties and independents grows. The present distribution of organised actors in the New Zealand political system is a pointer to possible groupings here, particularly in the Senate. A more assertive Senate and/or minority government in the House of Representatives could open up institutional possibilities that now seem remote. If this forecast proves to be false, what follows should be discounted. Even if the major parties standing in the electorate erode, a shift in the balance of power between parliament and the executive would depend on the imagination and determination of those who then occupy leading political roles. My study is also a normative argument ultimately aimed at those leaders and setting out the case for such a shift. It argues the net result would be more effective public policy making. At the centre of this change would be an enhanced role for the Senate, particularly its (now weak) committee system. The considerable formal powers of that body are now largely unexercised. Committees could be the springboard for attention to strategic issues as well as for oversight and interest intermediation. Committees would carry the transaction costs in mobilising ad hoc interest group coalitions and, in the process, enhance their ‘learning’ about the implication of their sectional concerns and aspirations in larger shared interests. The parliament’s powers and its capacity to attract publicity make it the only possible institutional setting for the public drama which such ‘learning’ requires. A regime change is the most fundamental political transfiguration. There are bound to be teething problems at every level—as there are currently in New Zealand. And there will undoubtedly be a role for measures such as the Fiscal Responsibility Act to buttress political probity. But I argue more transparent policy making, enlarged attention to strategic issues, enforcement and oversight, and an institutionalised capacity for ad hoc coalition building, could be the foundation of a more flexible and adaptive polity. The two party system emerged in response to the social consolidation that occurred at the end of the nineteenth century. This was spearheaded politically by the Labor Party. At the end of the twentieth century we experience an analogous process—but in a reverse, ‘decollectivising’, direction. The question is: how far might ‘decollectivisation’ transfigure established political institutions? I am perhaps more sanguine than Michael Keating about the virtues of a transfiguring renovation. 3. The Role of the State in Economic Governance: Douglass North’s Critique of the Neo-Classical Framework White The second issue I would like to take up concerns the role of the state in the economy. Current conventional wisdom favours an approach based in neoclassical analysis. One alternative is some version of a ‘developmental state’—a model based on East Asian experience, with approaches modified to accommodate a robust liberal democracy. The former is based on a deductive and the latter on an – 118 – Vol. 22, No. 1 COUNTERPOINT inductive methodology. Systematic evaluation and comparison was thus impossible. Now however at least the outline of a common framework is available. This is provided in Douglass North’s study Institutions, Institutional Change and Economic Performance (1992)—an ambitious attempt to provide a theoretical framework to explain longer term economic performance. North seeks a framework that is consistent with the historical record—namely optimal solutions are often ignored, efficient solutions are rarely replicated, decline is as often experienced as development and there is minimal convergence between states and between firms from different states. He is reaching for coherence, comprehensiveness and verisimilitude on an Hegelian scale: far beyond, for example, the eclectic Michael Porter. The importance of this book from the perspective of state policy for economic performance lies in at least two considerations. First, North repudiates the neo-classical framework as insufficient as an explanation of economic performance, and in some circumstances misleading as a guide to policy. He reframes or qualifies every basic postulate and norm—preference formation, expected utility theory and the idea of rationality, diminishing returns, the role of price, the possibility of equilibrium and the norm of allocative efficiency. He suggests the simplifications on which this framework is based occlude key consideration. And he discounts its extensions—for example, in evaluations of the role of interest groups (in public choice theory). The second important consideration lies in the alternative approach that is sketched. North proposes a much more elaborated account of the causes of economic performance. He does not offer a fully developed testable theory. But he marshals most of the required elements and explores their interaction—this book is a kind of prolegomenon. At the centre of his approach is a theory of institutions. Institutions determine the rules of the economic game—a game which is then played out by organisations. Institutions determine transaction costs and influence the motives and mental ‘choice sets’ held by individuals and (metaphorically) by organisations. They determine the costs of measuring the valued attributes of what is being exchanged, of protecting rights and of enforcing agreements. Institutions also influence what organisations identify as relevant information and how they gather, process and act on the latter. ‘Institutions . . . are the underlying determinant of the long run performance of the economy’ (p. 107); and elsewhere, ‘the institutional framework is the critical key to the