Why Australia Prospered: The Shifting Sources of Economic Growth
by Ian W. McLean, Princeton University Press, 2012, 304 pages, US$35
Australia achieved the highest global income per capita a few decades after European settlement. The top position was lost around 1900, but a leading position has been retained throughout the troubled twentieth century and reinforced during the current mining boom.
To explain why, Ian McLean blends economic analysis, historical narrative and counterfactual imagination in ways that, if not unique, are unusual enough to be noteworthy. The economics is unimpeachable, and McLean warns the reader when he is considering possible competing explanations. Unimpeachable economic analysis is tested with strict reference to fact, often as assembled by other economists or historians. Reasonable people sceptical about the value of economic theory in guiding economic development should revise their scepticism after reading this important book. McLean also illustrates how economic theory can be tested rigorously against the facts of historical experience.
Bravo, Professor McLean, you have produced a wonderful book, a book that should be enormously helpful to future leaders of this lucky country as well as to students of economics or history.
I shall illustrate these points by presenting several of Ian McLean’s lines of argument. The case for an historical approach is made on page 1; in any country “the roots of prosperity are buried in the past: the levels of income observed in the currently rich economies are in every case the result of very long-run processes”. The richest countries over the past 150 years include Australia, the United States and Britain throughout; and the Netherlands, Canada, New Zealand and Switzerland for much, but not all, of this period. Comparisons of Australia’s experience are made with those of the USA and the “other settler economies”, Argentina, Canada and New Zealand, as well as the United Kingdom.
There can be no tidy dominant explanation for Australia’s prosperity. Luck played a part, because of extensive resource endowments relative to a small population. Success in overcoming an initial handicap of distance from major trading partners and sources of new technologies must be recognised. The benefits of cultural and institutional legacies of the British settlers, themselves with deep historical roots in British history, were important. All these factors and others play a part in the narrative, often with a twist that surprised this reviewer despite a lifelong interest in Australia’s economic history and economic policy.
Standard economic growth theory relates income–output growth to accumulation of capital, including “human capital”, growth of population and “technological change”, or productivity using existing resources of capital and labour. In “settler economies”, extensive growth becomes far more important than the intensive growth that is the focus of basic growth theory. The link between extensive and intensive growth arises when one asks why each major “factor of production” evolves as it does, which sends the analyst straight to historical accounts.
This study is not concerned, asserts McLean, with short-term influences such as variations in saving rates, business and consumer sentiment, the rate of immigration and the expected profitability of new investments. This point seems laboured to me, since prolonged variations in these “short-term” influences are a large part of the historical narrative. The decision to promote immigration immediately after the Second World War is clearly important, as is the dramatic drop in the household saving rate following the inflation and other disturbances of the early 1970s and its partial recovery that began just before the onset of the global financial crisis in 2007. Perhaps I have missed a point here, but it is one of the rare cases in which I cannot follow McLean’s logic. After all, the long run is just a succession of short runs.
Apart from methodological matters, the second chapter—“What Is to Be Explained, and How”—involves stating some of the main conclusions, which I shall forbear from summarising further here so as to maintain suspense. Chapter 2 sets out the evidence about Australia’s position among the wealthiest nations. It also defines the various periods that form the basis of McLean’s analysis: early settlement, from 1788 to 1820; fast growth from 1820 to the early 1850s, punctuated by a severe recession and ending with the massive positive shock of the gold discoveries; three further decades of strong economic growth, ended by the powerful depression of the 1890s followed by the severe “Federation drought”; the shocks of the two world wars and intervening great depression; strong postwar growth ending in 1974; slower growth punctuated by two recessions in the early 1980s and early 1990s; then uninterrupted strong growth until 2010.
A chart on page 19 shows variations in growth of GDP per capita in various periods from the decade of 1850 when it recorded a rate of 3 per cent. From 1861 to 1889 GDP per capita grew at just under 1.5 per cent. From 1889 to 1913 it was less than 1 per cent. From 1913 to 1939 it fell to almost zero. Then from 1939 to 1974 it was up again to 2.3 per cent. From 1974 to 2010 it was around 1.7 per cent. In other terms, in Australian history per capita growth starts high, falls almost to zero, then recovers to be above all previous decades except the first golden age of the 1850s.
