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The Paradox of Debt w/ Richard Vague, ex-Sec. of Banking & Securities, Pennsylvania – EP195

Economics Explored host Gene Tunny chats with Richard Vague, a prominent American businessman and investor, about his new book, “The Paradox of Debt: A New Path to Prosperity Without Crisis.” Richard, who has previously written about “The Case for a Debt Jubilee”, shares powerful insights into the benefits and drawbacks of debt, discussing how it can help grow household wealth while also promoting economic instability and rising inequality. He also offers thought-provoking ideas for helping households and businesses manage and reduce their debts. 

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored

Note: this episode was recorded in mid-June 2023, i.e. before the Supreme Court decision regarding student loan relief, which is why the decision isn’t mentioned in this conversation. 

You can listen to the episode via the embedded player below or via podcasting apps including Google PodcastsApple PodcastsSpotify, and Stitcher.

About this episode’s guest: Richard Vague

Richard Vague served most recently as Secretary of Banking and Securities for the Commonwealth of Pennsylvania. As the author of The Paradox of Debt (2023), The Case for a Debt Jubilee (2021), A Brief History of Doom (2019), and The Next Economic Disaster (2014), Richard Vague established himself as a clear and independent voice in the ongoing conversation about the role of private sector debt in the global economy.

What’s covered in EP195

  • [00:04:39] Debt and the global financial crisis. 
  • [00:11:23] Debt always grows faster than the economy, Richard argues.
  • [00:12:53] Increased debt and higher net worth. 
  • [00:17:23] Paradox of debt and inequality. 
  • [00:23:01] Type one and type two debt. 
  • [00:28:50] Regional banking crisis in the US. 
  • [00:32:13] The paradox of debt: summary. 
  • [00:35:10] Debt forgiveness in the private sector. 
  • [00:41:43] Debt restructuring in banking. 
  • [00:47:48] A win-win-win solution. 
  • [00:49:53] Massive job training as something Richard would like to see.

Links relevant to the conversation

Where you can buy Richard’s new book The Debt Paradox: A New Path to Prosperity Without Crisis:

https://www.amazon.com.au/Paradox-Debt-Prosperity-Without-Crisis/dp/1512825328

Richard’s previous book The Case for a Debt Jubilee:

https://www.amazon.com.au/Case-Debt-Jubilee-Richard-Vague/dp/1509548734

Gene’s conversation with Allen Morrison about the Enterprise China model which he mentions this episode:

https://economicsexplored.com/2022/12/26/enterprise-china-what-western-businesses-need-to-know-w-prof-allen-morrison-ep171/

Transcript:
The Paradox of Debt w/ Richard Vague, ex-Sec. of Banking & Securities, Pennsylvania – EP195

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It was then looked at by a human, Tim Hughes from Adept Economics, to correct anything an otter might miss. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:06

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host Gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show.

Hello, thanks for tuning into the show. This episode I chat with Richard Vague about his new book, The Paradox of Debt, a new path to prosperity without crisis. Richard Vague is a prominent American businessman and investor. He’s a former secretary of Banking and Securities for the Commonwealth of Pennsylvania. He sits on the University of Pennsylvania Board of Trustees as well as on the boards of other prestigious organisations such as the Institute for New Economic Thinking. As you’ll discover Richard has some powerful insights into the good and bad aspects of debt. He talks about how it helps grow household wealth, while also promoting economic instability and rising inequality. Richard offers some thought-provoking ideas for helping households and businesses de-leverage and get their debts under control. Richard’s book is definitely worth a read. So I’d encourage you to grab a copy of it after you listen to this episode. I’ll include a link to the Amazon page for the book in the show notes. Okay, let’s get into the episode. I hope you enjoy my conversation with Richard Vague on the paradox of debt.

Richard Vague. Thanks for joining me on the programme.

Richard Vague  01:54

Thank you so much for having me.

Gene Tunny  01:55

Excellent. Richard, I’m keen to speak with you about your new book The Paradox of Debt. Debt’s a huge issue around the world. I’ve had recent shows on the debt ceiling in the US and and also the, what they’re calling the emerging economy debt crisis, there’s been a lot of discussion about that. And it’s one of those things that seems to come back every now and then we have these, these debt crises in various places. And in your book, you’ve got, I think, a good description of historically what’s been happening in this, this process that we’ll talk about. Could I ask to start off with what made you want to write this book? What motivated you to write the paradox of debt?

Richard Vague  02:42

Well, thank you so much for asking. And thanks, again, for having me on your show. We had done a lot of work for a number of years about financial crises be it in the Great Depression, or the great financial crisis of 2008, and so forth. And really, all of those are tied up in private debt and really rapid escalations of private debt. And we wrote a book called A Brief History of Doom that chronicled the 43 largest financial crises in the world over the last 200 years. And as we went around and presented that folks would love what we had to say, but ask you know, what about the other side of the balance sheet? You know, what about the assets that these individuals have? And? And can you put this together with the government debt story that we normally spend more time on? So I after hearing that for a few years, I finally said, well, that those questions are legitimate, they’re productive. So let’s roll up our sleeves. And let’s get into it. Let’s look at the entire balance sheet of countries of the sectors within those countries. And that’s this book.

Gene Tunny  03:54

Okay. So you wrote a previous book, and you’ve been speaking with various different people about that. And this gave you the idea. You’ve had a distinguished career in business and public service. Are you taking lessons from that? Are there things you that you saw in your career that have helped inform this book that you’ve written?

Richard Vague  04:14

Absolutely, you know we were in the banking business. So I studied debt, from the context of being a president of a bank. For years and years and years. It’s all I did, but I didn’t think you know, when you’re CEO of a company, you really thinking about the results of that company, and you don’t step back and think about the equation as a whole. And so that’s that really changed in 2000 and 5,6,7, when we began to see this tsunami of mortgage debt in the United States that ultimately ended up being the great global financial crisis. So we I honed my ability to look at debt and my interest in debt over an entire 30 year career, but it took the GFC for me want to step back and look at it holistically.

Gene Tunny  05:11

Gotcha. Right. Okay. And you mentioned the balance sheet. So you wanted to look at all of the you want to look at the debt, you wanted to look at the, well the liabilities for the people who owe the money. But you also wanted to look at the the assets. So is that part of the problem is the problem that a lot of the money that was borrowed was spent on unproductive investments? Is that is that one of the issues that you’ve been looking at?

Richard Vague  05:41

Well, yeah, and I want to be careful with the word unproductive. There. But yes, when you see a great financial crises, as we’ve had in this country, many, many times, we had one in the Great Depression, we had one and the 1980s, we of course, had one in 2008. You see lenders lending too much. And really, what we see is they’re doing loans that in normal circumstances would be just fine, mortgage loans, commercial real estate loans, but they overdo it. They do too many mortgage loans, they do too much construction debt. And not just a little bit too much, an egregious amount too much. So let’s take the 08 crisis, mortgage loans in 2002, were 5 trillion in the US by 2007. They’re 10 trade. So they doubled in five years. Well, you had to be a blind man to miss that. Or you had to have economic theories that excluded debt as a variable. And that’s really the way the Mac, the Orthodox macro economics profession looks at the economy, then their models don’t even take debt as a factor. So if you were looking at debt, it was easy to spot. It was egregious. And clearly, it’s one of the things we study.

Gene Tunny  07:16

Okay, so a couple of things that I’d like to discuss, Richard, what do you mean by their models? Don’t consider debt is a factor is that you? Are you saying that they’re too short term that they’re not thinking about the longer term and debt is in the short term, maybe you can get away with a buildup of debt. But in the long term, there can be a reckoning. So I just want to understand exactly what you’re saying there?

Richard Vague  07:41

Well, it’s surprising. But what’s called the DSGE model, which is the core model used by the Federal Reserve and academic economists everywhere, simply does not have bank and other forms of debt as a variable in the model, period. And you know, as as a career banker, I find that shocking. I’m not sure how you can study an economy without studying debt. But that is, in fact, the case. And it’s pervasive in orthodox economics. And that’s the very simple, straightforward reason that, you know, in 2005, and six and seven orthodox economists, were absolutely sanguine about the economy. At the very moment, it was about fall apart.

Gene Tunny  08:35

Yeah, yeah. I understand what you’re saying. And, and that’s true. So you’re talking about these DSGE models, these dynamic stochastic general equilibrium models of the economy. And yet you look at the macro models that the central banks run, and yeah, I mean, they’ve got a lot on inflation expectations on they’ve got their, their Phillips Curve and their Taylor rule. So they’ve got all of these traditional macro economic equations in them. But yeah, I have to look at what our RBA our Reserve Bank of Australia is doing here. But yep, I take your point and understand what you’re saying there. Now, I might have to have another look at that. And, yeah, I mean, I agree about in the lead up to the financial crisis. I mean, what was extraordinary about that I was in the when I was in the treasury at the time. So we were following it from the government perspective, also what was happening in the private sector, of course, because that was relevant to the state of the economy, government revenue, and what we’d have to borrow. But yeah, I remember just how much it did take a lot of people by surprise that suddenly everyone was talking about Hyman Minsky again. And someone who was considered a heterodox economist. And suddenly, everyone’s talking about the Minsky moment. So yeah, very, incredibly revealing time that one. So yeah, that’s more of a comment.

Richard Vague  09:56

Yeah, what I would say is, you know, I spent my career as a financial analyst, you know, as a as a bank executive, as a bank CEO, as in any of these capacities, you look at companies and industries, in the context of a balance sheet and income statement. And all any economy is, is the sum of the individuals and businesses and other institutions, primarily government institutions. In it, you just add those all up, and you have the aggregate balance sheet of the country. And so, you know, not coming up through a traditional economics route. I just took it as a given that the proper way to study an economy is the way I studied businesses and industries as a financial analyst. And this book, The Paradox of debt is that exercise, we just go in, and we look at it the way, you know, a financial analyst would look at it. And you’ll see for all seven of the largest countries in the world, we have assets, liability, income and expense, and we draw conclusions from that.

Gene Tunny  11:12

Okay. From that framework, Richard, what would you say are your key insights, and how that are different from the traditional way of looking at it?

Richard Vague  11:23

Well, one of the key insights is that debt always grows faster than the economy itself. And I spent decades in my banking career not even thinking about that. But to the extent I did, assuming that debt, you know, ebb and flow that it went up went down. But you know, over time, it was in a similar rein. That’s not even remotely true. Debt always grows faster than the economy. And we see that in the seven largest economies in the world that together constitute 60 plus percent of GDP. In the US, you know, circa 1980, debt to GDP, total debt, government debt, and private sector debt was 125% of GDP. Today, it’s more than double that level. So there’s no equilibrium, we are getting more and more leveraged as economic entities. So that’s the first thing that kind of hit you in the face, like a two by four, you know, we’re getting more and more leveraged. One of the other things that really is, you know, a central conclusion of this book, and again, was something that I hadn’t thought about, but is abundantly ever evident from the data is, the more debt you have, the higher the net worth of households go? So in 1980, at the time, you know, total debts 125% household net worth is about, let’s call it 350% of GDP. Here we are, you know, what is it 40 Something years later, debt has doubled. Net Worth, the net worth after subtracting debt of households is now almost 600%. So we should we actually demonstrate in the book that debt increased debt actually causes asset values to go up? And, you know, that’s good news insofar as it goes, but we also see show that it, it severely increases inequality, because the top 10% are the primary asset holders. So they’re seeing their net worth go up, you know, abundantly and folks kind of in the middle class and below, are not seeing increases in their net worth to GDP.

Gene Tunny  13:51

Gotcha. Okay. So yeah, a few things there. The so you talk about the tendency of debt to grow faster than the economy, and you’re talking about both private and public sector debt?

Richard Vague 14:03

The two added together.

Gene Tunny 14:06

Okay. And that you call this a debt staircase? Is that correct?

Richard Vague  14:11

Yeah, we’re very intentional about that, because most people call it the debt cycle. And while that’s, you know, somewhat accurate, it implies that debt returns to the previous level. Well, that essentially never happens. Debt will go up rapidly and then might come down, you know, a little bit it almost never comes down at all, frankly, and only in a calamity. And then it might plateau for a little while, and then it rapidly ascends again, to an entire new level. So we felt like debt cycle in a certain sense was misleading. So debt staircase really talks about we jump up to a new level plateau jump up in either higher level. That’s really been the history of debt in most countries.