relative success of economies’ (p. 69). In turn, North’s theory of institutions is constructed from two prime elements: ‘a theory of human behaviour combined with a theory of the costs of transacting’ (p. 27). A focus on behaviour and transaction costs amplifies the scope of enquiry into economic performance. First, the polity is critically implicated. ‘The polity and the economy are inextricably linked in any understanding of the performance of an economy’ (p. 112). The polity is the setting for institutions and institutional change, to the extent it is possible, requires political action. The polity is the setting in which trust (an informal constraint) and credible commitment (a formal constraint) can be mobilised. The level and modes of trust and credible commitments, amongst other factors, determine the transaction costs faced by organisations in the competitive market sector. – 119 – AUSTRALIAN JOURNAL OF MANAGEMENT June 1997 Second, ideas and ideologies shape behaviour no less than price. For example: The way in which knowledge develops influences the perceptions people have about the world around them and hence the way in which they rationalise, justify and explain the world, which in turn influences the costs of contracting. (p. 76) And elsewhere: Ideas and ideologies matter and institutions play a major role in determining how much they matter. Ideas and ideologies shape the subjective mental constructs that individuals use to interpret the world around them and make choices. (p. 111) In other words, ideas and ideologies influence the motives and choice sets held by individuals and organisations. The polity is the sphere through which many ideas and ideologies are propagated and/or shaped and the structure and norms of the political process determine these effects. Third, the central issue in economic development is posited not primarily as innovation or invention but rather as cooperation. This is the domain of politics. Innovation, ‘creative destruction’ and technical progress are subsumed as second order phenomena. Economic history is a record of ‘the endless struggle of human beings to solve problems of cooperation’ (p. 133). And elsewhere, the central issue is stated as: ‘What combination of institutions permits capturing the gains from trade inherent in the neo-classical (zero transaction costs) model at any moment in time?’ (p. 118). In other words, economic dynamics is an interplay of cooperation and competition, in which the modes of cooperation are decisive. Trust, credible commitments, motives, choice sets and efficient markets (in a contingent sense) can be mutually reinforcing. Such a combination would mimic the technical model of efficient markets. But path dependence, uncertainty and the salience of factors other than price means there is no universal formula and no fundamental convergence between states. The polity frames many of these outcomes and relationships and is the setting where some at least can be mobilised. This analysis has a number of important practical implications. First, neoclassical perspectives are insufficient as a guide to strategic economic policy. The scope of trust and credible commitments, the generation of motives and the nature of choice sets are no less important in determining economic performance. Trust and credible commitments may be expressed in a variety of formal and informal constraints. Each state must look to its own history in defining the agenda for, and solving its problem of, cooperation. A second implication concerns the envelop of policy. How might this be amplified and extended? North’s own discussion implies stringent criteria. Possible extensions need to be debated. The point is North’s approach licenses a discussion that does not now exist. Most policy makers (including, I surmise, Michael Keating) assume the debate about the role of the state is settled. North provides powerful grounds, in the trade language of economists, for revisiting this issue and for broadening the agenda of discussion at least to include the formation of motives and choice sets and transaction (ie, measurement, compliance & enforcement) costs (see also next paragraph). – 120 – Vol. 22, No. 1 COUNTERPOINT A third implication is the insufficiency, sometimes the inappropriateness, of allocative efficiency as a goal of policy. Allocative efficiency may be a desirable objective. This will only be the case if it is not inconsistent with a more complex notion North terms adaptive efficiency. Adaptive efficiency is concerned with the kinds of (tacit or explicit) rules that shapes the way an economy evolves through time. It is also concerned with the willingness of a society to acquire knowledge and learning, to induce innovation, to undertake risk and creative activity of all sorts, as well as resolve problems and bottlenecks of the society through time. (p. 80) The acquisition of knowledge and learning, the inducement of innovation, the willingness to undertake risk, the fostering of creativity, and the identification of problems and bottlenecks, in the context of an historic trajectory and a contingent economic environment, implies a much larger range of considerations than those currently deemed pertinent by the Treasury, to say nothing of the Productivity Commission and the Competition Commission. A fourth implication is the importance of information. Ideas have influence— and the state can be an important source of learning. How this might occur on a much more finely grained scale is the central concern of my own study. The state can influence both the motives of economic and other actors and how these actors decipher their environment. The states overriding responsibilities for outcomes such as employment and the balance of payments may give it uniquely encompassing or strategic interests and perspectives and unique motives for initiating action. 