Economic thinking has driven policymaking in the past, but will it in the future?

By Sean Innis

Monday March 2, 2020

John Howard and Gareth Evans in the National Tally Room on election night, 24 March 1990. Labor won the election, with a small swing towards the Coalition. Picture: National Archives of Australia

Economic thinking has clearly played an important role in the prosperity and position Australia enjoys today. For that role to continue into the future, economic thinking needs to respond to the changing nature of our society, the challenges we are now seeing emerge, and deepen the understanding and advice it brings to the policy table, writes Sean Innis.

Many in the policy community look to the 1980s and 90s as a pinnacle of rational policymaking.  And it is certainly true that this period saw reformist governments, working closely with other key actors, make sweeping changes to Australia’s policy landscape. The reforms were not without detractors but did enjoy reasonably broad support across political boundaries. Well, at least that is how it looks from today.

Track forward, and many of the key players from that era look almost bewildered by the policymaking environment in Australia today. In their eyes, Australia is now where politics and populism rule, where evidence matters less than ideology, and where the national interest has disappeared into a sea of competing self-interests. 

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A major feature of the ’80s and ’90s was the key role economic thinking played in policy-development. Widely held economic theory, coupled with empirical evidence in areas like tariff policy, combined to present compelling answers to major problems besetting the nation. Economics dominated the policy kingdom; social, environmental, and foreign policy danced to the beat of the economic drum. 

Today, the strength of that drum within government has diminished. Economic thinking remains important but no longer dominates policy discourse — at least outside the overall management of the economy. Other frames, notably one around national security, have risen. Far from setting the agenda, many economists now wonder how to be heard. 

There is little doubt that Australia owes a debt of gratitude to policy leaders, inside and outside government, of the ’80s and ’90s. The economic thinking that underpinned decisions back then has helped create a socially coherent, prosperous, and globally connected society whose economy has grown steadily for 30 years. But past success is no guarantee of future success. Increasingly, it is clear that economic thinking needs to adjust both to the changing policy dynamics of today and some lessons of the past if it is to continue to play a major role in guiding future policy. 

Today’s policy environment: four dynamics

Every era of policymaking is different and complex. Looking backwards simplifies the world: today’s complexities and uncertainties become tomorrow’s points of historical simplicity. Even a short conversation with some of the key policy players of the ’80s and ’90s reveals nuance and uncertainty that history generally ignores. 

Even so, there are a range of reasons why the environment that confronts policymakers today differs from that of the past. Understanding these dynamics is important, as it defines both the context in which policy decisions are taken and the objectives those decisions are seeking to achieve.

Of the many dynamics driving policy today, four seems particularly relevant to the role of economic thinking. 

Dynamic 1: Expectations of government have increased and expanded

Expectations of government appear to have both increased and expanded over time. Competition for votes has tight focus on meeting the — often competing — needs and desires of the population. The problem, of course, is that when those seeking election lose sight of a coherent role for government or its ability to deliver, this strength becomes a weakness.  

Democratic competition may be one reason for the increasing role government is playing in protecting people from harm. This is part of a long-term trend that has seen government more willing to assume responsibility for ensuring the goods and services consumed by people are, to use the legal concept, fit-for-purpose. It has also seen government more willing to compensate people for losses incurred through bad luck or outside agency. This trend has not been the result of a conscious ideological agenda but a path of policy evolution built on many small decisions over time. 

Expectations have also expanded on what government should take an interest in. Care services provide a prime example. It was not that long ago that, outside health, government-funded care was a residual function focussed on those at the bottom of the economic distribution. Today, government plays a leading role in most areas of formal care — health, aged, disability, and child. In a similar way, the role of government in protecting and promoting a sustainable the environment has increased dramatically in response to both scientific understanding and community demand. 

Dynamic 2: Confidence in government’s ability to deliver has fallen

Rising expectations have occurred alongside falling confidence in government. Trust in both government and the institutions of governance in our society are at historic lows. Amongst the complex factors behind this, two stand out. 