Gene Tunny  15:05

Yeah. So I think this is that Ray Dalio, his idea of a debt cycle. I’m trying to remember who you are, I guess plenty of people, commentators talk about a debt cycle and leveraging

Richard Vague  15:16

it’s a natural tendency to think of things going up and down like a sine curve or something.

Gene Tunny  15:21

Yeah gotcha. Okay. Now, I want to go back to this, yeah, this tendency to go more and more into debt. And you mentioned that it does increase net worth. household net worth over time, and it’s increasing inequality. Yeah, I guess I’d probably Yeah, maybe I think too much in terms of the cycle. So I guess the story, many commentators or economists will tell us is the boom bust cycle. And there’s the exuberance, the over exuberance, and there’s too much lending, because there, there’s just too much optimism or frothiness, about the state of the economy and potential investments. And we see this time and time again, whether it’s railroads or whether it’s IT, whether it’s housing, there’s a there’s a new boom, and that’s when all the new debt gets created. So I’m just wondering, but it sounds like it’s not just a boom and bust phenomenon is it, you’re saying that this is something that actually has a there’s a trend increase in, in debt over time,

Richard Vague  16:30

you’re hitting the nail on the head, you know, I think that when people say boom, bust cycle, debt cycle, things like that, they kind of the unspoken implication is things return to the way they were previously. But that’s simply not the case. We instead, we have a boom, we have a bust, but we’re at an entirely new and higher level of leverage or indebtedness.

Gene Tunny  16:58

Hmm. Okay, I might ask you about this, what you call the paradox of debt. In your epilogue, you’ve got a really great summary of what this is. So I’ll just read this out, because I think this is really, really great. “This has revealed the paradox of debt, debt builds household net worth while also increasing inequality is essential for economic growth, and yet in excess leads all but inevitably to periodic economic calamity and stagnation. As a result, the paradox of debt portends the certainty of economic challenges and difficulties going forward, unless we are willing to get creative, and ambitious.” So I think that’s a really great summary of your of your arguments in this book, I want to unpack that I’d like to ask first, could you just explain again, how does this it builds household net worth, I get that because households are borrowing to invest in housing, but also in some other assets. But it also increases inequality. How does that work, Richard? How does it increase inequality at the same time?

Richard Vague  18:11

Well, this gets back to the relative distribution of stocks in real estate. Right now in the United States, household net worth is about $150 trillion. Let’s put that in perspective. Aggregate government debt is 31 trillion. So you can see household net worth really dwarfs anything else, it’s the biggest factor in any economy, and typically somewhere near 70%. So at least 60%, maybe near 70% of all household net worth is two things. Real Estate net of the debt to acquire that real estate, and stocks net of the debt to acquire those stocks. So your wealth really boils down typically, to those two things, your ownership of stocks and real estate. Well, the top 10% of households in the United States own 65% of all the stocks and real estate in the country. The bottom 60% That’s six zero % That’s surely most if not all of the middle class, collectively only own 14% one four % of all the stocks and real estate. So if stocks and real estate values go up, well then inequality by definition increases. And I think that is the fundamental equation in every developed economy. Debt goes up pushing asset values up. And since assets are held unequally, inequality widens.

Gene Tunny  20:04

And is it access to credit to then? And obviously the I guess the wealthier you are, the higher income, the more access, you have to credit. And that allows you to grow your wealth that way?

Richard Vague  20:15

Well, certainly that’s part of it. But even if we took the extreme example, where somebody in the top 10%, you know, had an asset had real estate, and a company selling goods, it is often the debt that the bottom 60% are accruing, or acquiring to buy the goods from the top 10% that contribute to this rising inequality. You know, famously, Apple didn’t really have much debt as a company and still doesn’t. But I guarantee you that the financing that’s provided to its customers, are what allow them to buy all the laptops and Macs and iPhones and, and other goods. I actually was a banker that provided some of that at one point in my career. So it’s the debt of the 60% that are buying the goods owned by from companies owned by the top 10%. That is part of this equation as well.

Gene Tunny  21:18

Right. And that’s, it sounds like that’s a sign that a lot of that is consumer debt. And so it’s not good debt, so to speak. So. Okay, what I want to understand which I’d love to know, your views on to what extent is this a good bet for the different players in the economy? So it sounds like so households seem to be on? Well, so far, they’ve Well, at least the the top 10% And maybe a larger share, they’ve done well out of this out of, you know, borrowing to invest? It’s, it’s been beneficial to them. I mean, that we’ve, you’ve had a housing crash, and you had one in LA, of course. So it’s not always, it’s not always smooth, but in general, have households benefited from it? What about business? I mean, clearly, some businesses have been able to access finance to grow, but then you do mention that, you know, this can lead to periods of economic stagnation. You talk about this debt, there’s a tax buyer, so the debt is favoured in the tax system in the states relative to equity finance. So how do you think about all of this in terms of is it rational to the whole debt? Or is it? How do you think about this? What about for business? And what about for government trying to regulate all of this, the central bank looking at it? I mean, to what extent should we be concerned about this growth of debt? There’s a lot there sorry, that I’m trying to understand the rationality, what your views are on that, please?

Richard Vague  22:52

Well, I would, what we do in the book is we divide debt, private sector debt into two categories. Type one debt and type two debt. And type one debt is debt for spending on new things, you know, and type two debt is spending to acquire an asset. Now, I’m being a little simplest, overly simplistic here. But, you know, from my perspective, if you borrow to go on a vacation, that debts a little bit more problematic, than if you buy you borrow to buy a house, or a company or something like that, you know, you might, you know, buy a small, you know, gift shop, or a retail store, you might borrow to buy a house or buy a rental property, those have a better chance of increasing your wealth, then the debt you incur to buy that motorcycle you’ve always wanted or go on that trip to Haiti, or what have you, and that that’s a little bit too simplistic, but directionally, I think, that would reveal the direction of our thinking about, you know, what debt we would encourage individuals to enter into and not.

Gene Tunny  24:17

Okay, so that’s for individuals, you mentioned this tax, this the tax system and how that works and how it favours debt finance. Is this part of the story? Is this does this mean that companies end up borrowing too much money and then to an extent, they can then invest in unproductive assets? Is this part of the story this, this tax treatment of the debt because of the interest payments are tax deductible and therefore, the other reforms? Is there any reform to that system that you see to the tax system that you you would propose?

Richard Vague  24:56

Well, you know, this is I think, is something that’s been debated endlessly for a long time. But you know, the, what we want to do, I think, and I think this would be true of all of us, I don’t think you’d find a lot of disagreement around this, what we want to do is we want to encourage stock ownership. And what we would like to somewhat avoid is the accumulation of too much debt. The irony is that the tax code would drive us in the opposite direction, because, you know, much of the interest we incur on debt is tax deductible. That’s a little less true than it was a generation ago. But it’s still, you know, broadly true. And at the same time, companies are double taxed, you know, on the stock side of things, so, you know, they’re taxed on earnings, and then the holder of the equity is taxed on dividends, but it’s famously referred to as double taxation. So, you know, I don’t think changing that changes the world irrevocably or radically, but I think at the margin, if we switch that around, you know, and made, you know, took away the tax penalty on the equity side and took away the remainder of the advantage on the borrowing side. At the margin, it would make a difference over time.

Gene Tunny  26:23

Okay, yep. So, so some difference, but it wouldn’t be the it wouldn’t completely solve this.

Richard Vague  26:29

It’s not the magic bullet

Gene Tunny  26:31

Not the magic bullet. Okay. Okay. Fair enough. Right. Well, I want to ask now about back to your, your summary of the paradox of debt. So “paradox of debt portends the certainty of economic challenges and difficulties going forward unless we are willing to get creative and ambitious” first, how bad could those economic challenges get? So when we were talking about risk, see you talk about how this debts leading inevitably to periodic economic calamity, calamity and stagnation? Are you seeing another financial crisis down the track for the US and the global economy?

Richard Vague  27:10

Well, we measure that by how rapidly the escalation in private debt to GDP is in a short period of time. And we do not see that as a problem in the US at the moment. It’s certainly a problem in China. You know, the Evergrande debacle that we all read about this past year was a direct result of an escalation in the equivalent of private so you know, there’s no private sector in China to speak up. But, you know, non government debt or the equivalent of private debt has shot up since 2008, in China in an unprecedented way. And I think one of the things you have there as a result is something on the order of 100 million empty dwellings, buildings were built in the interest of economic growth, that there are overcapacity, and thus, there are no buyers for so, you know, I think most western economies developed economies right now are not in danger of an imminent financial crisis. I think China’s got got its hands full.

Gene Tunny  28:23

Right, right. Yeah, yeah, absolutely. Good point about China. I had a guest from the business school in Arizona, I think it was on last year to talk about the enterprise China model where just the close links between the business in China and the the the administration over there, so you know, good, good point about that. What about the regional banking crisis in the US? Is that something you’re concerned about? Richard? That’s something that’s been talked about recently.

Richard Vague  29:00

Yeah, it’s it’s a minor concern. It’s not a major concern. You know, there were some banks that broke the, one of the fundamental laws of banking. In banking, you’re supposed to match the maturity of assets and liabilities. You know, I entered banking as a young cub in the late 1970s. And, you know, I think one of the very first reports I was asked to prepare was the asset and liability matching report. So if it, you know, 5% of your assets, were at a 10 year maturity, then 5% of your liabilities were supposed to be at a 10 year maturity, and if 30% of your assets were at a, you know, one month or less maturity, you know, 30% of your liability, so, it matched so that if interest rates went up or down, the spread between the two would be relatively constant. What you didn’t want to have is a lot of long term assets, five year, ten year twenty year bonds, for example, funded by zero maturity liabilities, checking accounts, basically, or what we call demand deposits in the industry. You didn’t want to have that. Because if interest rates go up sharply, you’re screwed. That’s not a new concept. That’s banking 101. Well, what happened was interest rates were so low, and you had certain institutions like Silicon Valley Bank, who had way more deposits than they needed or should have had. And it was actually a penalty to them, because the yield on those assets was so low. Well, what you do to increase the yield on your excess assets is to buy long bonds. It’s the tempt, it’s like, you know, the forbidden fruit in the garden of Eden, you’re not supposed to do that. And everybody knows, you’re not supposed to do that. And yet they did it. And they did it in a huge way, they made a huge bet, has nothing to do with credit quality, has nothing to do with, you know, the fundamentals of the banking system as a whole. It represents their falling to the temptation in a in a gigantic way. And they weren’t the only ones. But it’s not so pervasive, that it’s a sustaining threat to the US banking system, it’s, you can go look at any banks, you know, call reports and other financial information. And we know exactly how much of this misbehaviour occurred and which institutions that occurred in and it’ll it’ll hurt, it’ll hurt a few and it’s hurting a few. It does not represent, you know, I’m gonna put a put a dimension on it. It’s a several 100 billion dollar problem in in an industry that has well over 2 trillion in capital, so it’s not a sustainable growth.

Gene Tunny  32:05

Okay. Okay. That’s, that’s fair enough. I’ll go back to your points on the paradox of debt. Yes, the creative and ambitious solutions you talk about, one of the things you talk about is a debt jubilee? Could you please explain what you mean by that, Richard?

Richard Vague  32:23

Yeah, this is, this is a hard problem. If as the evidence shows, debt always grows faster than GDP, You’ve almost got an engineering problem. You know, it’s as if you were designing an engine, and you found out after you had built it, that the temperature of that engine grows perpetually? Well, as an engineer, you could predict that that engine is going to explode from time to time. So you would introduce some kind of exhaust system or heat valve escape system to try to combat or overcome the perpetual increase in the temperature of that engine. I think we’ve got the same problem. You know, in modern developed economies, they always get more leverage. And so we’ve got, you know, put put your ideology aside put, you know, put all you’ve learned aside, you’ve got a problem here. And, and unless we solve it, we’re going to continue to have a couple of things happen, we’re going to have periodic crises. And we’re going to continue to have a slower and slower economic growth, as businesses and individuals get, you know, what I would call stultified by high levels of death. That leaves you with kind of only one solution, and that is ways of taking away debts that do not involve paying down that debt. Because paying down debt and aggregate just produces GDP, right. So we get into this quite a bit in the book. But there’s no easy way to do this. So I propose, you know, I kind of go out on a limb and try and propose some areas that maybe hopefully will provoke some thinking. So for example, student debt, which has gone from in the United States, a couple of 100 billion dollars to over one and a half trillion dollars really within a very short period of time. So you got all these students who graduate and then you know, lug around too much student debt for the next 20 or 30 or 40 years of their life. How about a programme where even I don’t support a programme of just forgiving all that debt, because it penalises the folks that were that did pay their debt. But I do think a programme whereby we let them do you know, a certain amount of voluntary community or civic work, you know, over, you know, five or 10 year period as a way to get relief on their student debt is something that we could consider. So, right now, if you graduate with student debt, and you enter government service, and you stay there for 10 years and you make 10 years worth of payments, you get whatever’s remaining of your student debt forgiven? Well, let’s, let’s create something that’s similar to that for the private sector. If you did 800 hours of community service, let’s say, after 10 years, the remainder of your student debt would be gone. That’s what I mean, when I say let’s get creative. Let’s try to think of ways to do this.

