The financial and economic indicators that signal the start of a downturn are evident in advanced economies.
Australia is at particular risk with households currently the second most indebted in the world and with a total private sector debt ratio of 205% of GDP.
We are facing a serious economic security challenge; however, most Australians do not appear to appreciate that economic security is the foundation of national security.
We cannot rely on past economic performance and assume that we will have the resilience to address the significant economic risks in the decade ahead. Australians need to face an unpleasant reality and take appropriate action.
If you read the newspapers in early January this year you could be excused for feeling some anxiety when you saw Deutsche Bank’s grim warning of the top hazards threatening global markets in 2019 with one of the top 30 factors being the potential “house price crash” in both Canada and Australia.1
Other reports noted that the global economy is “leveraged to the hilt with a $264 trillion problem2
These warnings have been sounding throughout 2018, e.g. in June it was reported that “global and Australian economies are experiencing record and abnormally high structural imbalances that in previous historical episodes have resulted in catastrophic economic and social outcomes.”3
So, how is our Government addressing these risks?
In the Mid-Year Economic and Fiscal Outlook in December 2018, the Government stated that their “economic plan is working, delivering a strong economy and making real progress in restoring the nation’s finances … A strong budget position allows Australia to face the future with confidence, providing a buffer to respond to any adverse developments that might occur in the global economy.”
It reported that the global economy has continued to grow at a solid rate since the start of the year and forecast global growth of 3.75 per cent is expected in 2019 and 2020, while growth in Australia’s major trading partners is forecast to be 4 per cent in each of the next two years.
This is a picture in stark contrast to the analyses reported in the media.
The claim that the Australian economy will have a buffer to respond to any adverse developments that might occur in the global economy, suggesting that we have adequate economic resilience, is fanciful at best.
This situation is a bit like flying in an F/A-18 when the master caution light comes on, accompanied by an engine fire light and multiple systems failures, and then deciding to ignore the warning and just talk about how well the flight has gone so far. The difference in an F/A-18 is that in a crisis you have a checklist that you can follow that has a good chance of working. If it doesn’t, there is always the ejection seat.
We don’t have a checklist or an ejection seat for the economy … and, if our economy is severely impacted, then so is our national security, because in order to have national security, Australia must have economic security.
This article will discuss national and economic security, economic risks, our economic trajectory and then explore the potential impact on national security using Australia’s defence budgetary approach and assumptions as an example.
National Security and the Economy
For the purposes of this article, national security is defined as the survival of the Nation through the use of economic, diplomatic, military and political power.
Understanding the complex systems nature of national security and why the economy is a part of the equation is crucial.
However, trying to build an understanding of our economy from the perspective of a non-economist is a major challenge. The language of economics is opaque (similar to that of Defence),academic and business sector views are often contradictory and historical economic models are now less relevant as the global economy staggers under growing debt and a challenging political environment.
Most importantly, the lack of clearly stated, shared assumptions related to our economy is a significant risk factor in itself.
If you come from a Defence background you may initially search for an “Economy White Paper” and hopefully an integrated, forward‑looking, and outcome‑based strategic plan for our economic security that has bi-partisan support.
You would be disappointed.
A clear statement of risks, considered options and a coherent, integrated plan appears absent. In contrast to Australian Foreign Affairs and Defence policies and plans, the Government’s economic policies must be deduced from budget statements and a plethora of political announcements and claims which are often targeted at the opposition, thus precluding a coherent bi-partisan approach in favour of electioneering.
In their July 2018 Australian Financial Review article, Professor Peter Drysdale and Mr Shiro Armstrong from the ANU noted that “the problem lies in how Australia’s strategic policy choices are currently being framed and made … Strategic policy is overwhelmingly framed from a security perspective in political-military terms.
“Yet the economic dimension of national power and influence is also central to the hard choices to be made on strategic policy … taken separately, the responses of the security specialist and the economist are each inadequate … the problem is that Australia’s strategic decision making is not currently configured to integrate security and economic considerations in a way that balances and integrates these twin objectives.” 4
The authors have identified a key gap in our development of strategic policy.
Another significant gap is the lack of an Australian National Security Strategy.