First is that the ability of government to control some of the key factors influencing societal wellbeing has declined. This falling influence is partly the result of past, very good policy decisions based on sound economic advice. There can be little doubt, for example, that Australia’s open, market-driven economy has delivered great benefits to our society. But with these benefits has come a lessening of government’s ability to intervene effectively in the economy. Globalisation inevitably means that outside forces rather than home grown decisions play a key role in our economic fortunes. 

In a similar vein, it is increasingly clear that many of critical issues facing our society cannot be effectively addressed by Australian governments alone. Climate change is an obvious example. Effective regulation of supranational platform-based businesses like Google and Facebook is another. This does not, of course, relieve Australian governments of their responsibilities in these areas. But it does add to the complexity of policymaking. And it is also notable that much of the economic benefit we enjoy today from globalisation comes from international agreements for which Australia was a keen advocate.

Government has also failed to deliver in areas that matter to society as a whole. A series of royal commissions and other inquiries has highlighted genuine failure in areas where government plays a major regulatory and/or delivery role — including through the creation and management of markets. These failures are not simply a matter of the rules failing to keep up with rising community expectations. In the banking royal commission, for example, existing rules (set by policy) were not the major problem; rather, it was the culture of the banks and the ability of government to ensure regulatory standards were met at most question. 

READ MORE: Regulatory capture: did we need a royal commission to bust it wide open? Adele Ferguson says you can bank on it

Dynamic 3: Policymaking has become more targeted and precise

A key shift in policymaking has been away from the setting of broad-based rules and institutional structures towards policies targeting relatively small groups seeking very specific outcomes. Even major initiatives such as the National Disability Insurance Scheme tend to affect (at least directly) relatively small sections of the population as a whole. 

There are many reasons for this shift. One is maturity. Australia has in place comprehensive institutional structures and broad policy frameworks for most areas of policy interest. Changes are occurring within these structures, rather than fundamentally to them. 

A second reason is technology. Technology has allowed policy to target smaller groups of people. For example, actuarial analysis of Australia’s welfare system is able to identify very small groups of people for early policy intervention in a way that was not possible before. Modelling has also underpinned (often false) precision by claiming to show the detailed outcomes of policy on individuals and small groups. This encourages, for example, the pursuit of finely grained decisions designed to achieve detailed policy ends and to avoid policy ‘losers’. 

The changing balance between broad-based policymaking and precision-based policymaking has implications for the way governments engage with the population. In particular it makes it harder for government to connect individual change to a narrative about society as a whole. The consequence is that policy is almost always about ‘someone else’ reinforcing a ‘what- about-me dynamic’ in the game of competing policy claims. 

But within the pursuit of precision lies some dissonances. In responding to threats from the very few, recent national security legislation has been designed in a way that potentially captures the many. In this case, flexibility and convenience for the enforcer has proved more important than precision. 

Dynamic 4: People live global and local lives

A key feature of the 21st century is the extent to which global dynamics influence lives of Australians. As noted earlier, the economic path of our nation is largely determined by events overseas rather than decisions at home. More and more people are engaging directly with overseas suppliers in making purchases, and more spend time overseas. Interest groups and cultural pursuits, facilitated by social media and internet, often cross-national boundaries. People live globally.

People also live locally, as they have always done. On a day-to-day basis, the places they go and people they see tend to be geographically bounded. The weather, travel times, service availability, the availability of key resources (such as water), and local amenity play a major role in determining individual wellbeing. Local opportunities too, are critical. The bottom line is that most people care about the community they live in and want to see it thrive. 

Overlaying this trend has been a substantial long-term shift in the economic geography of the nation. Agglomeration effects have seen cities grow. Technology change and the pursuit of economic efficiency have seen some regional towns shrink as other grow. Immigration patterns and population ageing is creating greater diversity. Changes in ownership structures, especially away from the family-run farm, is affecting the size and dynamics of towns. These long-term trends are seeing a growing perception of unevenness in the prospects of different places across the nation. Weather events, natural disasters, and access to resources are also emphasising the vulnerability of individuals and places to Australia’s harsh and changing climate. 

These dynamics are changing the focus of policymaking. National decisions, especially at a time of sustained growth, have become less important than local ones in influencing the day-to-day lives of many Australians. This has heightened the focus of national governments on localised issues, creating competition with other levels of government and further blurring traditional lines of policy responsibility. 