Another indicator of success or failure of economies is inequality of wealth or income. Here the data is fragmentary, but it seems Australia’s inequality declined from sometime early in the twentieth century (and possibly earlier) with a partial recovery (if that is the right word) in recent decades.
McLean is well aware that GDP per capita, or growth of real wages and other economic measures, does not tell the whole story of national success. He concludes, however:
it appears that extending the search for evidence relating to “economic prosperity” beyond the conventional measure of GDP per capita to a range of alternative measures designed to capture further aspects of “living standards” or “well being” does not significantly alter either the Australian trends in prosperity since the nineteenth century, or the position of Australia relative to other countries.
Chapter 2 ends with a little gem—“Recent Themes in Growth Economics”. If you have a son or daughter struggling with modern “growth theory” (which is highly mathematical), these elegant five pages may put it into context. This section presents the analytic bones of McLean’s analysis, after which he proceeds to add the historical flesh in an engaging and compelling manner. When you have finished reading the book, you may well agree with me that it is a masterful and authoritative account of “Why Australia Prospered”.
So let us begin: Why were the first European settlements in Australia so successful?
The settlers from Europe found a continent whose resources, apart from the thinly populated if rather arid land, were not immediately obvious. Crucially, the Aboriginal inhabitants had not engaged in resource exploitation, except for harvesting (in a sustainable way) the flora and fauna and carrying out land management using regular burning, the value of which is not yet fully appreciated—although this is not a point made by McLean. He also does not speculate about whether the cultural norms of the Aboriginal inhabitants helped the new settlers by (some sporadic opposition excepted) failing to oppose their arrival.
He does, however, point out that Aboriginal Australians provided input to an unknown extent in a wide range of tasks and occupations—as trackers for the police, guides for the early explorers, domestic workers, shepherds and stockmen. There was “a match of Aboriginal skills and European needs” in the pioneer stage of European settlement.
In later times, with more complete data, studies have identified what McLean calls “significant contributions” by indigenous Australians to economic development, in both the cattle industry in the northern regions and agriculture in the south. Now the often reviled mining industry is providing serious job opportunities for Aborigines, documented most clearly by Marcia Langton in the 2012 Boyer Lectures.
Ian McLean also discusses convicts in a more positive way than in most previous history or economic analysis. England did not settle Australia to create a thriving economy—and in my opinion most Englishmen are still puzzled at the outcome of sending their best criminals to the other side of the world. Some 160,000 convicts were transported between 1788 and 1868, with free settlers only becoming significant in the 1820s.
Most historians, McLean asserts, have seen the convicts as a “thoroughly disreputable and criminal lot”. But from an economist’s perspective Australia was a convict-worker colony, run under military orders by a governor with wide powers. The convicts were overwhelmingly young and fit—just the people to clear land, construct key infrastructure and produce food. As in times of war, a command economy with clear objectives and appropriate incentives can work well, and in Australia, “with hiccups along the way”, this was the early experience.
McLean points out that the convicts were not slaves, and also from early days the colony had a developing free market (initially run by the officers of the Rum Corps). Convicts had numerous legal rights and, when their daily tasks were completed (exceptionally hard cases apart), they were free to pursue other activities. In addition, some convicts were assigned to work for free settlers. New South Wales had a dual labour market—with one part government-directed labour, the other part a free labour market, with workers consisting of convicts with free time, “assigned” convicts, emancipists and, later, free immigrants.
The evidence suggests that tasks were assigned roughly in accord with the skills of convicts (albeit self-declared, while still in England), and that some convicts had professional training; a few even had university degrees. Convicts received a wage (but below the free market rate) and could be freed under the “ticket-of-leave” arrangement to finish their sentences working for a free settler. Despite stories of shirking or unsuitability for specific tasks, McLean says most convicts were employed “profitably”—with value of output higher than their wage and indirect costs of employment.