Australia needs a strategic, forward‑looking, outcome‑based plan for its economic security that is integrated with the other elements of national security under a National Security Strategy.
At the time of the 2008 financial crisis, Australians were fortunate that the preceding Hawke, Keating and Howard Governments had taken political risks in order to build a strong economic base that had the ability to deal with the subsequent financial crisis. An October 2018 Treasury Working paper on Australia’s experience with economic reform in the period 1983 through to 2000, details bold and visionary economic policies such as the floating of the dollar, the Prices and Incomes Accord, Tariff Reforms, the Charter of Budget Honesty and the introduction of the GST. The paper states that most of these actions were arguably the most premeditated and planned economic reforms undertaken in Australia, particularly where they demanded coordination between Federal and State governments. In military terms of preparedness, we had appropriate resilience (readiness and sustainability) in our national economy as a result of these collective actions. As the Treasury paper notes, it is evident that policymakers of that time were mostly persistent in their pursuit of reform, they did not give up in the face of adverse outcomes or events and, perhaps most importantly, appeared to learn from past mistakes.
The 2008 financial crisis revealed major gaps in many economist’s understanding of financial intermediation. Enormous efforts were made to counter the downward trend that had led to the global economy shrinking for the first time in more than 60 years, and to restart the “growth engine.” Despite economic stimulus, ballooning debt burdens, record low-interest rates, and many guarantees applied to markets or entities requiring support, growth targets were regularly missed – even today, after some 10 years, that “growth engine” is still spluttering, and predictions are regularly revised downward. So far, few people have picked up on the paradox of how little has come from all those unprecedented interventions. We are all still hoping for things to get better next year.
Currently, Australian public sector debt levels are relatively good compared to many other developed countries; they were 41.7% of GDP in 2017. This level of government debt and the servicing of that debt is not considered to be a significant economic risk. However, it should be remembered that current debt levels do not reflect the total risk to our economic resilience as obligations in unfunded promises do not represent deficits today but will represent deficits and debt in the future.
The greater risk factor for the Australian economy is private sector debt which was at 205.5% of GDP in 2017. Australian households are currently the second most indebted in the world (after Switzerland) with a 121% debt to GDP ratio in Jun 18. Australia’s private debt levels are largely attributed to home loans, which have come at the expense of productive business lending. The credit ratings agency, Moody’s, has stated that “A key issue for the Australian sovereign and the country’s banking sector is their reliance on overseas funding … This means a relatively greater vulnerability to ‘event risk’ than most other AAA-rated sovereigns.”5
As at June 2017, the banking sector had borrowed some $850 billion from offshore, equating to 49% of Australia’s GDP. More than 90% of this lending for property investment was for existing houses, not for new housing that would help boost supply.6
This is, in effect, non-productive debt.
When reflecting on Australia’s economic security and resilience, it is concerning to read an October 2018 speech made by Jennifer Westacott, Chief Executive of the Business Council of Australia. She noted that household debt is at a record high … half of that GDP growth in the June quarter reflected household and government spending … you have to question the sustainability of that … new business investment fell in the June quarter, and is … as low as it was coming out of the 1990s recession.
The combination of global risks, high household debt, high government debt, weak wages and low productivity led her to pose an important question: is this a recipe for resilience in a volatile world?7
An additional example of unfunded liabilities of concern can be found in the pensions sector.
Actuarial reviews of the Commonwealth’s defined benefit pensions funds found that the total unfunded government liability has increased to $216 billion with only $150 billion of the estimated liability backed by Future Fund assets.
The Australian Government 2018 budget papers predict a liability peak at around $315 billion in 2050.8
This, before we count the unfunded pension liabilities of the State Governments.
However, this pales into insignificance compared with the total value of unfunded or underfunded government pension liabilities for twenty OECD countries which was estimated in a 2016 Citibank report to amount to $78 trillion, or almost double the $44 trillion published national debt at that time.9
This is truly a global economic security and societal risk.
For Australia, economic security requires the resilience to fend off both economic and non-economic challenges. Many Australians have a tendency to view conflict in military terms and to define our response though a build-up of military capability and alliances.