Five challenges for economic thinking

So, what does all this mean for the role of economic thinking in policymaking? Without seeking to be comprehensive, five challenges spring immediately to mind. None of the challenges are new. But behind each lies the need for economic thinking to evolve to meet the needs of Australia’s changing policy environment. 

Challenge 1: What is progress anyway?

Economists have long understood GDP to be a useful but imperfect measure of societal progress. But even as an imperfect measure, it is tiring badly. Societal expectations are increasing beyond the things GDP measures well (production and income) to the things it measures poorly or not at all (a clean environment and high-quality care). This shifting emphasis means that a core tool for defining societal progress is becoming less resonant and less useful. 

GDP remains an important and valid measure. After 30 years of sustained growth, we must be careful not to underplay the importance economic growth plays in our society. It is easy to undervalue something you have always had. But it is also clear that we are in a phase of policymaking whereby many people are happy to trade GDP growth potential for other objectives. To put this down solely to a misreading of the value of growth would be a mistake. It is a deep and conscious setting of priorities that are different to the past. 

This creates a challenge for economic thinkers. Economic thinking needs to define and embrace measures of progress that better reflect the genuine aspirations society. Unless economic thinking can do this in a way that better explains how economic growth and policy advice contributes to that broader concept of progress, the power of economic advice will continue to lessen.

Challenge 2:  Whatever happened to a win-win world?

Dialogue around globalisation has shifted dramatically from a prevailing assumption that free trade and investment delivers win-win outcomes for all nations to an emerging view in some quarters of a zero-sum game. This dynamic has shaken one of the strongest foundations of policymaking in the ’80s and ’90s — that free trade and global engagement is at the heart of delivering economic prosperity and national security. 

Many reasons exist for this shift. Changes in geopolitical power, particularly with the rise of China and relative decline of the US, have seen great power contest and increased bilateralism. Longstanding weaknesses in the global rules-based architecture have emerged as key sticking points in international cooperation. Technology changes that have underpinned a more globalised world have also created new risks to national security. And the uneven distribution of benefits across and within economies has created domestic disquiet in a number of key trading nations. 

These changes have seen national sovereignty being reasserted by some nations at the expense of global growth potential. The traditional economic view that increased interdependence delivers greater national security has also lost influence, being replaced with one of closer national control. In saying this, it is important not to overstate what is happening. These changes have not (as yet) resulted in a wholesale retreat from a generally open world. But it has given some pause to a long-held general view that further globalisation is good. 

This is the second challenge for economic thinking. A better intellectual reconciliation is needed between the desirability of enhancing global (and national) growth potential via increased globalisation and the opportunity cost of that globalisation. This reconciliation needs to consider whether current high levels of global openness mean that at least some nations face diminished marginal gains from further globalisation.

Challenge 3: Markets work, but…

Economic thinking has played a major role in the promotion of using market mechanisms to achieve societal objectives. This has seen a proliferation of markets created and supported by government. These markets have been used, amongst other things, to pursue a range of environmental (such as water) and social policy objectives (such as disability and aged care). 

The theoretical benefits of competitive markets are attractive — by facilitating choice competitive markets optimise consumer benefit and the use of constrained resources. In essence, using markets are good for the consumer and good for the economy. And, where markets are truly competitive and work well, this is true. 

A mature reflection on the use of markets as a policy tool over the past 30 or so years suggests that the promise of the market has always not been delivered in practice. There is little doubt that some of this failure reflects bad implementation of good ideas, but this is not a full answer. It is also clear that advice based on economic thinking did not anticipate and respond to some of the core challenges posed in using markets to achieve policy ends. 

Two dynamics, in particular, warrant further attention by economic thinkers. The first relates to the time it takes for markets to form and adjust to competitive processes. The second relates to the ability of a market to meet widely differing population needs, circumstances, and capacities. 