Gene Tunny  35:43

Okay, we’ll take a short break here for a word from our sponsor.

Female speaker  35:48

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Gene Tunny  36:18

Now back to the show. So debt jubilee is about debt forgiveness in in some form or another and there might be some community service for two so people could reduce their student debt. What about a more broader programme of debt forgiveness? Is that what you’re proposing in the private sector debt banks forgiving part of the debt? How does it all work?

Richard Vague  36:44

Here’s another idea. Because like I said, I stopped short of just getting a magic wand out and forgiving everyone debt, which, by the way, is what in ancient civilizations, rulers would do. And I think, you know, guys like Michael Hudson and your countrymen, Mike, Steve Keen and others have have talked about, you know, this is Hammurabi, this is Ancient Egypt, this is even ancient China. We don’t have that luxury. So let’s get creative. And, you know, another possible programme would be, after the ’08 crisis, when, you know, it was probably on the order of 15 million mortgages in the United States that were underwater by 10% or more. How about kind of a debt debt to equity exchange, you know, if the lender would write the mortgage down to the new current market value, appraised value. So maybe you bought a house that was 300,000. And now it’s only worth 200,000, you’ve still got a $300,000 mortgage? If the lender will write it down to that new value, and write your payments down proportionately? Well, then you would, in exchange, give the lender certain ownership of the house, which would be realised only on the event of a sale of the house. So they would get the upside. And the way the government could facilitate that is by going to the lender and saying, if you do this, we won’t make you take that as a hit against earnings in the current period. We’ll let you amortise that over, pick a number 30 years. So it’s kind of a win win win at that point that the bank deals with problem loans, the individual gets a lower payment. And the lender has the potential upside down the road if the house is sold.

Gene Tunny  38:49

Okay. Okay. So you’re talking about something that is voluntary, you’re not going to compel banks or lenders to to forgive part of their loans or force them into restructuring your you want this voluntary, but there may be some policy tweaks that could facilitate this restructuring. Is that the argument that you’re making, Richard?

Richard Vague  39:12

Yeah, to make it real, legislatively realistic or feasible? You, you have to construct it. So it there’s something in it for everybody.

Gene Tunny  39:22

Gotcha. Gotcha. And I think one of the interesting points you make is that, look, debt’s a contract. Do you quote, Dave Graeber on this, if I remember correctly, and look, these things get renegotiated. Well, throughout history, we see various periods in which there’s restructuring of debt. I mean, what’s extraordinary is that, you know, some countries seem to the periodically defaulting or and then there’s restructuring and then the banks keep lend to them 20 years later, and then you go through the same thing.

Richard Vague  39:55

Yeah contracts are contracts, you know that you know, if you are a data servicing provider and somebody wants you to write a programme and have it done by August 1, and you don’t have it done by August 1, you haven’t done by the following February. That’s not a moral failure. And, you know, but somehow, and folks like Hudson would argue for good reason. People have conflated morality with performance in a commercial contract. So if an individual doesn’t repay their debt, that’s, that’s a moral flaw or moral moral failing. Well, in my career, I was in banking for 37 years and debt contracts with companies get renegotiated all the time, you know, the company, you know, was manufacturing XYZ product and a competitor came along selling for half of what XYZ was being sold for, and we all knew that this debt was never going to repay. And if we absolutely enforced that repayment, we would cause the company to fail and get zero of our money back. Well, instead, we restructured the note so that we get paid half of what we rode back, the country could company could survive and compete. So you know, a rational restructuring of debt goes on in the banking industry all the time, all day, every day. And I think the light bulb that went on for me was, you know, 10 years or so ago when David Graeber’s book, delightful book, you know, ‘Debt: The First 5000 Years’ and he, and he just says, you know, this is not a moral issue. This is a contractual issue.

Gene Tunny  41:43

Yeah, yeah. Want to ask, What about the policy changes? So you in a official position, you’re in a very senior position in Pennsylvania, but I imagine that this would require a federal change regulatory or legislative changes do have you thought about what, what could be done at a policy level to help smooth things to help make it easier to help make it easier for restructuring to to help households and businesses deal with this higher debt that that we’ve seen?

Richard Vague  42:19

I think the federal regulators in the Fed in particular have this ability. And there are a couple of famous instances of this. And to me, the most famous and applicable would have been in the early 1980s, when the New York money centre banks had been making lots of loans to less developed countries, the predominance of which were in South America. And, you know, they got to a point where the what were called LDC or less developed country debt was equal to, I think so, you know, well over 100%, of the capital of those New York money centre banks. So, you know, 150, 100, and the number that comes to mind is 170% was a big, big number, such that when things turn because of interest rates and the rising price of oil, if the regulator’s had come in and enforced their normal rules, all the New York banks would have failed, which, you know, by the way, would not have been a good thing for the country for, New York, for anybody. And so Paul Volcker, one of the giants of economic history came in, this was in the days before Twitter, and all those other ways in which information leaks, so porously, called those bankers into a room and said, We’re not going you know, you kind of put a fence around this, we’re not going to deduct these loans, from, you know, our analysis of your capital reserve adequacy. But you guys better get busy. And over the next several years, all your earnings ought to go towards building up reserves, again, so much of this as you can muster over the next few years. And then whenever you get a big enough cushion, we want you to write it down. That is exactly the kind of thing and by the way, they did this in a more structured and overt way relative to the savings and loan industry, which at that exact time had a very similar problem. That’s a way the regulators can step in the case of the LDCs. It was a regulatory matter. In the case of the same Solomons, it was actually a legislative matter. But those are ways you can do this. And sure enough, but I can I think it was 86 or 87 when Citibank announced a billion dollar write down of its LDC debt? Well, it shocked the world. But it related to a conversation that actually been held four years earlier. And for Citibank to do that was actually an announcement, they were now in good shape, rather than an announcement that they were in bad shape. They’d been forced do the same thing in 82 they would have failed. They had four years worth of earnings to cushion that. And it was it was actually a positive cleanup sign.

Gene Tunny  45:30

Yeah, yeah. So just, just to be clear, I mean, the reason I’m just just want to make sure I understand this properly in your, in your view as a banker, so what’s the, how are bankers looking at this when they do agree to a restructure or write down, they’re figuring that we can extend the term of the loan, or maybe we can cut the interest rate, or we take a haircut ourselves, we write down some of the value, they figure that well, this makes it more likely that they’ll actually be able to pay us back the full amount is that they’ll survive? Is that the logic from a bankers perspective?

Richard Vague  46:03

Yeah, if you’re the banker, the first thing, let’s just say it’s $100,000 write down, if you’re allowed to take that over 30 years, the hit to earnings this year is what? Roughly $3,000 instead of $100,000. You know, the second thing I would do in that case, is let them take the full deduction for a tax standpoint, because you know, most companies have regulatory accounting and tax accounting are two separate things. So they don’t have to take it, from a regulatory standpoint, they get to take it from a tax standpoint. So probably from a current earnings standpoint, at that point, they’re just fine. But in the meantime, the consumer who was struggling with their, you know, their loan now has a loan, they can make payments on adequately. So they they go from having a credit that is a troubled, questionable credit, to a credit, that is a solid credit. As it relates to the consumer, the household, they now have breathing room, they can go back to being kind of a regular participant in the economy, they now have a little extra money not only to make their payment, but to go on vacation and go out to restaurants and this that the other. And their give up is seven years down the road when they sell their house and they they get a gain of you know, $50,000 or whatever they might have give a third or a half of that to the bank, whatever they negotiated. So it makes it comfortable and possible for everyone. That’s why think of it is kind of a win win win.

Gene Tunny  47:50

Yeah. Okay. Very good. Richard, we’re coming to the end of our time. Any final thoughts, any additional thoughts on what other policy measures may be desirable? Or that you’re someone who’s concerned about the inequality in the US? And, you know, clearly that has grown over the last few decades? Are there any other policy measures you’d be recommending to address that?

Richard Vague  48:14

Well, I would make the observation that if the bottom 60% of the US population only holds 14% of the stocks and real estate, that you can probably afford to actually give tax incentives? You know, because we talked earlier about just modifying the penalties. But how about a tax credit, if you buy stock or a tax credit, if you buy real estate, for those, that bottom 60% It’s such a small number, that you have the room to do that without affecting the tax receipts of the government by much, if any, might actually be a positive there. So I make the point that there’s the latitude to create incentives for accumulating asset ownership among that group that we could be taking advantage of that will probably that we’re not. And there’s other things in that final chapter that we touch on too. And they may all be terrible ideas. Hopefully, some of them are good ideas. But, you know, having set up the problem in the first 90% of the book, we we take a stab at, you know, maybe some ways to deal with it in the last chapter.

Gene Tunny  49:29

Yeah, yeah. So, I mean, we talked about forgiveness or the debt jubilee as a possibility, renegotiations. Then you mentioned some, you’re trying to encourage asset ownership and then there are some others one other one or two that you you’d like to highlight.

Richard Vague  49:45

You know, it kind of kind of gets off the subject a little bit, but I put it in there anyway. I think there needs to be massive job training because if you want the bottom 60% to accumulate assets, you got to give them a little more income. We got a situation in the US that I think it’s parallel, at least to a certain extent elsewhere, that we’ve got a lot of jobs that need training that are going unfilled. We got a lot of under under employed people that don’t don’t qualify for that job that feels to me like a perfect place for government to step in, in conjunction with the private sector, and especially the companies and underwrite that, you know, I think it’s kind of the spiritual equivalent of, in the US what we call the GI Bill, where after World War Two, we underwrote college education for pretty much all the returning soldiers. And I think that helped fuel the increased size of the middle class and the 50s and 60s, I think there’s that opportunity here.

Gene Tunny  50:47

Okay. Well, Richard, thanks so much. And I’ll put a link in the show notes to your book. And yeah, I’d encourage people to buy it and read it. So it’s published by the University of Pennsylvania Press.

Richard Vague 51:16

Yes.

Gene Tunny 51:18

Very good. So very distinguished publisher, and yeah, well researched, and lots of lots of good facts and figures. And yeah, very interesting analysis. And, but very good. But Richard, thanks so much for your time. I really appreciate it. And good luck with the book sales. Yes. And I hope you, you get a lot of a lot of readers and a lot of people are engaging with you on the issues, and I certainly enjoyed our conversation. So again, thanks so much.

Richard Vague  51:29

It’s a privilege and I’m all thanks go to you.

Gene Tunny  51:32

Very good. Thanks, Richard.

Richard Vague 51:36

Bye bye

Gene Tunny 51:39

Righto, thanks for listening to this episode of Economics Explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

52:23

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Podcast episode

GDP & the National Accounts: What they are and why they matter w/ Brendan Markey-Towler – EP153

The National Accounts are a huge intellectual achievement and an incredibly useful set of data, including GDP and its components. Chatting about the National Accounts with Economics Explored host Gene Tunny is fellow economist Dr Brendan Markey-Towler, author of the Substack newsletter Australian Economy Tracker. Brendan explains how the National Accounts help us track the current state of the economy as well as longer-term trends, such as shrinking manufacturing sectors and growing services sectors in many advanced economies.

You can listen to the episode via the embedded player below or via podcasting apps including Google PodcastsApple PodcastsSpotify, and Stitcher.

Links relevant to the conversation

Brendan’s Australian Economy Tracker Newsletter

Brendan’s post discussed in this episode

Planet Money episode on Simon Kuznets

Australian Financial Review article (pay-walled, alas) which reported “Federal government business generated $1.7 billion in revenue for the big four accounting and consulting firms over the past five years – though the government has a different take on the contract value of that business.”

Transcript: ROI of education: how economists estimate it + US economic update – EP152

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:01

Coming up on Economics Explored.

Brendan Markey-Towler  00:04

So, that’s where we get the view that Australia is less and less a country that makes things and builds things. Construction, manufacturing declining as a share of GDP.