The convict-based workforce was in many ways well suited to the task of creating a thriving colony on a distant shore. “Nowadays,” McLean comments dryly:
one might envisage such a project being contracted out to a large corporation rather than the military, who would perhaps employ either foreign guest-workers, or a “fly-in/fly out” labor force, such that the “community” would not look so different in age and gender mix from that arriving in 1788.
(The reader is invited to think of the isolated communities near the natural gas fields of the North-West Shelf in Western Australia or near the Olympic Dam mine in South Australia’s outback.)
And the decision-making and management structures within the company overseeing the construction project would likely bear more than a passing resemblance to those of the governor and officers in the first years of New South Wales.
Once the colony was established, self-sufficient in food, there was another vital requirement—an export capacity sufficient to pay for imports of goods not able to be produced locally. The answer was the discovery that merino sheep could be farmed profitably in New South Wales for their wool, a commodity in strong demand to feed the high demand of the booming English woollen mills.
Crucially, merino wool was worth enough to overcome the “tyranny of distance” and wool remained a leading Australian export commodity, with Britain as its main destination, until well into the twentieth century—producing a massive short-lived spike in Australia’s terms of trade during the Korean War in the early 1950s.
Successful economic growth also required a suitable institutional setting. The initial suitability of the military structure has been mentioned but, as seen many times in later history, this ultimately involved a blurring of roles and widespread opportunities for corruption. The “government store” nevertheless in the early days of European settlement provided a reasonably fair and efficient trading system extending to provision of credit—an embryonic banking function.
The supply and regulation of money was another need of the fledgling economy that “seems to have further illustrated human ingenuity at work in the pioneer outpost”. The use of rum, McLean says, may have been exaggerated. Spanish dollars, overstamped coins of various sources and other foreign currencies circulated. The wool trade demanded access to sterling (or bills drawn on the British Treasury) and this was an “additional and persisting complication”. Ramshackle improvisation however worked well enough, until in 1817 the establishment of the Bank of New South Wales marked a fresh milestone of economic development. Then, in 1825, imperial currency reform led to the creation of an Australian pound alongside domestic acceptance of British currency as legal tender.
Also crucial was the development of Australian political life. Here a vital point was that Britain had learned from the adverse outcome of its harsh treatment of its American colonies. An entire chapter is devoted to this matter, including the handling of the crucial matter of dealing with the squatters. Failure to deal with this matter probably would have produced a highly unequal society of the sort that bedevilled development on other places, notably the banana and drug republics of South America.
However, there was also a more immediate issue, one that “receives little attention in most treatments”:
This was the continuing subsidy from the British government, which permitted the settlement not just to survive its uncertain first years, but financed the investment in infrastructure and pioneer agriculture that would permit growth in the population and the attainment of a degree of self-sufficiency.
Reliable estimation of the amounts involved is impossible. Much of the British contribution was made in kind, rather than monetary grants, loans or “aid”. Members of the military engaged in commercial ventures. Many placeholders were not salaried officials, though having their income augmented in various ways. Convicts were assigned to work for wages below market rates. Land was owned by the Crown, but access was not always by purchase or paying rent. There are many further barriers to any attempt at accounting.
That great Australian quantifier Noel Butlin nevertheless made an heroic attempt, and suggests initially the British contribution to Australian GDP was as high as 75 per cent, declining perhaps to a bit less than 50 per cent by 1820, and more important than wool until around 1830. Other quantifiers have broadly confirmed the view that British subsidisation was substantial and helped Australia to reach British levels of GDP per capita before the gold discoveries of the 1850s.
The wool industry was clearly a key reason for Australian self-sufficiency. Wool was the largest export for every decade from the 1820s to the 1950s, with the exception of the 1850s and 1860s, when gold was the winner. There were 75,000 sheep in 1816 and 16 million in 1850. Dividing wool exported by population for New South Wales shows wool rising from six pounds to 113 pounds (weight) in 1849. And in 1850, Australian wool provided 53 per cent of total British imports.