4. The East Asian Developmental States White It is in this broadened context that the economic and institutional strategies of Japan, Korea and Taiwan, the model ‘developmental’ states, might be revisited. Their approach to economic governance may offer a different model for grounding credible commitments, a different framework for enforcement and different approaches to the development of appropriate motives and for expanding the choice sets held by individuals and organisations. North suggests: The most likely and indeed most empirically observable state in which contracts are self-enforcing is that in which parties to an exchange have a great deal of knowledge of each other and are involved in repeat dealings . . . in such a world the measured costs of transacting are very low. (p. 55) In a discussion of the characteristics of Japan as a network state, Moon and Prasad (1994) argue ‘the factor influencing economic performance is not state dominance or bureaucratic competence, but continued interactions between public and private organisations’ (p. 373). These arrangements reduce transaction costs through ‘extended bounded rationality, reduced opportunism and uncertainty, reduced small number indeterminencies, better information and a group-oriented atmosphere’ (p. 374). In the context of a discussion of formal public and private sector consultation and other patterns of interaction in Korea and Taiwan, Gary Hawes and Hong Liu suggest: – 121 – AUSTRALIAN JOURNAL OF MANAGEMENT June 1997 . . . (states) can reduce transaction and information costs as well as provide collective goods. They do this by reducing bureaucratic red tape, by pooling information, by reducing the need for regulation, and by increasing the efficiency of decision making. The collective goods produced by these institutions may include market information, sectoral coordination, bargaining leverage, or a myriad of other factors that have helped to make Southeast Asia internationally competitive in an expanding range of products and services. (p. 656) Charles Sabel embellishes this theme in his discussion of exchange in Japan. He argues transaction costs are reduced by building from, and making explicit, the shared or common interests of the parties. This arises from: . . . institutions that make discussion of what to do inextricable from discussion of what is being done and the discussion of standards for apportioning gains and losses inextricable from apportionment . . . discrete transactions among independent actors become continual joint formulations of common ends in which the parties identities are reciprocally defined . . . these institutions transform transactions into discussions, for discussion is precisely the process by which parties come to reinterpret themselves and their relation to each other by elaborating a common understanding of the world. (p. 234) These perspectives suggest ways in which the practices of Japan and the East Asian states may be relevant. The practice of these states, both at the level of the substantive policy framework and the level of interaction between the state and business, suggests a different model for economic governance than that emerging from neo-classical analysis. To summarise an extensive literature, economic governance in East Asia has at least three core elements. First a credible commitment to shared growth which is championed by the political leadership (Campos & Root 1996).1 This is the foundation for wider community mobilisation on behalf of strategic economic outcomes. The second element is elite bureaucratic agencies capable of taking a strategic view of structural and technological developments—which may be modified in interaction with relevant interests. These two elements could be seen to help generate and propagate appropriate motives and choice sets. The third element is elaborate arrangements to make routine sectoral and intersectoral consultation between the state and representative business organisations. By such means credible commitments are framed, enforcement and compliance is facilitated and choice sets are extended. This latter can occur in at least two dimensions: spatially (ie, to market opportunities that are geographically far distant & in relation to which there are high information, cultural or other barriers); and temporally, to encompass outcomes that are remote or far distant in time (ie, that involve strategic considerations & factors—spillovers & externalities, upstream & downstream linkages, technology developments, etc). This third element could be seen to influence motives and choice sets at the sectoral level as well as to reduce transaction costs. In general, information, enforcement, the mobilisation of trust and credible commitments flow less from arms length legally sanctioned contracts, and more from a reliance on informal and routine interactions, often orchestrated by the 1. This study is deficient in its political analysis—but it is important in framing the key contribution of a strategic consensus to state performance. – 122 – Vol. 22, No. 1 COUNTERPOINT state, within a strategic economic frame. Fierce competition prevails at the level of the market—even between Korea’s chaebols. But cooperation is extended both spatially and temporally through the polity. Along with this cooperation there are the usual problems of error, rent seeking, predation etc. But these are not dysfunctional from the perspective of economic performance. Of course the pace of development in the region means particular cases need more detailed examination. The transition to democracy in Taiwan and Korea transforms fundamentally the task of economic governance. It affects mobilisation at community and business-sector levels. It transforms the relationship between the state, and labour, as is evident now in Korea. Also in relation to the latter state, Peter Evans suggests ‘chaebol centred economic growth has reached the point of diminishing returns’ (1992). Meantime Callon (1995) claims MITI is harming Japanese technological development—other studies question this finding (eg, McMillan 1994). Terence Gomez (1991) suggests rent seeking has come to predominate in Malaysia. 