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GUIDING POLICIES WITH A KIND AND
THOUGHTFUL HAND - PAUL KEATING
Financial Innovation
It follows the full text transcript of
Paul Keating's Financial Innovation speech,
delivered at the Second Asian Leadership Conference, Seoul,
Korea - February 21, 2008.
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Your host, Chosun
Ilbo, |
has asked me to
concentrate my luncheon address on the subject
of financial and labor market reform. Your host
has asked me to draw upon my experience in
introducing reforms to those markets in
Australia during the period when I was Treasurer
and Prime Minister.
With a new President and new Government coming
to office in Korea, President-elect Lee Myung
Back has, amongst other things, foreshadowed
financial market reforms to raise Korea's global
competitiveness.
In setting this subject for lunch, Chosun Ilbo
has asked me to reflect upon similar changes
made in Australia 25 years ago and more
recently, 15 years ago to give today's luncheon
guests some clue from a practitioner as to the
importance of these reforms and how they might
work in a Korean context.
Perhaps I should make the overarching and key
point first and make it succinctly. It is this:
any country has a right and can choose the
economic pathway of economic nationalism and
protectionism. But supporters of that policy
have to know that such a pathway, while having
some popular appeal, carries with it the choice
of sub-optimal or lower rates of economic growth
coupled with lower and slower rates of income
growth.
Perhaps I could paraphrase it this way: open
markets provide more opportunities, more growth
and faster income growth. But they require
greater challenges from the ensuing adjustments
and the greater requirement on the political
system to respond to the need for those
adjustments.
Open markets also do something else: by allowing
competitive pricing, they make clear which parts
of the economy are true profit centers and
which, by contrast, are the parts which perform
sub-optimally.
These outcomes inform investment choices such
that capital is drawn to those parts of the
economy where enhanced profitability lifts
returns and with these returns, GDP growth. In
other words, open markets identify the more
likely and natural parts of the economy where
scarce capital is best employed.
What impediments to trade, such as tariffs and
quotas, financial regulation and labor market
rigidities do, is to falsely pump up particular
sectors and industries within the economy,
making them appear more attractive and
profitable than they really are. Whereas, those
nominal attractions can only exist at the
expense of the broader community by way of
diminished incomes and lower GDP growth.
Like I say, we all have a choice but why, if we
have the option and the power would we take the
low income road over the high income one, simply
to satisfy entrenched interest groups and to
keep the political system free from trouble?
There is no revelation about this but the fact
that these truths are so often ignored makes
their recital worthwhile.
Politicians and political parties exist for one
purpose and one purpose only: to safeguard the
people while making the required and continuing
changes to the fabric of their economies and
their societies.
Politicians who are in the business of politics
but not in the business of change let their
communities down badly. The political game is
about, and only about, getting the changes
through. Bureaucracies are more than capable of
running an existing system, but bureaucrats are
not capable of changing it.
The great curse of modern day political life is
incrementalism. Moving change along, millimeter
by millimeter, taking few political risks while
pretending to be the elector's friend.
Mandates for paradigm shifts in an economy or
society belong only to politicians and to the
political system; they can never belong to
bureaucracies. Bureaucracies have no political
power on which to draw; what they do, sometimes
well and sometimes clumsily, is to filch morsels
of power which they use to incrementally move
along their own agendas.
It is no accident, that in countries where
bureaucracies have been in the ascendancy, we
find generally slower rates of economic growth
and slower rates of income growth.
Decisive cabinet government aided and abetted by
a competent bureaucracy is the highway to
change.
With that in mind and with a new government
about to take office in South Korea, your hosts
have asked me to say something about the
financial system and financial market reform.
When I first began opening the financial markets
in Australia in 1983 I used to talk about a
sclerosis which inhabited the Australian
financial system. And I used to apply the
analogy of saying we needed to clear the
financial arteries to get blood to the muscle of
the economy . That remark is as true today of
unreformed financial systems as it was then.
