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Challenging orthodoxy in the battle for sustained growth, Australian FInancial Review 16 April 1999

Beyond Meltdown: The Global Battle for Sustained Growth, Peter Brain, Scribe Publications, Melbourne xiv+273pp

Although he has long been well-known among economic modellers, Peter Brain achieved his five minutes of national fame when he was among the first to correctly predict the severity of the Asian crisis, sparked off in 1997 by a run on the Thai baht. His subsequent prediction of a severe flow-on effect for Australia has not yet been fulfilled, but, as the introduction to his new book reminds us, it is too early to tell whether or not he will turn out to be right in the end.

Brain's forecast of the Asian meltdown is particularly striking when it is remembered that works extolling the 'Asian economic miracle' continued to appear right up to the beginning of the crisis. There was also a long-standing tradition in Australia which warned that we were doomed to become the 'poor white trash' of the region unless we mended our ways. Mostly, but not always, mending our ways was taken to mean the adoption of radical microeconomic reform on free-market lines.

Brain was not the only one to see the weaknesses of these arguments. Any competent application of standard neoclassical growth theory yielded the conclusion that the Asian boom could not last forever, and that the 'white trash' thesis rested on shonky statistics. A number of economists pointed this out, most famously the US enfant terrible, Paul Krugman in an article entitled, 'the myth of Asia's miracle'.

However, as Krugman himself concedes, while standard growth theory yielded the prediction that Asian growth would eventually slow, it did not predict the crash that actually occurred. Indeed, neoclassical economics has largely been based on models of gradual adjustment to equilibrium, in which crashes and meltdowns do not happen. Since it seems pretty clear that crashes and meltdowns do happen, economists (at least those not so dazzled by the beauty of their models that they are unable to see the outside world) have long been interested in promises of a theory that would explain, and better still predict, such crises.

So far, they have been disappointed. Models of the business cycle based on an complex versions of the Keynesian multiplier effect were popular for a while, but have now been abandoned as excessively mechanical. The 'catastrophe theory' developed by French mathematician Rene Thom enjoyed a vogue in the 1970s, but it turned out to be just a cute marketing label for a branch of differential geometry, with little genuine relevance for economics. More recently, there has been a revival of interest in game theory. Models influenced by game theory can produce bubbles, booms and crashes. Unfortunately, the main message of game theory is that 'anything can happen'. Economists have got about as far in predicting crises as have seismologists in predicting earthquakes, that is, not far at all.

Since it seems unlikely that any grand theoretical model of economic crises is at hand, a mixture of formal modelling and intuitive insight is going to be our best hope for some time to come. Brain offers just this kind of mixture, so it is certainly of interest to see him explain his view of the world.

As his subtitle 'The Global Battle for Sustained Growth' suggests, Brain does not believe there is anything easy about the attainment and maintenance of a stable growth path. On the other hand, although he suggests at one point that economic growth is a 'zero-sum' game, the book is not, as one might imagine, part of the alarmist literature on the inevitability of trade war.

Brain claims that economic growth is zero-sum because the success of any one country in exceeding the technologically determined world average rate of growth (about 3.5 per cent per year, he suggests) will inevitably attract capital, innovation and new industries away from those that fall short. His use of military metaphors relates, not so much to a view of economics as a theatre of international conflict, as to his conviction that the achievement of sustained growth requires military-style strategic planning, co-ordination and control and a close watch on the strategies of competitor nations.

Brain's main target is the 'neo-liberal' model, based on the notion that unfettered market forces will guarantee the maintenance of economic stability and growth. After setting out the complex conditions required for sustained growth, including the need for internal and external balance, financial stability and a steady supply of investment opportunities, Brain concludes that 'condition failure should be the expected reality, with the satisfactory working of the mechanism for year after year being the exception rather than the rule'.

At this point, readers who have been imbued with the neo-liberal view of the world will be getting impatient. The miracle of simultaneous equilibrium in many markets, which Brain sees as so difficult to achieve, is precisely what the invisible hand of the price mechanism is supposed to produce without any need for intervention. Brain never confronts this claim head-on. Rather he uses his view of the world to motivate a way of telling the story of the recent economic history of Australia, Asia and the United States. In Brain's version of the story, the price mechanism plays at best a supporting role. Readers will have to judge whether they find this story more plausible than the neo-liberal account in which deviations from equilibrium arise only from the misguided interventions of governments.

In the aftermath of the Asian meltdown, it is Brain's analysis of financial stability that is most interesting. Brain argues that the role of international capital flows as a cause of the crisis has been overstated and that the fundamental problems have arisen from failures of prudential regulation. However, far from constraining governments to follow sound regulatory policies, foreign lenders allowed unsound boom conditions to be maintained longer, increasing the severity of the inevitable crash.

Brain's analysis of the consequences of financial deregulation in Australia follows broadly similar lines. By allowing greatly increased indebtedness, deregulation generated a boom in asset prices. Because the real economy was not overheated, the authorities were initially unwilling to deflate the boom through a general increase in interest rates. When they finally acted, the result was a severe recession. This interpretation of the 1980s is consistent with what is now the general consensus. However, whereas the official view is that the excesses of the 1980s were 'teething difficulties' of deregulation, Brain sees the same problems re-emerging in the near future, as households take on steadily increasing levels of debt and the Asian crisis finally bites.

The central lesson of the Depression era, that a stable financial system can be achieved only through the imposition of stringent and independent regulation, has been forgotten by policymakers in the developed countries and was never learned in the emerging markets where the tradition of doing business on the basis of personal connections was extended to monetary policy and prudential regulation. Brain argues that to control financial speculation without choking the economy, policymakers must be prepared to resort to quantitative controls over the direction of credit when and where necessary. In view of the dangers of crony capitalism, this requires a degree of accountability which is hard to achieve and maintain.

Brain offers a highly individual view of the world, and most readers will find points of agreement and disagreement. For example, in his list of six necessary conditions for sustained growth, Brain nominates 'human capital balance', that is, the availability of a skilled and well-educated workforce, as the easiest to achieve. In keeping with this view, issues related to education receive only brief mention in the book, even when topics such as the rise of the 'knowledge industry' model in the United States are being discussed. Yet the problems of education policy in Australia seem at least as intractable as those of industry policy, and the dangers of simple-minded neo-liberalism at least as great.

On the other hand, Brain is right on the mark in pointing out the emergence of the 'global city' (Sydney, in the Australian case) as a major factor in the resurgence of inequality within developed countries. This phenomenon seems much more compatible with Brain's view of the need for strategic planning to capture the opportunities created by the global economy than with the neo-liberal view that governments should confine themselves to constructing an 'investment-friendly' framework of sound fiscal policy and low taxes in the faith that 'if you build it, they will come'.

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