McLean however has a “more focused” interest than these stunning achievements. This is to account for wool’s contribution to underpinning a high-wage economy despite high immigration and rapid population growth. Once it was discovered around 1820 that the central west of New South Wales was a large natural grassland on which stock could be grazed, Australia became a place that could be described as short of labour and capital but with abundant land. This constituted a major addition to the natural resource endowment of the colony, like deposits of valuable gold, iron ore or natural gas. Abundant land would be expected to drive up the relative price of capital and labour.
The early pastoralists devised “a quite remarkable labor- and capital-saving, but land-using, method of producing wool”, totally unlike the system they would have been familiar with in England. “Squatting” on Crown land was technically illegal, but in practice unconstrained, and (presumably), says the economist McLean, the squatters chose amounts of land to maximise profits. Free land and economies of scale were very important aspects of the new model. But, even better, sheep could be allowed to wander free with little supervision, therefore little need for the scarce items of capital or labour. Sheep reproduce reliably, so the herd (technically the squatter’s major “capital stock”) would grow without further input from the squatter.
Wool was in most years sufficiently valuable that it could absorb the costs of cartage to a port by horse and dray and a long sea voyage. And labour was sufficiently costly that wool was generally not even washed. The lack of value-adding, McLean notes, is typical of later exports like iron ore or natural gas. Innovation was required to set up marketing and financing businesses, and the result was the development of independent stock-and-station agents.
The development of an embryonic democracy was delayed until there were sufficient free settlers, but British experience in America (including problems in Canada) made the Colonial Office prepared to move at a reasonable pace. But particular experiences and personalities affected the outcome, especially (my reading of history suggests) the attempted rebellion in the Victorian goldfields, including the juries’ refusal to convict the rebels of treason. McLean says that the squatters fought hard to “secure and then to preserve a dominant position in the emerging colonial political institutions”. They sought to obtain permanent tenure of their land and a guarantee of continued cheap labour in the form of a flow of convicts, while the “liberals” (mainly town-based) opposed this. Had the squatters succeeded, a very different political future might have been created, and impaired Australia’s economic prospects.
Chapter 4 covers the subject of land ownership and the debate on transportation in some detail, and is full of interest. On the more narrowly economic matters, McLean notes the positive effect of South Australian copper (creating Australia’s first mining boom) and broader agricultural activities such as growing wheat, dairy farming, meat production and horticulture. The towns saw the growth of brick-making, brewing, baking, boat building as well as banking, wholesale and retail trade and other industries needed in a developing country.
Australia’s second mining boom was sparked by discoveries of gold. McLean in economist mode calls this “a major shock” which “ushered in a dramatic episode in the history of the country’s prosperity”. Its effects rapidly and thoroughly “permeated the social, political and even cultural spheres, some so deeply that their impression has lasted to the present”.
Like wool production, gold was so valuable that the alluvial gold that was first exploited could be produced without sophisticated technology or much capital. A first effect was to attract a rush of mainly young men—like the convicts, ideal demographic material—almost tripling the non-indigenous population in the decade from 1850.
Shocks to an economy, whether positive or negative, offer “a sort of natural experiment”, an experiment that stress-tests leaders and institutions and presumably also those citizens affected by the shock. Some economists, McLean says, see different nations’ responses to shocks as having a crucial impact on relative well-being and economic success. As he points out, this is a perspective that colours (appropriately in my view) his approach to the other shocks afflicting or benefiting Australia—the major examples of which include the 1890s depression and drought, the two world wars and the depression of the 1930s, as well as the resource boom we are still experiencing.
Two perhaps obvious facts about the gold shocks are examined more closely than usual by McLean—the fact that the shock was positive, and that most of those people attracted by the gold stayed to build a nation, something that does not always happen when a rich resource is discovered in a sparsely populated place. Indeed, economists more often describe a major resource discovery as a curse than as a blessing.