Open and porous financial markets can bring
financial resources to parts of the economy that
were undreamt of even 30 years ago. Financial
deregulation allows financial engineering and
packaging of a kind which the old regulated and
traditional financial system was unable to
provide. And, more importantly, unwilling to
try.
Most financial systems built around deposit
taking institutions were characterized as high
margin businesses, offering a relatively limited
range of services. Institutions of this kind
serve a society particularly badly by making
people pay too high a margin for financial
resources while limiting the size of the group
who qualify to enjoy those resources. Low
margin, big volume, fungible financial services
are able to help the great body of the community
into assets and services they require. In doing
so, they promote higher GDP growth.
The absence of unnecessary financial regulation,
also underwrites the more rapid development of
capital markets; those places where financial
resources are available to industry and commerce
other than through the intermediation of
traditional banks. For instance, Japan is the
model of a tops down bank intermediated
financial economy where, on the other hand the
United States has been the model of a much more
horizontal financial structure where
corporations and individuals have access to
capital through a vibrant capital market. Where
banks do what banks should do: look after the
consumer, the householder and the small business
entrepreneur.
Let's say of its essence; financial regulation
represents a set of structures most valuable to
the already wealthy while deregulation, openness
and fungibility present avenues which are most
valuable to the clever and the imaginative. When
a society leaves the door shut to the clever and
the imaginative while leaving it remain open to
those of established wealth, that society is
heading for second best outcomes.
That said, financial innovation also carries
with it ongoing adjustment problems and
distortions as we have seen in the United States
more latterly.
A sustained period of economic expansion like
the one we have experienced since 1982 will
generate an ever growing role for the financial
economy in world economic affairs. A 25 year
expansion characterized by low inflation and
with less circumscribed financial markets will
inevitably underwrite an expanding role for
financial services in our economic life. Indeed,
we have seen a proliferation of institutions and
services of a kind never before witnessed. And
this period, at least for half of it, has also
been characterized by accommodating monetary
conditions and high levels of liquidity induced,
in the main, by central banks.
The outcome has been a pot au feu ; a financial
milieu without precedence in financial history.
Financial innovation in this period has lead to
all sorts of financial engineering and packaging
to get financial resources into every crack and
crevice of the economy, while on the asset side,
ownership of those resources has been spread to
the four corners of the earth under every
instrument imaginable. Each new instrument
brings another new name: collateralized debt
obligations, or CDOs, derivatives, hedges,
swaps, securitized bonds and all manner of
financial units, be they in listed trusts or
private portfolios.
The fact is, for the first time in modern
history we now have a financial system whose
affairs and influences, are beyond the reach and
remedy of central banks.
However true this is, would we have turned our
back on the financial innovation which has
lubricated the last 25 year expansion; or would
we have opted for the safe house of bank
intermediated economies run in clubby cabals by
central banks, commercial banks and finance
ministries?
The answer has to be, that of course, we should
have preferred innovation over regulation,
notwithstanding the problems that too often
accompany innovation. The current sub-prime
crisis in the United States teaches us again,
that no amount of financial slicing and dicing
can turn a bad credit into a good credit.
If sub-prime loans were bad to begin with they
remained bad even as they were sliced and diced
into a collateralized security held by
unsuspecting investors. And let me add, that
none of these tendencies have been helped by
central banks who feel it is their bounden duty
to underwrite the financial adventurism of
investment banks and PE funds, by putting onto
the state the contingent cost of financial
miscalculation.
I do not think it is too much to claim that as a
consequence of the behavior of central banks and
their opportunistic clients, that moral hazard
has become the leitmotif of financial services.
This has to be a worry for all governments and
all prudential supervisors. But it is a worry
that we have to work our way through, so that we
can enjoy the advantageous aspects of financial
innovation while seeking to limit the fallout to
investors and the state alike.
North Asia, especially China and South Korea
have an enormous stake in getting the design of
their financial systems right. With economies
growing in the order of 8 to 11 percent in a
year, the ongoing resourcing of these economies
will not be possible unless their financial
systems move in tandem or are allowed to move in
tandem, with economic expansion.