Gene Tunny  00:16

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional economist based in Brisbane, Australia, and I’m a former Australian Treasury official. 

This is episode 153 on GDP and the National Accounts. What they are and why they matter. 

Chatting about the national accounts with me this episode, is my good friend and fellow economist, Dr. Brendan Markey-Towler, who started a new sub stack newsletter, Australian Economy Tracker. Brendan explains how the national accounts help us track the current state of the economy, as well as longer term trends, such as shrinking manufacturing sectors and growing services sectors in many advanced economies. 

In the show notes, you can find relevant links and any clarifications. Please send any comments or questions to contact@economicsexplored.com. I’d love to hear from you. I’ve been very grateful for all the comments on recent episodes. Your comments really helped me figure out the issues that you’re interested in, and the types of guests that you’re interested in hearing from. So, please keep the comments coming to me.

Right oh! Now for my conversation with Brendan Markey-Towler on the national accounts. Thanks to my audio engineer, Josh Crotts for his assistance in producing this episode. I hope you enjoy it. Brendan Markey-Towler, welcome back to the program.

Brendan Markey-Towler  01:43

Gene, it’s always a pleasure to be here. Sorry, I’m a bit husky today, but I’ve bruised my throat. I’d like to pretend that it was under heroic circumstances, but it was not.

Gene Tunny  01:52

Okay, well, thanks for participating. I understand it’s not damaging your throat, you’re able to talk, you’ve been talking all day. And you’re still happy to talk.

Brendan Markey-Towler  02:01

I could talk under wet cement, mate. So, a bruised throat isn’t going to stop me.

Gene Tunny  02:07

Well, you know, now, you can get a job as a rugby league commentator, possibly?

Brendan Markey-Towler 02:14

That’s true. I’m more of a union man. Yeah, but I will go with league. That’s good. 

Gene Tunny  02:18

Right oh, okay. So, the topic of today, national accounts, what it is, why it matters? You’ve started a sub stack and one of your first pieces that came out on the sub stack was on the national accounts. And you displayed a level of enthusiasm for the national accounts that is very rare. And it actually reminded me of just how marvelous the set of data – the national accounts are, and what a superb intellectual achievement. 

So, going back to the work of Simon Kuznets, and Colin Clark, who, was it Stone as well, Richard Stone, who formulated the methodology financial accounts, and then it was like a system a toss by the UN. So, I think, what your note did was it really helped us; well, it really reminded me of just how impressive those national accounts are. So, could you just tell us first, what you were trying to do in that note? And what’s your sort of general take on the national accounts, please, Brendan? Why do you think they’re so important?

Brendan Markey-Towler  03:28

Partly to justify why I had no friends at school. Because I get excited about nerdy stuff like this. But look, when you actually know what the national accounts are, they’re extremely interesting. And what they really do is they aim to provide a snapshot of the activity within an economy over a set period of time. So, in Australia, and throughout almost the world, I’m not sure of any country that doesn’t do it this way. It gives you a snapshot of all the activity that went on in an economy over the previous quarter. And the central number that depicts that activity is the number that we call gross domestic product. And gross domestic product is a measure of how much wealth was added to the economy, how much production, how much activity, and under the three great categories production, exchange, and income, or earning. That’s what the national accounts do. And they add that up into a single number, GDP. And that tells you how much activity went on in the economy over that quarter. 

Now, where it gets really interesting, is that number not alone would be kind of cool. And we talk about the GDP growth rate. That’s what we mean when you hear on the news that people say economic growth or the economy grew by, that’s what they meant that GDP number increasing or decreasing. But where it gets really interesting is that we approach GDP in three ways. And you can think of this as looking at the economy as the same thing, but from three different directions. And that changes the way that you interpret that number. So, we call these GDP I, or at least I call them GDP I, GDP O, and GDP E. That is, GDP expenditure, GDP income and GDP output. 

And what those numbers are doing are adding up GDP, the activity in the economy, looking at that activity from one to three ways: as a production, as an expenditure, and as an income, right. So, if you think about it this way, when you go down and you buy something that’s dear to our heart, here in Queensland, you go down into buy your coffee, there’s three things going on, there’s three ways that they get that same transaction gets measured and add to GDP. From the expenditure side, the expenditure that you make, when you buy that coffee goes into GDP E, and we add all of those up together, and we get GDP. That expenditure becomes income from the perspective of the person behind the bar. And that gets added up into GDP income. 

And there’s also an interesting concept of gross value add, which is how much value has been produced by that transaction. The way that we measure that in GDP O, is we take the value of the output that was sold and subtract the value of the inputs that went into it. And that by definition, that’s the value that was added. 

So, that’s the three ways that we add up GDP and we get an interesting view of the economy from that. A little bit further breaking that down, obviously, you can break that down to the level of the individual transaction. But the you know, you don’t get a huge amount of information that you get so much information, you have no information. So, we categorize at a high level, these different activities to get a sense of what’s driving GDP. So, within GDP E, the expenditure, which is the most popular and most focused on of the national accounts measures of GDP, we break down expenditure by consumption, investment; in Australia, we break down by housing, as well, government expenditure, both consumption and investment, and net exports.

Gene Tunny  07:34

And by investment, we mean capital investment, we mean expenditure on capital goods. So, we mean, new housing developments, or we mean, new, non-residential buildings, new schools, new factories, new capital equipment that’s purchase.

Brendan Markey-Towler  07:55

That’s right. Yeah. So, in Australia, we call it gross fixed capital investment, which is at the addition to the capital stock of the country in the capital stock of the country is; in Australia, again, we trade a little, perhaps, oddly, that we add housing into that. But factories, equipment; we actually add intellectual property as well. So, science and technology research get added into that figure. And so that’s what we that’s, that’s the way that we break down the economy. 

So, when we break down GDP E that way consumption, investment, government spending net exports, we get a sense of which sector of the demand side of the economy is pulling the economy along. Is it household consumption? Is it buying new houses or building new houses? Is it businesses investing? Is it government consuming, spending money? Or is it government investing? Or is it coming from the international sector? And that gives us a lot of information about the activity within a country, it also gives us information about what might be dragging economic growth as well. So, that’s expenditure. 

Another really interesting measure, well, I mean they’re all interesting, but the second measure GDP O – GDP output, sometimes called GDP gross value add, gives us a sense more of the supply side of the economy. 

So, expenditure gives us a view of what’s driving the economy on the demand side. GDP O gives us a view of what’s driving the supply side. So, we get GDP in Australia, broken down by industry. And that’s where it gets really interesting because we can see which industries are adding the most to GDP. So, that’s cool. We can say, oh, mining adding more? Or how much is mining adding to GDP and how much is it driving or dragging on GDP? Ditto for professional scientific and technical services is another one that we use, agriculture and fishing, public administration safety; how much are these sectors adding to GDP and how much are they dragging or driving GDP. And then finally, the GDP I number. This is typically not quite as informative as the others, which is kind of ironic because it’s the easiest to add up because we just look at the tax returns. GDP I, breaks down GDP by income. And in Australia, we do it by what we’d call the greatest states of Australian society. So, wage earners, non-financial corporations, financial corporations, and government. And we can get a view of who’s earning the income within GDP. How what of that GDP that’s expended and outputted. Where is the income from that activity accruing to? Is it accruing to wages? Is it accruing to company profits? If it’s an accruing company profits, is it occurring to financial or non-financial companies? So, that’s some of the really interesting stuff that we get from GDP, it gives us this, really, especially in Australia, because our accounts are quite amazing.

Gene Tunny  11:05

Yeah, we’ve got some of the best in the world for sure. 

Brendan Markey-Towler  11:09

They really are and we get a really rich view of what’s driving and dragging the Australian economy. What’s creating the wealth in our economy and what’s potentially dragging on the wealth of our economy. And kind of, we get a sense as well, where it’s going.

Gene Tunny  11:26

Okay, so the few things I want to talk about there, Brendan. Okay, so you mentioned that GDP; well, is it an approximation of the addition to wealth? Let me think about this. I mean, part of it is in addition to wealth, to the extent that you’re increasing the capital stock, but then part of it is consumed, and then part of the investment is consumption of fixed capital. So, I mean, it’s national income really, isn’t it? I mean, it’s related to wealth. Yes. So, it’s certainly related to that. It gives us a picture of our national income. I think national income was the original term for it, wasn’t it?

Brendan Markey-Towler  12:11

Yes, although national income gets a little trickier because the we focus on GDP, because it’s really limited to the geographical definition of the country. And that distinction was made early on in the development of the methodology, because national income is a bit fuzzier because it’s typically added up by nationals, rather than by where the activity occurred. So, that’s why the classic example that we give in an economics course, is that national income for a country like Luxembourg is, I think, Ireland, sorry. National income for a country like Ireland is actually much higher than its GDP, because a lot of its nationals live overseas. So, there’s few distinctions that we make within it. But really, what it’s giving you is a view of the activity that’s occurred in the economy, the economy being that system of human behavior, why we produce and exchange stuff that we need for everyday life. And so obviously, that adds to the stock of wealth in the economy, because some of that gets consumed and taken out and other elements of it gets allocated to the national wealth. 

So, yeah, it’s a flow metric in the classic distinction between stocks and flows. It a reflection of the consumption and investment activity in an economy during a particular period.

Gene Tunny  13:40

Yes, it was developed during, well; the need for it became obvious during the 30s, when they were trying to quantify the extent of the Great Depression, I think Kuznets produced a report for the US federal government that strangely became a best seller. I mean, it was the first time someone had produced numbers like this. There’s a great planet money episode on that. I’ll try and find it and link to it in the show notes.

Brendan Markey-Towler  14:09

Well, that’s a good point, right? Because before then everyone kind of knew when times were good, or times were bad. And so, you could tell there were panics and manias and crashes as Charles Kindleberger famously said, but before the national accounts were developed, we never really were able to quantify what that was. And a lot of this was crystallized by John Maynard Keynes, his famous book, The General Theory of Interest, money and employment. I’ve got that wrong, interest money I think I got three. I’m one of the few in my in my generation, I think who actually read the book, which is, which is why it’s embarrassing I can’t remember the name because we always refer to it as the general theory.  And what Keynes was trying to do there was give a theory of why we experienced these manias, panics and crashes, you know, boom and bust. And the problem was that when he wrote it, he was dealing with a lot of abstract thoughts and that needed to be measured. And I’ll actually give a little plug here for our home state of Queensland because Queensland was at the forefront of this, currently the building out at UQ, which houses the School of Economics, the University of Queensland, the School of Economics there is housed in the Colin Clark building, which is kind of ironic because Colin Clark didn’t become an academic at UQ until much later in life, I think around the 1980s. But Colin Clark was at the forefront of developing the methodology, not only for what the national accounts are, but how you actually design the surveys that add up those numbers and find out what the numbers are. 

Gene Tunny  15:49

And he’s quoted in Keynes’s book because Keynes used his estimates of consumption spending for Great Britain, if I remember correctly, in the general theory. 

Brendan Markey-Towler  16:01

And it’s kind of funny. So, Colin Clark who came out here to Australia and did a tour of Australia and he was the hotshot wizkid political economist from Cambridge. And he met with all of the premiers because back in those days, we understood the constitution. So, the premiers were much more powerful than the prime minister. And when he came up here to Queensland, the premier at the time William Forgan Smith, which the alumni of UQ will know, is that is the main building at the University of Queensland. Kind of, a nice little coincidence. Forgan Smith basically said to him, look, do you want to come and be my adviser on all things economics? As Forgan Smith was a great reformer and trying to develop the Queensland economy, he needed to be able to measure the size of the Queensland economy: what was driving, what was dragging, what was causing development, what was dragging on development. And there’s a famous letter that Colin Clark writes back to Keynes to say, I’ve been offered a job to basically become the shadow premier of Queensland. I’m not going to turn that down. And Keynes, I think said something to the effect of where is Queensland. So, then, Colin Clark came out, join the Queensland Statistical Bureau and, he was instrumental in the development of the national accounts and as a point to why the national accounts are so important. While Colin Clark was doing that, he’s obviously thinking about what goes into an economy? What is an economy? What exactly does it mean to say an economy? Because when you actually; we all kind of know what it is, is the economy stupid?

Gene Tunny  17:44

It’s an abstraction, isn’t it? 