5. Industry Policy in Australia White Michael Keating suggests the state might take responsibility for such outcomes as the level of saving and investment, the rate of inflation and employment growth, but not for ‘picking winners’. States cannot predict wholly new technologies or the products they might spawn. To this extent the hoary canard of picking winners remains apposite. But there are many patterns of interaction outside this limit case that offer to improve knowledge and/or lower transaction costs. The East Asian states illustrate the range of issues that might be involved and the patterns of economic governance that are associated with positive outcomes. Consider, for example, Australia’s emerging sectors—based on potential export and/or employment contribution. These sectors, such as education, health, tourism, autos and auto parts, engineering and construction, financial services, bio medicine and pharmaceuticals, telecommunications and IT, are already critically implicated in public policy. The issue is: could more collaborative action enhance their strategic contribution? Are the motives of relevant actors appropriately framed, are their choice sets aligned to the opportunities, are transaction costs inhibiting? At the least, these are contingent questions—to be investigated with the same analytic sophistication and prudential vigour that the Productivity Commission or the Competition Commission now bring to their enquiries—and with the same level of institutional commitment. These are not remote academic issues. There is currently an enquiry on industry policy, led by David Mortimer. What questions can he ask—for example, about the desirability of extending cooperation between the state and business, or for extending the latter’s role in influencing motives and choice sets? Can he ask if future export receipts are likely to be adequate? Can he explore the relationship between this outcome and the emerging pattern of firms? Even if he asks such questions, will the answers be heard by ministers or the Treasury? Present conventional wisdom delegitimises such issues. Influenced by neo-classical models, governments regard cooperation or collaboration with business as tantamount to rent seeking. They also assume the economic assets – 123 – AUSTRALIAN JOURNAL OF MANAGEMENT June 1997 freed from particular sectors are fungible. Issues of motivation, information and transaction costs are not judged germane. Attention to motives, choice sets, information, and transaction costs opens up a whole new dimension for policy attention, and perhaps action. Transaction costs can be significantly reduced, and motives and choice sets significantly influenced, through collaboration between the state and business as well as through more efficient market structures. Indeed if we follow North, without complementary change in the former action in relation to the latter may be otiose. Transformation costs may be lowered—but this may be more than offset by increases in transaction costs or by the misalignment between motives and choice sets and possible opportunities. More generally, I do not see how present policy approaches can deliver outcomes that will satisfy the norm of fairness (in the utilitarian sense), historically highly valued by Australians. I believe its renewal will ultimately be seen to require a more integrated or collaborative polity. Perhaps we will be weaned from this norm. But if we are not, the quest for approaches that deliver higher levels of integration and collaboration seems ultimately unavoidable. References White Campos, J.E. & Root, H.L., 1996, The Key to the Asian Miracle: Making Shared Growth Credible, The Brookings Institution, Washington. Callon, S., 1995, Divided Sun, MITI and the Breakdown of Japanese High-Tech Industrial Policy 1975–1993, Stanford University Press, Stanford. Chaney, F., 1997, ‘Is there a glorious summer to be made here?’ Australian Quarterly, vol. 69, pp. 63–73. Evans, P., 1992, ‘The state as problem and solution: Predation, embedded autonomy and structural change’, in The Politics of Economic Adjustment, eds Stephan Haggard & Robert R. Kaufman, Princeton University Press, Princeton. Gomez, E.T., 1991, Money Politics in the Barisan National, Forum Press, Kuala Lumpur. Hawes, G. & Liu, H., 1993, ‘Explaining the dynamics of the Southeast Asian political economy’, World Politics, vol. 45, pp. 629–60. McMillan, C., 1994, The Japanese Industrial System, de Gruyter, New York. Moon, C-I & Prasad, R., 1994, ‘Beyond the developmental state: Networks, politics and institutions’, Governance, vol. 7, no. 4., pp. 360–86. North, D., 1992, Institutions, Institutional Change and Economic Performance, Cambridge University Press, Cambridge. Sabel, C.F., 1994, ‘Learning by monitoring, the institutions of economic development’, in Rethinking the Development Experience, Essays Provoked by the Work of Albert O. Hirschman, eds Lloyd Rodwin & Donald A. Schon, The Brookings Institution, Washington, pp. 231–74. – 124 –