And what is true of financial markets is just as
true as of labor markets.
Policy toward labor markets should be such as to
encourage labor to go to the most productive
places in the economy; to secure the greatest
increments to income. Productivity based wage
adjustments therefore represent the best way of
lifting incomes while holding down inflation.
And this is best accomplished by labor market
mobility with workers being free to switch their
time to the best jobs.
Social democratic states, very properly have
another objective: and that is to guarantee that
working people are able to enjoy a living wage,
one that lifts them and their families above the
poverty line. This can take the form of a
legislated minimum or a basic award but in
whatever form, it provides the foundation of a
civil society. We should always remember that
the point of economic policy is economic wealth
and social progress. It should never be about
top end wealth provided off the back of an army
of working poor, denied the kind of wages and
conditions that are conducive to the sustenance
of families.
We ought remember that in that great cauldron of
opportunity, the United States, real wages have
not risen since the early 1980s. That is, the
huge increments to productivity from the late
1990s on, have gone solely to profits and to
those lucky individuals at the uppermost reaches
of the corporate and financial system. This
represents a massive indictment of the United
States as the country of the fair society. This
is not a model which will suit rising societies
particularly of the Asian variety, which rely
upon the family unit, family cohesion and family
income as their nation's basic building block.
What a country needs is wage justice with full
employment. Had by directing national financial
resources to the appropriate and best parts of
the economy, unfettered by the distortions of
protectionism. Investment of the kind which,
through productivity, is able to lift wages and
profits simultaneously. Any fool can run a low
wage economy in the quest for low prices and
competitiveness, what we need are clever people
to run systems which are productivity inducing;
where real wages rise with GDP and where
competitiveness is not had unfairly from the
sweat of the low paid.
There will always be groups in the labor market
whose positions are so weak that they are unable
to bargain their way into high wages, to garner
a share of the productivity. This is invariably
true for women and young people and the broadly
unskilled. Policy has to work at protecting
these vulnerable people from exploitation while
the better off are able to reasonably enjoy
their economic rewards.
There is a real challenge here: we want flexible
and mobile labor markets with earnings related
to productivity but decency demands that we
should have this only in the context of safety
nets for the disadvantaged.
Education of course, provides the great spring
board of opportunity including, into higher
incomes. This is why an economy becoming more
urbanized, with greater service orientation has
to have a premium on education. Education is the
conduit through which higher levels of
productivity are had.
Education has been a notable and strong trend in
Korea; it knows the way forward in the post
industrial age. A country like Korea must
continue to lift itself up the international
division of labor and not be left behind to
compete with low wage countries.
There is nothing more noble than lifting the
great body of a population into higher levels of
employment and income; indeed, there can be
nothing more uplifting for a political system
than lifting up the great body of a community.
But this can only be done by governments
competent in the ways of the world: knowing
about the economy, knowing about business,
knowing about the financial system, knowing
about the workforce. Guiding policies with a
kind and thoughtful hand.
Financial, product and labor market deregulation
has brought much wealth to countries which have
promoted these policies. Australia, as a case in
point, has now experienced a continuous 17 year
expansion averaging near 4% GDP growth per annum
with inflation at 2.5%. In the 25 years since
1983, real incomes in Australia have risen by
one third, over 30%. The largest increment to
incomes at any time in the twentieth century.
These policies will work just as well for Korea
as they have worked for Australia.
Given that all societies are different, the
variations on the theme in Korea will of course
have to be Korean. But the underlying efficiency
of the changes is guaranteed to lift people more
rapidly up the income scale and to lift Korean
GDP more obviously up the international totem
pole.
It is a very encouraging development indeed,
that one of this country's premier newspapers,
Chosun Ilbo, is committed to these kind of
outcomes and is prepared to meet the
organizational responsibility of promoting a
conference of this kind in promotion of those
outcomes.
Let me congratulate the newspaper, its
management and staff, on this important
initiative.
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