Brendan Markey-Towler  17:47

But it is an abstraction. And so, he had to think about, Okay, what does it actually mean? What is an economy, what counts as economic activity? And this is becoming very pertinent again, in these days, where we’re talking about things like Facebook and Amazon and Google where a lot of the activity that goes on there, we sort of think of as economic but it doesn’t measure it. But what happens as a result of Colin Clark thinking through these questions, is he’s starting to develop views of how economic development occurs. So, he ends up writing a large book, which sort of became a classic and development economics on how economies develop, what the basis for economic development are, what the settings for economic policy should be to encourage development. Particularly important question here in Queensland, which was a quite underdeveloped economy at the time.

And as a result, he became a very close adviser to Bob Santamaria, who those diehard fans of Australian politics will know was instrumental in the foundation of the Democratic Labor Party. So, this is the guy who invented a lot of the methodology behind the national accounts. So, when you understand something at that level, when you understand what an economy is, when you know how to measure it, imperfect as that measure may be, you get really rich insights into how an economy is tracking over time. And you get really rich insights as a result that develop over a long period of time of working with these things of what drives economic growth. You can situate those numbers in a history that tells you why the economy is growing, or why it’s not.

Gene Tunny  19:32

Yeah. Where do you get that Colin Clark story from? Is that in that book you keep talking about by, was it Millmow?. 

Brendan Markey-Towler  19:38

Yeah. Alex Millmow, A History of Australasian Economics Thought. I think that’s where I got it from. Yes, it is where I got it from. It’s a really good book because Alex points out that a lot of Australia’s economic contributions to economic thought came from really practical questions like this. How do we measure?

Gene Tunny  19:57

Absolutely. Yeah, yeah, absolutely. Okay, we’ll take a short break here for a word from our sponsor.

Female speaker  20:07

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Gene Tunny  20:36

Now back to the show. Okay, now, I did want to go back to the point you made about the difficulty of well, the issues around the modern economy and the India head, etcetera. There was a great lecture that John Quiggin, who’s a professor at UQ. And if any Australian economist is going to win a Nobel Prize, it’d be John. I mean, he’s one of the most cited academic economists that Australia has. I mean, maybe, Warrick McKibben could win one. So, but yeah, certainly, John is;

Brendan Markey-Towler  21:11

I always like for John Foster personally.,

Gene Tunny  21:15

Well, John Quiggin, is incredibly distinguished economist and his view at the this lecture he gave was that the problem with GDP is that it’s gross, its domestic and its product. Okay, so we’ve already talked about the domestic issue. So, the fact that you could have a lot of production, but if all your incomes remitted overseas, okay, because it’s just foreign mining companies producing and sending profits home, and then you may not see all of that benefit. But the point he was making is it because its product, and it’s measured at market prices, what you could be missing out on is consumer surplus, you’re not necessarily measuring the benefit to consumers, because all of these products are provided for, well, a lot of them for free. But yet, the foreign company makes money out of you in some other ways, because it’s monetizing your attention, isn’t it?

Brendan Markey-Towler  22:11

Yeah. And so, this is a debate that’s been really reopened, it’s been a perennial debate in economics, and there’s a lot of interesting ideas floating around, inspired by it, which is that when we talked about, you know, how GDP is added up, we talked about the exchange, okay. But the only way that we really observe and exchange is by the exchange of money, right? So, the price multiplied by the quantity of goods or services sold. Now, the problem merges; what happens in a world full of freemium models? What happens in a world where the price of a Facebook membership is zero? That sort of kind of, well, I don’t particularly like Facebook. So, you know, I would challenge just how much consumer surplus is creating, but there’s, you know, many people would argue that there is a value added.

Gene Tunny  23:11

I think TikTok is creating the most at the moment. Especially among the younger generation..

Brendan Markey-Towler  23:16

Massively, yeah. the only thing that shows up in the national accounts from Facebook, Google, TikTok, Instagram, is the data sales. That’s the only thing that shows up in the national accounts. I mean, apart from the marketplace exchanges that go on as well in the Facebook marketplace, and so on like that. But really, it’s ultimately the advertising for Google the sales of data from all of them. That’s the only thing that shows up in the national accounts. So, but there’s more than that, as well. Another problem, And Peter Thiel has recently raised this issue.

Gene Tunny  23:53

Oh, the billionaire? Right.

Brendan Markey-Towler  23:57

The chap who founded PayPal, he thinks that we’ve actually had no economic growth or very little economic growth in the past 70 years. And the reason he says that is because he contends that what is observed as economic growth in the past 70 years, is actually just us bringing production and exchange; valuable production exchange that used to happen in the home, into markets. So, cooking, cleaning, keeping the house in order, gardening; all this stuff gets done on marketplaces, rather than in the home. And that’s a bias in GDP. It doesn’t measure that stuff because it’s not on a marketplace. It can’t be observed. So, that’s another argument. 

You know that GDP doesn’t measure the actual value that’s being created. Now, the problem ultimately is, this goes back to a problem of micro economic theory, which is what is utility? And what is consumer surplus? And actually, from my perspective, why I ultimately say, look, let’s stick with GDP. It’s the worst measure we have, except for all the other things. Some countries have toyed with measuring gross national happiness. You know, New Zealand is toying with that at the moment, Bhutan famously measured it. The UN uses the Human Development Index, which is a weighting of GDP per capita literacy rates and life expectancy, I think.

Gene Tunny  25:31

All of which are highly correlated, aren’t those?

Brendan Markey-Towler  25:33

Yeah, and so, that was a March Ascends Brainchild, Jagdish Bhagwati famously said, well, yeah, they’re correlated. So, what are we talking about here? So, all those debates over replacing GDP ultimately, were reduced to a deep, deep philosophical problem, which economists are not well placed to solve, which is, what is value? What is good, what is true, what is beautiful? And I got some views on that. But as an economist, I ain’t got nothing to say about that. And so, when economists start dabbling in it, you kind of go, I used to be a fan of the happiness literature. But now I read and go, ah, this is, you know, it’s very simplistic. We’re going to use subjective wellbeing measures to add up Gross National Happiness. Okay, fine, that’s a really subjective and not very tangible measure. Whereas I can look out the window and see the cranes on the skyline here in Brisbane and see that’s an objective, measurable thing.

Gene Tunny  26:37

Well, it stood the test of time, hasn’t it? So, we’ve been using it for decades now. And there’s a general feeling that it does capture the state of the economy reasonably well. I mean, there are going to be people who grumble about it from time to time, but generally well, in Australia, at least when we had the recession, I mean, I always remember the 91 recession, because I was in high school at the time. And like, things just look bleak for anyone who was in high school and wanted to get a job. But then that was the period when retention rates at high school really ramped up. So, it was it was telling us something important there and it tends to; like it could give false signals, there’s a big debate at the moment over what’s happening in the US. But then look, the economy’s looks like it is slowing to an extent. There’s the impact of the Federal Reserve hikes. So, let’s wait and see how it all plays out. I mean, my feeling is, it’s generally a pretty good indicator of the state of the economy. 

Brendan Markey-Towler  27:38

I look bad, I’m a Queenslander first, Australian second, and as a result, I do have a bias which is towards tangible reality. Right, feelings are very ephemeral. And feelings are important, right? They are very important, but they’re really difficult to measure. And they’re very subjective, and they can be easily manipulated. Now, GDP can be manipulated as well, depending on how you count things up. But at the end of the day, it’s stuff that’s being produced stuff that’s being consumed. And it’s tangible, observable goods and services. So, insofar as I really have a criticism of GDP, my major criticism is that it really; I agree with Peter Thiel largely, biases us away from realizing the value that is produced in a house. 

And look, I’ve got a young, I’ve got a four-month-old son now so and my wife is at home, taking care of that. And I tell you what, that is incredibly mind blowing valuable work that she’s doing; doesn’t show up anywhere in GDP. Now, that doesn’t negate GDP. Because I think the solution to that is really, let’s just realize what GDP is actually measuring. Now, that does work in a political debate, because in politics and the way that the media works, you need a number and you need that number to be growing, otherwise, elections get lost, and so on and so forth. But when you’re, you know, when you’re doing grown up analysis instead of politics, I think the solution is to look at what GDP is actually measuring. It’s not a measure of value and if you think of it that way, then you’re wrong. Stop thinking of it like that. Think of it as it’s a measure of the production of stuff and the exchange of stuff within the economy, within the market that we can observe. Don’t try and start thinking about as a measure of all of the economic activity that ever happens in an economy. Just recognize the limitations, it doesn’t measure this stuff that goes on the household and that’s incredibly important.

Gene Tunny  29:51

Yeah, fair enough. That’s a good point. I’ll have to come in another episode to this issue of what’s in GDP? What’s out? What does it all mean? I’ll try and have that discussion in a future episode because there is a couple of other things I wanted to pick up on from your note; your note reminded me of a couple of things. And it’s the fact that this system is so beautiful, I mean, we end up getting from two different directions, possibly two different sets of data. I mean, we can look at what spend on consumption goods, final consumption goods, now, we have to be careful, we’re talking about final consumption goods and final investment goods, because what we’re trying to do is avoid double counting, we’re trying to get; because there are a lot of business to business transactions, businesses selling to other businesses inputs, so you have to take care of all that and make sure you’re not double counting title output, you want the expenditure on final goods and services. 

So, if you look at that, that ends up telling you what GDP is, once you add exports, subtract imports, because, well, if you import something, then you don’t have to produce it here. So, there could be stuff that shows up a consumption spending or an investment spending that’s imported, and we didn’t produce it here. So, you have to subtract it. And likewise, if we’re exporting something, well, we produced it here, we know we produced it here, then that adds to our output. But then, you look at spending data, on the other hand, you can look at income data. So, you are saying, look at the wages data, look at the profits data. And yeah, I guess it is coming from the ITR. I’m not sure exactly where the IBS gets it from. But I mean, that’s a likely source. I do surveys of businesses.

I’d have to check exactly how much they’re using ATO data, but I know they do surveys of businesses to get that information. They’ve got a household expenditure survey, they’ve got surveys of, well I guess they got their business server; I’d be looking at what they spending on capital goods. Looking at what they’re earning. And so, they build up this picture of earnings that way, and also the gross value added in the business. Which as you described, is their revenue less their production costs, and wages are part of the value added to. So, wages plus the gross operating surplus, is your value added in the business?

Brendan Markey-Towler  32:21

Yeah, it’s a very slippery definition, because it’s not quite profits. But it’s, you know, the value of inputs minus the value of outputs. And that by definition has to be the value that is added by that business to the economy, insofar as we can measure it.

Gene Tunny  32:35

This is because we’re talking about gross domestic product. So, we haven’t subtracted for the depreciation of capital stock, because some of the investment that occurs is just replacing existing capital stock. So, the building wears out and we have to replace it.

Brendan Markey-Towler  32:52

Too hard. We set that aside. Depreciation is very funny thing to talk about.

Gene Tunny  32:56

Right? Yeah. Well, we’ll leave that for now. You got time just to chat about your great quote? I should have brought it in earlier. You use these different perspectives on GDP to provide a really nice summary of what’s been happening in Australia. I thought this was very good. Exactly. Okay, so after you analyze where the growth has occurred, and you know, it’d be good if you could explain this at the moment. You concluded this; to put it somewhat tribally, Australia is less and less a country that derives its wealth from making and building things. Still a country that makes its wealth by digging stuff out of the ground and renting houses, and more and more a country that consults and cares. Could you please explain how you came to that conclusion, Brendan?

Brendan Markey-Towler  33:53

Well, you so what I did there, this is one of the most informative aspects of the national accounts I’m very interested; everyone focuses on the demand side of the economy, because we’re all Keynesian.

Gene Tunny  34:07

What we’ve been heavily influenced by Keynes, yes. There’s no doubt about that, whether we’re Keynesian. So, that’s another question. You can go ahead. Yes.  

Brendan Markey-Towler  34:13

We are all Keynesians. But the supply side of the economy is super interesting. See which sectors of the economy are generating the wealth. Now, the way that you can do that is by looking at gross value add, right. So, then you take the gross value added by each industry divided by the total GDP and you get the share of GDP, economic activity, economic value that is being created by that industry. And you can track that over time. Now, the problem with that data why almost no one really uses it? Some people do, but almost no one does. And you’ve used it, Gene, is that there’s a lot there, the ABS breaks the economy down by I think its 20 sectors. possibly 25. So, you’ve got to kind of cut it down to get some useful insights from it. 

So, the way I did it was alright, let’s cut out everything that’s less than 5% of the economy and look only at things that produce more than 5% of Australian GDP. Now, no sector really produces more than about 15. But there’s a clear standout. And there are clear standout trends once you do that, and you clean the graph up by eliminating all the Martin “minor sectors”. And you see some very strong trends. 