Markets do not form out of thin air. New demand is not instantly met by new supply. Instead, the process of forming a mature market can take many years, as we are seeing with the National Disability Insurance Scheme. Even in a mature market, the process of competition does not work instantly. Competition requires suppliers to offer different combinations of value and price, some of which will not appropriately meet demand. These ‘mistakes’ allow the entry of competitors who better meet the needs of consumers. But this process also takes time. Feedback loops that reveal opportunities for improvements in supply can also take many years to fully work through, depending on the sector.

The bottom line is that markets need time and space to adjust effectively. Yet in many created markets, governments are driven to retain a level of control over both price and quality — undermining the adjustment process. This drive often reflects reasonable concerns. Fiscal control does matter, especially in areas where costs are large. Quality also matters, and indeed is often the key variable. This is particularly true in care markets where the objective of government is to ensure a high standard of personalised care is delivered, consistently over time and across a population with widely varying needs, locations and circumstances. A challenge that many created markets have struggled to meet. 

These dynamics mean that it is sometimes difficult for a created market to deliver the benefits economic thinking seeks. This is not to suggest that markets should not be used in the delivery of policy outcomes. Markets can be a powerful vehicle for delivering choice and efficiency. But it is to suggest that some past advice and decisions have not delved deeply enough into the dynamics of created markets.

This is economic thinking’s third challenge. Until economic thinkers are able to articulate more convincingly how the dynamics of created markets will work, and how to ensure these dynamics do not generate unintended consequences, those advocating market-based approaches will become less influential.

Challenge 4:  Consumer choice is great, but…

Choice, and the freedom it brings, is a key tenant of policymaking in Australia. Traditional economic thinking has reinforced this by favouring market-based approaches, minimal intervention, and the promotion of both choice and personal responsibility. This thinking is influenced by assumptions of rationality and empowerment — that people can and do act in their own interests.

That people genuinely desire choice in our society is clear, but it is also clear that (as a population) people place some boundaries on that desire. While people want choice, they also want confidence in the quality of goods and services being offered and protection when things go wrong. Our growing understanding of cognitive biases in decision-making has also raised questions about the assumption of rationality that underpins much economic thinking. But even in the absence of these biases, diligent people sometimes lack the time and technical understanding to make the well-informed decisions economic theory assumes. 

This reality leaves policy-makers needing to design for a population whose decision-making capacity varies widely. Simple appeals to personal choice and responsibility are unlikely to be sufficient and may not deliver the efficient allocation of resources economic thinking rightly seeks. A more considered balance is needed between free choice, personal responsibility, and protection. 

This raises the fourth challenge for economic thinking. Policy-makers need a finer sense of when and how to support decision-making by consumers. Such thinking needs to incorporate our growing understanding of how individual decision-making actually works, and what this means for the best balance between personal responsibility and government responsibility for protecting and promoting the interests of individual consumers. 

Challenge 5: Location, location, location

The influence of economic thinking on national policy has traditionally had relatively little regard to local dynamics. The emphasis — reasonably — has been on ensuring that resources and people flow flexibly to where they are of greatest economic value. This focus has been important in building the international competitiveness of Australia’s economy, and should not be discarded.   

But the growing demand for policy to focus more strongly on local issues is unlikely to change. Local differences in opportunity and outcomes have been a powerful disrupter to both politics and policymaking in other nations. And while these dynamics are less pronounced in Australia, they exist and should not be ignored.

This creates a fifth challenge for economic thinking, which has two dimensions. The first is the need for policymakers to develop a more nuanced view on how best to manage Australia’s changing economic geography. This should not involve a reversion to protectionism but does require a more considered view on how to maximise economic opportunity, manage inevitable transitions, and ensure a fair distribution of benefits from our future prosperity. The second is to more clearly respond and account for the importance local issues play in the wellbeing of people when considering policy.

A final word

The discussion above does not, and is not intended to, provide a complete picture of either how the policymaking environment has been changing or the future role to be played by economic thinking. Rather, the intention is to provide a sense of the changing interplay between economic thinking and policymaking, and to encourage further discussion about the positive role economic thinking can play.   

Economic thinking has clearly played an important role in the prosperity and position Australia enjoys today. For that role to continue into the future, economic thinking needs to respond to the changing nature of our society, the challenges we are now seeing emerge, and deepen the understanding and advice it brings to the policy table. 

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