However, an adversary may choose not to threaten us militarily but rather to achieve their goals by impacting our economy through control of trade or energy supplies. Given that over 90% of our liquid fuels are imported, it is not difficult to envisage such a scenario.
Unfortunately, successive Governments have elected to leave this particular aspect of or national and economic security to the “market.”
Economic Security and Defence
Whilst Australia must have an appropriate military capability, such a capability requires a solid economic underpinning and a level of economic output that supports allocation of adequate resources to all elements of society.
Given the concerns regarding our economy and the apparent lack of coherent bi-partisan approach to improving Australia’s economic security, what are the implications for Defence budgets and therefore military capability?
The 2016 Defence White Paper released on 25 February 2016 set out a comprehensive, long term plan for Australia’s defence. The Government stated that “The plans in this Defence White Paper have been cost-assured and externally validated. Australia’s defence strategy and capability plans have been aligned with funding. These plans are affordable and achievable.”
The problem with the Defence Budget was that, according to the Australian Financial review, it was not based on “the amount of spending required to provide an acceptable level of security. Instead it is a rule of thumb that says we should spend about 2 per cent of our national income, or GDP, on defence.
While this 2 per cent target enjoys bipartisan support in Canberra, neither party has been able to explain how it meets Australia’s security and defence requirements … It is a measure of the defence burden on the economy, not a measure of security … To that end maybe the lack of a clearly defined national strategy, along with commitment to spend 2 per cent of GDP, is Canberra’s way of sitting on the fence. 10
In November 2016, the ADF’s future operating environment assessment included the following statement: “A combination of global population growth and increases in productivity is likely to see an average world GDP growth of about 3.5% in the years to 2035.”11
This figure would have been provided to Defence by Government. The analysis did not appear to have addressed the risk for the Defence budget and the force design in that assumption.
If the growth assumption does not eventuate and our economy stagnates, what is the risk to our defence capability and therefore to national security?
At the time of the White Paper, the provision of contingency for future funding pressures was understood to have been included in the Defence Budget to address that issue.
However, due to a lack of subsequent cost discipline and a focus on platform vice a balanced, whole of force acquisition model, project costs growths appear to have absorbed the contingency funds and have incurred a further budget shortfall as discussed in the following paragraphs.
Defence White Paper projections and budget estimates have had a history of being somewhat flawed and lacking in transparency. So, how is the Defence budget travelling in the two years since the White Paper was launched? The Australian Strategic Policy Institute’s Cost of Defence 2018-2019 Reportis the best public source of analysis available. 12
The report makes the following defence budget related observations:
- The Australian Government is broadly meeting its commitment to get the defence budget to 2% of GDP. But the content and timing of Defence White Paper’s investment program have not been revisited, despite changes (for the worse) in the strategic environment it was intended to address.
- Funding pressures are already emerging, with more to come in sustainment and personnel right at the time when a large share of the investment budget is being tied up in shipbuilding.
- There are no guarantees that future funding will be delivered.
- Informed decision making and public debate on these issues is essential to navigating them in order to keep Australia secure. To support this, the government needs to demand Defence provide greater public transparency in its planning and reporting. investment.
- The government has capacity to invest more in defence capability, should it want to; however, it would need to make a compelling case for any additional expenditure to an Australian public that doesn’t currently see national security as a key concern.
ASPI’s conclusions should concern all Australians.
Whilst the lack of transparency makes it virtually impossible to gauge the full extent of budget pressures on Defence, the extent of existing budget pressures within the capital investment program is probably the worst-kept secret around Canberra at the present time. It has already resulted in project budget slippages which have not been made public because of the somewhat disingenuous technique of delaying project budgets whilst maintaining unrealistic Initial Operating Capability dates.
This, combined with “unquantified” future funding obligations such as the rapidly growing cost of the submarine project, JSF sustainment costs, and the growth in operating and sustainment costs resulting from the significant expansion in defence capabilities, makes the defence budget a risk even at projected GDP growth levels.
If we discount budget growth based on a risk of economic stagnation in the 2020s, the potential pressures grow significantly. We could face the risk of replicating the “hollow force” problems of the past; e.g. platforms but insufficient weapons, lack of upgrades, lack of key force integrators and insufficient sustainment funds. Perhaps a 5thGen Force needs a 5thGen business model that takes such risks into account?