Trend number one that’s quite striking, and I should emphasize, this is all by real data. So, we hold prices constant to see what’s going on at the volumetric level in each of these sectors. So, we hold P constant, and we look at what’s changing in Q. Q is for quantity. And so, there’s benefits and costs to doing that. But it’s valuable as an exercise as long as you’re aware of the limitations of doing that. First interesting thing, manufacturing and construction are in decline in Australia. They’re not producing as much value add. In volumetric terms, they’re not producing as much value add anymore. They’ve been declining for the past 10 years as a share of GDP. So, that’s where we get the view that Australia is less and less a country that makes things and builds things; construction, manufacturing declining as a share of GDP.

Gene Tunny  36:30

So, with manufacturing, we had a car industry once, we subsidized a car industry, we tried to buy ourselves a car industry, and it just could not be viable on its own. And there wasn’t any more money we could throw at it to keep it open. 

Brendan Markey-Towler  36:48

And you look at somewhere like Maroubra or Ipswich. Which would you know, once kind of manufacturing ish areas in Queensland. Maroubra main manufacturing now is government contracts, building bullets for the Australian Army.

Gene Tunny  37:03

And do they build trains, still?

Brendan Markey-Towler  37:06

They do now. Yes, Maroubra now has a trains contract to build trains for the Queensland Government as well. And I think Ipswich still has a little bit of a train industry as well. But really not too much, by the way of price manufacturers. It’s not to say that it doesn’t exist, and it’s not to say that it’s very valuable. Queensland, for instance, has very vibrant medical manufacturing sector. That’s kind of grown up on the back of our extremely good hospitals and medical research. But generally, across Australia, the story is one of the car industries; we don’t really make stuff anymore. It’s just not competitive to build stuff. And so, that number is reflecting something that you see a lot when you go down to Fortitude Valley here, which, you know, the state would like to think Silicon Valley. Yes. Anyway, it’s Fortitude Valley, Queensland Silicon Valley, you see that a lot of the companies there just want to grow big enough that they can afford to offshore their manufacturing elsewhere. And the classic one is, I think Trivium, the electric car battery manufacturer, which is, as soon as they got big enough, they got a loan from the Queensland Government and then went to build factories in Tennessee.

Gene Tunny  38:17

Is that right? Is that a good use of taxpayers’ money?

Brendan Markey-Towler  38:21

Well, I’m completely agnostic on that. So, that’s what’s that number is reflecting. Similarly, construction,  this runs a bit counter to the crane index that we’re seeing in the city at the moment, but construction has been adding less and less to the economy. It’s not just large construction projects, but construction is declining as a share of GDP. 

Gene Tunny  38:48

Well, I’ll have to look at this. But I think what could be explained is 10 years ago, we had that massive project up in Gladstone at Curtis Island where we built the three LNG terminals or what are they? Refrigeration or liquification facilities. They turn the methane that comes from the coal field, the coal seams to liquefy it so, they can put it on a boat economically and ship it to Japan or Korea. And that was like $70 billion.

And it basically doubled the level of capital expenditure in Queensland at the time. It’s absolutely extraordinary.

Brendan Markey-Towler  39:31

There’s a huge effort on part of government corporations to get that going. 

Gene Tunny  39:35

And then in the southern states, maybe a few years later, I can’t remember the time; we had that big apartment construction boom. So, that could be explained. I’ll have to look at the data but go on. 

Brendan Markey-Towler  39:48

And that’s what’s really good about the national accounts is kind of counter to what you’re seeing if you’re walking around, particularly, Brisbane at the moment. The number of cranes in the sky is astounding, but this is why statistics are important because what’s local loss to a particular area is not necessarily true of the entire country. And what’s even true of a particular sector of construction, residential construction, government construction is not necessarily true, it might mean that we’re not building that many mines, which ties into the second point, which is, although it has declined in volumetric terms, the mining sector is still the single biggest contributor to Australian real GDP. And it’s not close, it’s way up; I forget the exact number, but it’s well up towards 10% of the entire Australian economy value added is produced by the mining sector. 

So, that’s, you know, digging stuff out of the ground, selling it to various countries around the world.. Behind that really interesting sector is, is the rental sector. So, a lot of value added in the Australian economy. It’s the only sector that holds candle to mining is the rental sector where people are building houses and renting them.

Gene Tunny  41:03

Okay. So, when you analyzed that, did you look at the industry, is it rental services? Or did you look at what’s in the national accounts as; there’s rental income, isn’t there? What do they call it? Trying to remember what the label is in the national accounts, but they impute rent for owner occupied dwellings as well, in that sector. If I remember correctly.

Brendan Markey-Towler  41:29

Rental services. I’m pretty sure is the exact name of the sector.

Gene Tunny  41:33

Looking at it by industry. Okay. Yeah.

Brendan Markey-Towler  41:36

So, that’s an important point, right? Because rent to also shows up as an income segment as well. Not nearly as big there. But the value add is quite large. And so that’s saying, you know, the Australian economy is very much one that is dominated at the moment, by digging stuff up out of the ground, and then sending it offshore, and providing housing for people. Those are the two biggest sectors of the Australian economy. And then, finally, the very long-term trend, we come to the third part of that bond ma that you so ably quaffed, which is, surprisingly, the sectors that are growing fastest as a share of the Australian economy are; you’ll have to double check me on this, but I’m pretty sure it’s called health care and social assistance.. And professional scientific and technical services. Those have gone quite strongly over the last few years as a share of GDP. 

Scientific and Technical Services is obvious enough, right? That’s the IT department and you know, the lab.

Gene Tunny  42:45

There’s professional too. 

Brendan Markey-Towler  42:49

Yeah. Professional Services is the big one. So, this is your consultancy lawyers. So on and so forth, right. It’s Eagle street, the consulting firms along Eagle street.

Gene Tunny  42:58

Where we are in Brisbane, in the top end of town, would you call it the big end of town? You’re sitting in water from place to the moment and the offices of Hopko Gannon, thanks, again for allowing us to use.

Brendan Markey-Towler  43:13

And so this area is growing really strong. I forget where the legal services are counted among professional service.

Gene Tunny  43:18

But I think I would be Yeah, sure.

Brendan Markey-Towler  43:21

They might be under administration, administrative services. But professional, scientific and technical services, basically, scientific and technical can kind of be in house. But a huge majority of that professional services is consulting, right? So, Australia is doing a lot more consulting as a share of GDP.

Gene Tunny  43:40

And this is business to business, typically? Business-to-business consulting services or business to government.

Brendan Markey-Towler  43:47

Business to government is the big one, especially here in Queensland right now. That’s not backed by a number. But that’s you know, that’s kind of;

Gene Tunny  43:58

There are numbers for the Australian Government. I’ll put them in the show notes, because I looked at what the Australian government has spent on the Big Four consulting firms like KPMG and PwC. And it’s hundreds of millions a year, right? It’s big money. 

Brendan Markey-Towler  44:12

And then, you go step below and the state governments will probably be even bigger again, because every consulting project by the Department of Public Works now gets a cut benefit cost analysis written by one of the big firms, right. So, just because of the procurement rules around that, so professional, scientific and technical services really growing as a segment of GDP, but also health care and social assistance. And so that I would posit is really a reflection of the ageing population. Ageing population, you need more health care and social assistance, certainly. That sector is growing very strongly – aged care.

Gene Tunny  44:49

Yeah. Which is NDIS too, the National Disability Insurance Scheme.

Brendan Markey-Towler  44:53

Absolutely massive, huge boom. You throw a stone in Brisbane and you hit NDIS provider, which is really not good, you shouldn’t do that because that’s naughty. And that getting on the back of Yeah, health departments are in Queensland; Queensland Health is the largest single employer in the state. That’s a massive sector. It’s a $20 billion in the state budget. That’s a big number, right? And we’re always trying to spend more on it. So, very big sector that. So, those are the two real growth sectors in the Australian economy. And again, I should stress by volumetric measures, right? So, notice that that kind of cuts against the mining booms like us, and that goes to the difference between real and nominal GDP. Real being a volumetric thing where we’re trying to hold prices constant, and the reason we do that is because nominal GDP could be growing because the actual underlying productive capacity of the economy is growing, or because inflation is growing. And real GDP tries to say, what’s the underlying volumetric productive capacity of the economy? How’s that growing and contracting. And in that measure, you really see the big growth sectors, mining is actually declining as a volumetric share of GDP as a share of real GDP, but it’s still the biggest by far professional, scientific and technical services, and healthcare and social assistance really, really growing. Yeah, that’s where the saying, that’s where my little trite way of putting it came from. Australia is less and less a country that makes things and build things. It’s still very much a country that digs stuff out of the ground and provides housing, but it’s more and more something of a white collar economy.

Gene Tunny  46:43

Oh, yeah. It’s postindustrial. We’re moving more to services. Yeah.

Brendan Markey-Towler  46:49

Natural I mean, with the natural resources sector.

Gene Tunny  46:52

Yeah. that’s right. And I mean, because the world wants to buy our resources. And for the last year or so, they’ve been paying ridiculously high prices for them. It’s an open question over whether we want to sell it. Right. Well, yes. I mean, there’s the big issues there of course that we don’t have time for.

You’ve been very generous with your time, Brendan

Brendan Markey-Towler  47:22

You are very generous letting me on the podcast to talk to people again, Gene.

Gene Tunny  47:27

You’re a great talker. Always enjoy having you on.

Brendan Markey-Towler  47:30

Even with the bruised throat? Like I told you, I could talk through a wet cement.

Gene Tunny  47:35

Very good. So, any final points before we wrap up?

Brendan Markey-Towler  47:39

No, it just ends up on I ended up with the note of circling back to where we started, which is don’t underestimate the national accounts. They’re a really, really, really interesting data set. They give us such a rich view. We didn’t even talk tonight about how in Australia, they break down by state as well, so, we can get an even richer view of how the different states are doing because you know, Australian economy tracker – my blog.

Gene Tunny  48:06

Okay, right. On Sub stack, is it?.

Brendan Markey-Towler  48:09

Yeah, on Sub stack. Please subscribe and contribute to the Markey-Towler retirement fund. It’s founded on two points, which is that one, the perfect graph says more than a doctoral thesis and two, there’s no such thing as an Australian economy. There’s actually six different city state economies and two territories. So, the national accounts in Australia are amazing, not just because of the depth of analysis, they allow us on the supply side of the economy, but on the demand side as well. We get some really, really rich version. So, a plug to remember has to diehard nerds who didn’t have friends at school, but now we have the national accounts.

Gene Tunny  48:53

I’m sure you had friends at school, Brendan. Brendan Markey-Towler, that’s been terrific. I really enjoyed talking to you about the national accounts. 

Brendan Markey-Towler  

I really enjoyed talking to you, Gene. Thanks for having me. 

Gene Tunny  

Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com and we’ll aim to address them in a future episode. Thanks for listening. Till next week, goodbye.

Credits

Thanks to Josh Crotts for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.auPlease consider signing up to receive our email updates and to access our e-book Top Ten Insights from Economics at www.economicsexplored.com. Also, please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

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Podcast episode

China, Taiwan & the Indo-Pacific w/ Dr Greta Nabbs-Keller – EP146

The next big global economic shock could come from a Chinese invasion of Taiwan, a shock which would probably have more extensive economic impacts than the Russian invasion of Ukraine. Joining show host Gene Tunny in episode 146 to discuss China and Taiwan and the Indo-Pacific more broadly is Dr Greta Nabbs-Keller, Senior Specialist in Defence Research at The University of Queensland and the Program Director of the Australian Program Office for Advanced Hypersonics. 

You can listen to the conversation using the embedded player below or via Google PodcastsApple PodcastsSpotify, and Stitcher, among other podcast apps.

About this episode’s guest – Dr Greta Nabbs-Keller

Dr Greta Nabbs-Keller is a Senior Specialist in Defence Research at The University of Queensland (UQ). She is also an Affiliate Senior Specialist at UQ’s Centre for Policy Futures where her current research project centres on issues of contestation and coherence in Indonesia’s national security policy making. Greta has extensive professional experience working on Australia’s bilateral relationship with Indonesia and continues to utilise her Indonesia country expertise in consulting, research, and international development roles. She contributes regularly to media and think-tank analysis on regional strategic, political and foreign policy issues, and engages with policy communities through submissions, dialogues, conferences and executive educations programs. Greta’s broader research interests include Indonesian civil-military relations, Indonesia-China relations, politico-security developments in Southeast Asia, and Australia’s regional foreign policy. Greta is an Executive Council member of the Australian Institute of International Affairs (AIIA) Queensland and Adjunct Research Affiliate at Griffith Asia Institute.