In Australia’s case, initial effects may have indeed been negative. The young men who rushed to look for gold did not all come from overseas, but also from jobs in Australia’s towns and cities and on farms. This potential negative effect weighed on the minds of the colonial administrators, and the people who first discovered gold had a struggle to convince the authorities of the reality of their discovery or to be rewarded. The fact that the gold technically belonged to the Crown was an initial impediment to wealth creation, but was solved after an early mining tax in the form of a steep licence fee caused quite of lot of unhappiness, especially in Victoria which at the time had an inflexible former sailor as its lieutenant-governor.
McLean concludes that the gold discoveries benefited some parts of the economy at a cost to other parts, an outcome known as the “Gregory effect” after an early analyst of mineral discovery. But the overall effect was such that the chapter that discusses the gold rushes is called “Becoming Very Rich”. He notes that there were virtually no effective border controls, so people arrived freely from the four corners of the globe. Economic activity in general was almost totally unregulated, with few barriers to starting a business or hiring and firing labour. This all happened without any national government with great armies of econocrats, tax collectors and other people trained to prevent, or severely slow down, those people ambitious to create wealth. There is much food for thought in this observation.
And the gold finds had a major democratising effect, with massive numbers of individual miners or small groups mining tiny areas. This was a major contrast to a tiny number of Tory squatters bestriding vast grazing lands.
It is important, McLean says, to consider the sustainment of prosperity after the decade of rushes. Australia produced around 3 million fine ounces of gold per annum in the 1850s, 2.5 million in the 1860s, 2 million in the 1870s and 1.5 million in the 1880s. The finds in Western Australia in the 1890s returned production to 3 million fine ounces. Californian production was initially also 3 million ounces, but declined far more rapidly than in Australia.
In Australia, after a fast initial decline, employment in mining remained at around 5 per cent of the total for the rest of the century, and mining’s share of GDP remained above 10 per cent of the total until the 1870s. Both ratios are greater than those being achieved in the current mining boom. The initial gold boom in the 1850s did not turn into a bust, as often happens, partly because only small numbers of the early diggers departed: “it is remarkable the extent the colonial governments engaged in a development strategy to garner long-term benefits from what might well be [governments feared] a short-lived boom if left to its own dynamic”. These actions included subsidisation of young, single female immigrants, incentives to encourage young men to marry and settle, opening new rural land for settlement and, in Victoria, introduction of tariffs to encourage colonial manufacturing. Victoria also entered the London capital market in 1858, to fund public works or infrastructure spending—especially railways and urban utilities.
The favourable demographic effect of many young immigrants having families stimulated demand for many types of urban development, creating jobs to match the needs of a rapidly growing population. A generation later there was a demographic echo, which contributed to Melbourne’s mad property boom of the 1880s. And the long boom from the early 1990s (like that from 1850 to 1890) includes a demographic boost from the postwar immigration program and its echo. “Demography is destiny,” as a politician once said.
The location of the major gold discoveries within a reasonable distance of Melbourne and Geelong also helped. This was not blind luck, as mining discoveries are more likely to be made where other economic activities are occurring. And also, following Geoffrey Blainey, hard times make mineral discovery more likely, and the finds in the early 1850s followed a serious recession in the 1840s. By the end of the boom of the 1880s, Australia was, per capita, the richest nation in the world.
I will end this discussion with Professor McLean’s summary of the era of wool and gold:
In short, Australians were primary beneficiaries of this first era of globalisation, becoming very rich on the basis of the interactions existing between their natural resource endowment, the efficiency with which this was utilised, the quality of the institutional arrangements, and their choice of an outward-oriented growth strategy.
There are several shocks to be analysed yet—the depression of the 1890s, the two world wars and the depression of the 1930s, the postwar boom, and the later resource booms, including the one Australia is still experiencing. There is also the more general issue of how Australia maintained its position as one of the richest nations after the severe bust of the 1890s and other negative shocks to the outbreak of war in 1939 (“a positive shock”), a time with no major mineral discoveries and in global terms generally unkind to our small, remote trading nation. Readers will find much of value in working through those examples, and Ian McLean’s summary chapters.