With a stagnating economy, budget pressures would, of course, not just be confined to Defence. Federal and State budgets would also come under immense pressure.
Given ASPI’s contention that the Australian public does not currently see national security as a key concern, it would seem sensible to have a public discussion of the potential impacts of the economic risks we face and the consequences for defence and, in turn, national security.
This may result in more prudent investment decisions than have been made in recent years; for example, the investment required to make Australia a “Top 10” arms exporter in the world may be better redirected to more economically productive outcomes that help build a more resilient economy and, in turn, a resilient Defence Force.
The bottom line is this – it appears that we are blind to the economic risks we face in the coming decade, largely for near-term political reasons.
In this Defence example, we appear to be proceeding with the implementation of a Defence White Paper that is both out of date and out of synch with present global economic realities and we face the risk of recreating a hollow force in the future.
Conclusions and Recommendations
We must ensure that we have adequate resources to protect Australia and to ensure our national security. As long as governments and central banks continue their current trajectory we may see a period of protracted economic stagnation. A consequence of this situation, and the resulting behaviour of institutions, is a growing disenfranchisement of large segments of the voting population in advanced economies. The risk is then that the strength of institutional defence mechanisms against the next crisis are weakened.
The economic warning signs are growing stronger each month and to ignore them is foolhardy. We must acknowledge that the problem is not just the current debt; it is the unfunded obligations that will be future debt that grows faster than inflation and faster than the economy grows.
We need to analyse a range of scenarios based upon credible threats for both today and the future, and to determine what actions can be taken to limit the risks for our economy. We need to face reality and understand the resource constraints that we have and are going to have over time. There needs to be a public debate leading to a bi-partisan approach.
The economic dimension of national power and influence is central to the hard choices to be made on strategic policy. Currently, Australia’s strategic decision making is not configured to integrate security and economic considerations in a way that balances these twin objectives. Australia needs a strategic, forward‑looking, and outcome‑based plan for its economic security that is integrated with the other elements of national security under a National Security Strategy.
To paraphrase the 2018 Treasury Working paper discussed previously, we need a current generation of policymakers who can be persistent in their pursuit of reform, who will not give up in the face of adverse outcomes or events and who can to learn from past mistakes. Perhaps the Economist Magazine was right when it published the following description of Australia: “Australia is one of the best managers of adversity the world has seen – and the worst manager of prosperity.’’
This article has been produced by the The Institute for Integrated Economics Research (IIER) – Australia Board Members: John Blackburn AO, Anne Borzycki, Neil Greet and Dr Gary Waters.
This article was first published by Australian Defence in February 2019 and is reproduced by permission of the authors.
- Expert reveals most dangerous threats to the global economy in 2019, A. Carey, news.com.au 2 Jan 19
- Leveraged to the hilt: The world has a $264 trillion problem, S. Bartholomeusz, The Canberra Times, 1 Jan 19
- Six pathways to Australia’s ‘economic armageddon’, F. Chung, news.com.au, 19 Jun 18
- Australian Financial Review, 8 Jul 18, Getting Australia’s geopolitical and economic strategies aligned, By Peter Drysdale and Shiro Armstrong
- Australia’s Debt – an honest debate, D. Smith, Jan 18. https://www.dicksmithfairgo.com.au/wp-content/uploads/2018/01/Debt-Paper-Brochure_Screen-1.pdf
- Speech to the 2018 Outlook Summit, 11 October 2018, Australia needs to lift Productivity Growth, by Jennifer Westacott, Chief Executive of the Business Council of Australia.
- John Ferguson, Public sector super liability projected to hit $216bn by June 30, The Australian, 9 May 18
- Citibank Report – The coming pensions crisis,Mar 16. http://www.agefi.fr/sites/agefi.fr/files/fichiers/2016/03/citi_retraite_hors_bilan_21_mars_1.pdf
- Will Australia’s annual $35b defence budget stand the test?Robertson and Yuan, AFR 3 May 18
- Future Operating Environment: 2035, published by the authority of the Vice Chief of Defence Force, Nov 16.
- The Cost of Defence, ASPI Defence Budget Brief 2018-2019, May 2018.