Links relevant to the conversation

Greta’s articles at the Lowy Institute Interpreter:

https://www.lowyinstitute.org/the-interpreter/contributors/articles/greta-nabbs-keller

Greta’s articles at ASPI’s the Strategist:

https://www.aspistrategist.org.au/author/greta-nabbs-keller/

Greta’s conversation article on Australia’s relationship with South East Asia:

https://theconversation.com/how-well-has-the-morrison-government-handled-relations-with-southeast-asia-181958

Background reading on China and Taiwan:

https://www.cfr.org/blog/what-xi-jinpings-major-speech-means-taiwan

Transcript of EP146 – China, Taiwan & the Indo-Pacific w/ Dr Greta Nabbs-Keller

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:01

Coming up on Economics Explored…

Greta Nabbs-Keller  00:04

I think Biden has, whether there were slips or not, he’s made it quite clear that the US will intervene, but I think it’s increasingly likely that we would be looking at essentially World War III if China did decide to attack Taiwan.

Gene Tunny  00:21

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional Economist based in Brisbane, Australia, and I’m a former Australian Treasury official. This is episode 146. On China, Taiwan and the Indo-Pacific.

The Russian invasion of Ukraine has highlighted how geopolitical developments can disrupt global markets and economies. The next big geopolitical and global economic shock could come from a Chinese invasion of Taiwan. The Chinese government claims Taiwan belongs to China. It has an ambition of taking over Taiwan by 2049, the 100th anniversary of the founding of the People’s Republic in 1949, following the Communist Revolution led by Mao Tse Tung. Various actions of the Chinese government and its military in recent years, have raised concerns that a Chinese invasion of Taiwan could happen sooner rather than later. Obviously, this would have profound implications for the global economy, and hence, I feel it’s important to cover the issue on the show.

Joining me in this episode of chat about China and Taiwan, among other geopolitical issues, is Dr. Greta Nabbs-Keller. Greta is a senior specialist in Defence Research at the University of Queensland, UQ, here in Brisbane. Currently, she is the interim Program Director of the Australian program office for Advanced hypersonics. Greta has an extensive background in defence and foreign policy issues with a specialization in Indonesia and Southeast Asia.

I invited Greta onto the show because I thought she’d be a great person to help us understand what’s happening with China and Taiwan, and what China has been up to in the Indo-Pacific region more broadly.

This episode, you’ll learn why foreign policy experts are so concerned about China, because it’s what they call a revisionist power, one with a goal of remaking global institutions and rules for its benefit. In the show notes. You can find relevant links and details of how you can get in touch with any questions, comments or suggestions. I’d love to hear from you. So please get in touch and let me know your thoughts on this episode. This is a big issue we deal with in this episode, and allow him to return to it in the future for a closer look at the potential economic impacts of a Chinese invasion of Taiwan, if that were to happen.

Right on, now for my conversation with Dr. Greta Nabbs-Keller on China, Taiwan in the Indo-Pacific.

Thanks to my audio engineer, Josh Crotts for his assistance in producing this episode. I hope you enjoy it.

Dr. Greta Nabbs-Keller, welcome to the program.

Greta Nabbs-Keller  02:57

Thanks very much, Gene.

Gene Tunny  02:57

Excellent, yes. Good to have you on the show. I thought I’d invite you on; I had a recent conversation with Michael Knox, who’s the Chief Economist at Morgan’s, which is a major stock broking wealth management firm, here in Australia. And I asked Michael about China. And I must say I was rather, surprised by his answer that he was so concerned about a potential Chinese invasion of Taiwan sometime in the future or in the next few years. So that’s, that was the original reason I thought I’ll be good to have you on the show. And then I know you’re also an expert on Indonesia and Southeast Asia. And we’ve got a new government here in Australia. And the first trip the PM made was to Jakarta and he had a bike ride with Joko. So, we got to ask you about Indonesia too.

But before we get into all of that, would you be able to tell us please, what is the Australian program offers for advanced hypersonics? That’s where you’re the interim Program Director. Can you tell us a bit about that, please?,

Greta Nabbs-Keller  04:10

Yeah. Thanks, Gene. Well, my position at UQ on both senior specialists Defence research in our engineering, architecture and IT faculty. And my other hat is the program director of the Australian program office for advanced hypersonics which is probably one of the most exciting titles, I think I’ve ever had Gene. Essentially, the program officer, the APOAH, as we abbreviate to it, it’s fundamentally about bringing Australian university expertise in hypersonics together So, University of Queensland is the world’s largest hypersonics group. And I don’t think many people are aware of that that the southeast Queensland with the University of Queensland and USQ are home to considerable expertise in hypersonics science and technology and indeed, I think really the genesis or the story of hypersonics in Australia from Professor Ray Stalker’s time, for around 35 years is largely been centered on the University of Queensland and the subsequent integration with US hypersonics program.

So, the Australian program offers for advanced hypersonics it’s fundamentally, a team Australia approach to advancing hypersonics research and more blue sky or beyond, you know, near horizon research, things around electric propulsion and plasma field engine. And it’s also fundamentally about workforce pipeline. As you know, Gene, Australia is facing increasing shortage of STEM graduates and the APOAH look at pathways to citizenship and basically developing a nurturing that workforce pipeline that’s in such demand by Defence and industry.

In essence, the APOAH provides a single gateway into the Australian university hypersonics ecosystem to include UQ, USQ, University of New South Wales, and RMIT. So, we’re developing that concept to be ready to provide Australian Department of Defence with hypersonic solutions and capabilities.

Gene Tunny  06:26

Okay, so hypersonic, that’s five times the speed of sound?

Greta Nabbs-Keller  06:30

That’s correct. Mark five and above. And I must say, Gene from a non-science and engineering background, and you introduce me as an Indonesian specialist. So obviously, I have more on international relations or comparative politics background, I’ve been on a steep learning curve about hypersonic about scram jets and various modes of propulsion. And it’s been very, very interesting for me.

Gene Tunny  06:56

Yeah, well, it’s certainly relevant in geopolitics, because one of the things that I’ve heard is that I mean, the Chinese, they’re making great advances in hypersonics. So, and I don’t know whether they’re ahead of the Americans or ahead of us or the British, I don’t know. But I know that that’s one of the concerns that’s out there. I mean, there are these hypersonic missiles that have been developed, or is that the Russians do?

Greta Nabbs-Keller  07:23

It’s both. You’re both right. I mean, the Russians have long had hypersonics technology and other players are India and Japan. And indeed, there may be others because a lot of that is closely guarded. Chinese did fire a advance hypersonic missile last year, which caused some alarm, at least in media reporting, Gene within the Pentagon and Washington. I think one senior US General described it as a Sputnik moment where the US I think, was, fundamentally alarmed at the advances in Chinese hypersonics technology.

Again, I’m not a hypersonics scientist myself, but certainly China’s formidable military buildup and integration of critical and emerging technologies is quite significant. And the rest of the world is looking at that with some unease, of course.

Gene Tunny  08:29

Right, okay. So, we might talk about China now. So, what stunned me as an economist in the last few years, I think it’s the last few years, is just how much that relationship with China has deteriorated. Because there was so much excitement about China joining the WTO in 2001. And I mean, we all saw the economic gains to Australia from the growth of China through them purchasing our coal and iron ore and what that meant for that sector. So yeah, this is all come as a real shock. And it looks like I mean, there’s been a real; it’s a big challenge for our country, and also for our allies, the US and Japan. And I suppose we’re part of this quad group now with India. So, I’d like to ask you about that later. What’s that all about? Because I thought India was not aligned. But now it looks like it’s aligned.

To begin with, could you just describe what’s your assessment of the current strategic environment, the current environment facing Australia and I suppose the US as well in the Indo-Pacific, I mean, how concerned should we about what’s going on?

Greta Nabbs-Keller  09:55

I think it’s deeply concerning, Gene, for those of us who follow international political and strategic developments closely, I think there are real reasons for concern and you know, indeed, in terms of Australia and take Australian strategic guidance and defence and foreign policy documents, you know, they describe the environment as more uncertain, and more complex and more dangerous. You might recall Peter Dutton talking about the drums of war, a beating and being criticized for that. But I’ve seen in my own career, particularly over the last, I’d say, post COVID, particularly Gene that that word war, is being more openly discussed and acknowledged as a real prospect due to the deteriorating strategic environment and rising strategic tensions between major powers.

So, I think in a nutshell, many of the current geopolitical tensions in the Indo-Pacific centre on a rising and a revisionist China and of course, it’s not only sino US strategic rivalry that we can see, you know, playing out, across economics, geo-economics, around technologies, around trade, around human rights, around maritime strategic competition. But of course, one also has to remember that it’s not only US and Australia have difficulties with China, but indeed, many countries even actually, European countries as well. Particularly, you mentioned the Koba particularly Japan and India, of course, as significant Indo-Pacific powers. And they have their own issues, which are probably, to some degree more concerning and more pressure than Australia’s facing, particularly India, on the line of actual control up there on the border. And definitely, India and China have gone to war previously. Over their contested border, they’re in the line of actual control up there in the Himalayas, you see increasing pressure on Japan, particularly in the maritime domain in the East China Sea.

So, China under current president, Xi Jinping and I acknowledge, as you introduced me, I’m an Indonesian specialist rather than a China specialist. But of course, I follow these developments closely. And a lot of these uncertainties centre on China and a more assertive, and aggressive China and decision Jinping’s presidency and how various states in the region are responding to these pressures and constraints. I think particularly with Australia, if you’re an observer or student of Southeast Asian politics particularly, you would have seen some of the coercive and punitive behavior playing out previously on Southeast Asia that was later applied to Australia, particularly once our former Prime Minister, Scott Morrison, called for and rightly so, an independent inquiry into the origins of the COVID 19, the virus.

Indeed, in Southeast Asia we’ve seen for a number of years, very coercive tactics, particularly in the maritime domain, and some implementation of coercive trade practices against Asian states like the Philippines, over tensions in the South China Sea; rival maritime claims in the South China Sea. And if I’m not mistaken, there was some tariff barriers put on Banano, a Philippines banana export. So. there have been a number of precedents here.

I think China, after COVID-19 obviously became more brittle and much more brittle and more sensitive to international criticism over the origins and the management in the earlier days of the COVID 19 pandemic. And I think a number of, you know, even seasoned foreign policy experts and senior Australian public servants are probably shocked by Australia’s treatment by Beijing after calling for that independent inquiry into the COVID 19 pandemic. But also, I think, a number of countries, we saw what was characterized as wolf warrior diplomacy, by Beijing, that list of 14 grievances against Canberra.

But there has been some precedent here in their treatment of other countries and indeed, it’s not just Australia that’s experiencing these problems as I said, countries like Japan are really at the frontline of increasing coercion and intimidation.

I think also China’s willingness to engage in grey zone tactics. And that’s something that Russia has also employed successively in Ukraine. Prior to the actual invasion of Ukraine, and you see, militia groups that, rather than they’re not Russian military forces, per se, but there are militia groups, you see disinformation campaigns, and I think China has increasingly engaged in those grey zone operations or what is termed hybrid warfare. So, their acts of intimidation and coercion, shorter warfare. And I’ll give you an example on that Gene, in the maritime domain. You’ll see China deploy heavily armed paramilitary vessels escorting their fishing fleets in the South China Sea, rather than PLA Navy vessels, for example, increasing cyber intrusion, cyber hacking against Australia, but a range of countries all around the world.

You’re seeing increasingly, aggressive and assertive China that looks to fundamentally kind of reshape the Indo Pacific and probably more broadly the global order; more convergent, with its own interests. So, I think there’s no doubt that, you know, China has achieved particularly, in Southeast Asia, increasing political, economic; in terms of military balance of power, that’s something we can discuss. I think it was quite a shock for Canberra and the Australian public to be on the receiving end of that rough kind of diplomacy and treatment post March 2020.

Gene Tunny  16:56

Absolutely. Well, they applied higher tariffs on many of our products on beef, barley; they restricted the imports of our thermal coal into their ports. I’m going to have to look at those sporting grievances. That’s interesting. And you mentioned Peter Dutton, was he a Defence minister?

Greta Nabbs-Keller 

Yes, former Minister for Defence.