I shall finish with my own meditation on the big question Ian McLean has asked, leaving readers to enjoy both the excitement of all the episodes and the considerable material not even sketched in this review. I shall do so in my own words, and offer some lines of thought I do not see emphasised in the book.
My first point is that economic success is not compulsory. This might seem trite, but it is forgotten or ignored by dictators everywhere and even some democratic leaders. Australia has been blessed with enlightened colonial administrators, dedicated public servants and generally competent and honest democratic politicians. Our many resources—both sustainable and those that can only be exported once—have made us rich. The historic conflict between capital and labour has generally been handled well and in my view the national aim of providing decent wages and conditions promulgated in the famous Harvester judgment was wise and deserves to remain a national objective.
Yet there are aspects of the generally positive achievements that fall short of what could have been. Modern capitalism has become overly dependent on deeply embedded consumerism. And modern governments have nurtured a deep sense of entitlement among their peoples. Government spending generally, and welfare outlays especially, have exceeded taxation to a point that merely servicing current debt levels will create intergenerational stress for an ageing population. Private spending in excess of income has raised private debt to uncomfortable levels. Households have recently rediscovered saving, which is a highly desirable development, but there is little or no encouragement of this trend by governments, and no serious preparation of people for attacks on unsustainable entitlements except in the bankrupt nations of southern Europe.
Australia is in better shape than most capitalist nations, thanks in large part to the “China boom” fostering a great increase in Australia’s terms of trade. But we have spent too much of the largesse provided by the current mining boom, and ham-fisted attempts to tax the mining companies have involved serious conflict with the creators of the greatest single source of Australia’s prosperity. Australia’s productivity surged after the reforms of the 1980s and early 1990s, but has tailed off since then.
We can and should do better. Our natural handicap is a relatively small population, so we should not waste too many resources on industries requiring large-scale production and cheap labour, both of which are more readily available elsewhere. Instead, we need to focus on things we do especially well. Mining and agriculture are two industries that have prospered here with very little government assistance for almost all of Australia’s history. Other areas of promise include medical science, education, tourism, sport (rapidly becoming a global business of influence) and various other services. One of the conclusions in the debate on the “mystery of economic growth” is that research-and-development spending, funded by government or assisted by suitable tax policies, is a prominent cause of above-average productivity growth. Yet successive Australian governments have not accepted this important finding.
I strongly believe that excessive and unnecessary regulations, including industrial regulations designed to help union members at the expense of non-unionised workers and contractors, capitalists and pensioners, the massive and complex income tax regulations, proliferation of other taxes, including the ridiculous mining tax, and burgeoning welfare dependency, are all matters we would be wise to review and reform. And the psychological aspect of all these matters requires careful thought by Australia’s leaders. Fostering a false view that 'governments will provide', which was so big a part of the Rudd-Gillard-Rudd government’s response to the global crisis, is to send a deeply dysfunctional message. The modern world is highly competitive, a fact that our sportsmen and women accept, leading them to deliver strong results at the highest level.
Winning is fun, and in my view that applies to the world of work. Leaders can and should do better.
It is also worth reminding ourselves that Australia is a lonely outpost of Anglo-American culture in a region that is far from well disposed to our dominant cultural and economic endowments. Trading freely and avoiding traditional ugly Australian behaviour is highly desirable, as is the generally accepted immigration program. But despite our wealth we are vulnerable and the world is a tough place. Defence spending in relation to GDP is now at the inadequate 1938 levels. Now, of course, with greatly advanced technology and a much diminished domestic industrial infrastructure, we are in no position to mount the massive effort in our own defence that we did in the Second World War, a matter that deserves much debate and decisive resolution. And in that war, as well as the wonderful industrial effort, it took the great courage of our soldiers in Papua New Guinea and the American fleet in the Coral Sea to push back a determined enemy.
Ian McLean has written a book of the highest quality and relevance, published by a leading American academic publisher. He is demonstrating another industry where Australians can shine on the global stage.
Article published in Quadrant, March 2013