Gene Tunny 

So that’s why those comments were picked up and he was accused of being, was it sensationalist? It was the right word to describe that. But yeah, there were people who were thinking that sort of commentary wasn’t helpful at the time. Right. Can I ask you what you mean, by revisionist? What do you mean by a revisionist China?

Greta Nabbs-Keller  17:42

The concept of a revisionist power, is a power or a nation state that wants to remake the international order, an international system and the rules. As I said, it convergent with their own interests. Undergraduate students studying international relations and politics, they understand about the post Second World War kind of US led global system, whether and of course, you Gene, you’re more an expert on the international trading order and the WTO, and the basis of rules and norms, and that extends, of course, to international legal norms that govern the maritime domain.

And so, it’s really that post Second World War Bretton Woods, US led system of strategic alliances that emerged out of the Second World War, where the US has largely been the dominant, the preponderant global power and that’s very much been changed. And I give a practical example, because it sounds abstract. So take the maritime domain and on class, the 1982 UN Convention on the Law of the Sea, which governs territorial waters and exclusive economic zones, and indeed, Indonesia, was one of the architects of on class the UN Convention, and as diplomats, played a key role being the world’s largest Arca pelagic state, and a system of rules and governance and norms that guaranteed maritime governance and nation states access to their territorial and the resources within their 200 nautical miles exclusive zone.

So, China has, increasingly refuted international legal norms, Permanent Court of Arbitration ruling 2016 which found in favor of the Philippines on rival maritime claims. China simply chose to ignore that and refute that. So, I think what you’re seeing more generally Gene, in terms of geopolitical tensions, you’re seeing countries like Russia and China who are more willing to challenge those established legal norms and international principles that have largely underpinned prosperity and security and stability in the Indo Pacific. And we’re seeing the erosion of that and that’s creating increasing uncertainty and tension.

Gene Tunny  20:21

Just on those maritime boundaries, is that what you were talking about before and China isn’t respecting what was decided by this international body? What does that mean, practically? Does that mean that they will help their fishing crews go into those waters and fish?

Greta Nabbs-Keller  20:45

Absolutely. The problem in the South China Sea; and you might be familiar with, China’s very ambitious South China Sea claim that takes in around 95% of the South China Sea, irrespective of those maritime boundaries that were decided under the UN Convention on the Law of the Sea in 1982. So, you’re seeing effectively, Chinese paramilitary and fisheries activities inside our state’s exclusive economic zones. You’re seeing increasingly belligerent and coercive behavior against the Coast Guards; more often Coast Guard, sometimes military assets of Southeast Asian states, littoral states that have claims in the South China Sea. So, you basically have a very powerful nation state who’s not willing to follow the rules of the game and has the power and the might to simply ignore that. And of course, the US is not innocent of ignoring international law. Let’s be fair here. But, we’ve also had harassment of regional states like Vietnam and Indonesia and Malaysia with their exploration of hydrocarbons, oil and gas in the maritime domain and harassment of oil rigs and oil exploration activity. So, it’s kind of spans a range of activities in the maritime domain, but again, it undermines the principles of sovereignty, and of course, maritime sovereignty and of course, that’s inherently destabilizing.

Gene Tunny  22:29

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Gene Tunny  23:03

Now back to the show.

I thought it was interesting before you mentioned this concept of grey zone activities. And I mean, they’re also engaging in applying economic pressure in a way, aren’t they? Or that they’re coming into these countries and they’re signing memorandums of understanding or they’re doing deals and then there’ll be some financing. But then what can happen is that if they don’t meet the repayments the country, then the Chinese can take it over or they can apply leverage on those countries. That’s a concern, isn’t it? So, there’s a whole range of things that the Chinese are doing, they’ve signed a deal; there’s some sort of deal with the Solomon Islands, you know what’s going on there? Does that fit in with a sort of a grander or a broader plan to dominate the Indo-Pacific?

Greta Nabbs-Keller  24:01

You’re talking about debt? What’s term debt trap diplomacy. And usually that some understood in terms of China’s expansive infrastructure and connectivity program, the Belt in Road Initiative or the VRI and indeed, there have been legitimate concerns about these massive infrastructure projects, extending from Africa and through, South East Asia, Pakistan, and the Pacific. The problem, particularly of debt exposure of these countries; they’re taking on debts for infrastructure projects that they’ll never be able to repay.

One of the key-case studies there is Sri Lanka actually, and the Hambantota port; I think I might have a pronunciation regret. Hambantota port facility in Sri Lanka, and exposure to too much debt and China can effectively take control of that strategic port facility, which of course, not only has, civil applications and uses, but strategic and military benefits, of course, by buying ceding control of that.

So, I think countries are increasingly aware of some of these risks. And I think the US has even the State Department has done work in some countries, including Myanmar, to revise the terms of those infrastructure projects, which had, incredible interest levels and unfavorable term. And some of them have actually successively, successfully been renegotiated.

I think what you, I don’t know if admires the right word, Gene, but certainly, I think if you’re talking about grand strategy and sweeping strategy, and coherent whole of government strategy from Beijing, using all its policy arms, from military, from economics, from political to technological, and so on. It’s a very strategic approach to, if it’s not dominance, to increasing economic influence and political leverage, and ultimately, being able to project military forces. It’s very sophisticated.

And we’ll turn to Honiara deal for a moment, the Solomon Islands China deal. I mean, that’s deeply concerning on a number of levels. First of all, for the Solomon Islands, people and parliament, it was not a transparent negotiation process. So, that’s been of great concern. There’s also a sense also from looks at Southeast Asia; it’s an indication of what will increasingly happen in the Pacific and some scholars and analysts call it elite capture that you’ll find in Southeast Asia, for example, that, Beijing’s ability to wield significant economic blood, yes, it has some respects, captured some of the region’s elites. But that doesn’t mean that there’s broader strategic distrust in in those countries in Iran. I think you’re seeing the same sort of thing with the Pacific that China can successfully co op some of the region’s elites. But there’s certainly lingering distrust and unease remains around in the region’s politics.

I think on the Honiara deal, what what’s most concerning to Australia as well, that Solomon Islands is only 2,000 kilometers from Cannes and if you look back to your history in the Second World War, and the Guadalcanal, fiercely contested battles between the US and Japan, principally. I mean, that was basically about, preventing Japan from gaining a strategic foothold and strategic access, that would cut the US off from allies like Australia, and indeed, if China was to increasingly base or rotate, military assets and military personnel through Honiara, that’s a deeply destabilizing concerning strategic development for Canberra.

Gene Tunny  28:42

Right. I mean, was that a failure of diplomacy on our part, or on the US’s part? It just seemed to take everyone by surprise that that came up. I was stunned when I heard it.

Greta Nabbs-Keller  28:53

Well, I think, again, about sophisticated grand strategy that I think Washington and Canberra and a number of countries are being outsmarted by Beijing on a number of levels. And there’s a lot in this and I won’t unpack it all, but I think the previous government could have done more. In some ways, I think during the Morrison government’s pacific step up, which I think was announced, if I recall correctly, around 2017, or 2018, was somewhat an admission of neglect. Now, I don’t want to overstate the neglect because obviously, both Southeast Asia and the Pacific have a fundamental, foreign policy importance to Australia. There’s no doubt about that. But I think the step up was a recognition in the context of growing geopolitical tensions Australia needed to do more with our Pacific neighbors, or as Canberra terms it, Pacific family.

I think the US has also realized recently that they need to do more in the Pacific, particularly in response to China. Fundamentally, Pacific countries like Southeast Asian countries want to be taken on their own terms, they want to be considered on their own terms. And they don’t want their relationships with Australia or Washington to be viewed; you’re only within the prism of sino US rivalries or geopolitical tensions. Yeah, they have their own fundamental development concerns, and as you know, Gene, the Pacific with existential threats from climate change, rising sea levels are, an abiding concern for Pacific Island countries.

The other thing I’d say about China and Bina Indonesian specialists have a number of decades, something I note with interest, Gene, is that the China builds the capacity and regional expertise of its diplomats. So, they have Chinese diplomats who are real Pacific hands, they have years of rotational postings through the Pacific, so they become Pacific experts. And they engender that kind of expertise and the context and the relationships that come with that. And I think Canberra could do more, I think, to build again, or rebuild from what’s a generalist type model with our diplomats. And when I say diplomats, I don’t only mean Department of Foreign Affairs and Trade Representatives, I mean, all our agencies that are involved in international engagement and diplomacy. And as you know, treasury and finance as much Defence and Home Affairs, and others are posted into regional capitals. I think we could do more; we need a more sophisticated approach, we need to recalibrate our policy settings and more whole of government approach to regional engagement, and particularly on the Pacific and Southeast Asia.

Gene Tunny  32:01

It sounds like it. The way you were describing it earlier, it sounds as if China has this coherent strategy. So, there’s coordination between the different arms of the government, the different departments with state owned enterprises, perhaps? I mean, is it because they’re an authoritarian country with the President; I mean, is he President for life now or something?

Greta Nabbs-Keller  32:24

Constitutional change; I think there’s some more detail, I think, in the machinations that remain outstanding, whether that’s, guaranteed by the senior leadership of the Chinese Communist Party, but it seems that there were there was some agreement that his tenure would be ongoing, but I don’t know if that’s absolutely guaranteed genuinely in that context. But, it looks certainly a very, very strategic approach. I think you’re right, in an authoritarian kind of party-controlled state, centralized command, it is much easier, of course, to formulate and operationalize a very coherent kind of, strategy as opposed to democracies, where intrinsically, there’s more bargaining, there’s more difference, there’s more debate. And, indeed, the parliamentary system with the government and opposition that’s sort of; the foundations of Westminster democracy. So, I think it is much easier in a centralized party-controlled state to wield power and influence and sort of mobilize all your arms of government, and you mentioned State owned enterprise, for the purposes of very sophisticated strategic kind of policy approach.

Gene Tunny  34:00

Yeah, I found fascinating to that concept of; was it debt trap diplomacy? Yeah. Because I heard about what happened with Sri Lanka. I’m going to have to look more into that and probably cover it on the show. It’s fascinating and disturbing.

Right, my chat about Taiwan. How big a risk do you think that is? I mean, because that would be so disruptive to the global economy. I mean, we’ve seen what’s happened with Russia – Ukraine, but if China did invade Taiwan, I mean, it would have different impacts, but it’d be just as bad, probably worse. I mean, if you think about how much of the world’s industrial production has shifted to China, they make all the iPhones, they make computers. And then in Taiwan, it’s a major producer of semiconductors, I think, the chips that go into computers, I mean, this would be profoundly destabilizing.

Do you have a sense of how big a risk it is? And I mean, what would actually happen? Would the US respond? Would Australia respond? How would it all play out? I’m hoping it doesn’t happen; we’re all hoping it doesn’t happen. My feeling is that it’s unlikely but when I talked to people like Michael Knox, and then I, I listened to people like Ian Bremmer and other global commentators, I realized that the risk is much higher than I understand at the moment that I had expected.

Greta Nabbs-Keller  35:42

I think, again, I’m not a sonologist or China experts. I’m not privy to classified briefings. I’m not privy to the inner workings of the Chinese Communist Party and their thinking, but in broad terms, of course, I follow these strategic developments in the Indo-Pacific.

I think there’s no secret that Beijing, and Xi Jinping is made no secret of seeking, as they term it, to reunify with Taiwan, but of course, Taiwan, strictly speaking, was never part of China. The Republic of China was originally under Japanese controllers; Formosa and then the Shang Kai Shek. After the  China’s civil war, the remnants of his army fled to Taiwan. And, if not a country formally, it’s a very successful; indeed, it is a country whether it’s formally recognized as a sovereign country in political terms is another aspect. It’s been a very successful democracy, very dynamically, economically, and of course, it’s a democracy. And I think Beijing’s made no secret, it seeks to peacefully reunify with Taiwan, but they have not ruled out military force to do so.

I’ve been present at the Shangri La dialogue in Singapore, which is the preeminent security defence dialogue in in in the Indo Pacific region based in Singapore at the Shangri La Hotel, every two years and there’s no secret that, senior Chinese officials and generals, speaking at that dialogue, make no bones about it, that Taiwan, is an inseparable part of China, and they will seek to reunify.

Now, the implications of China’s invasion of Taiwan are memes, as you say. I mean, it’s almost difficult to really comprehend the massive implications. I mean, we look at Russia’s invasion of Ukraine, and the flow on effects for the global economy, and indeed, food security for millions of people looks like they’re going to be threatened with food shortages, rising interest rates. And you’ve got the supply chain issues in China associated with COVID 19 lockdowns which are exacerbating that. And of course, you as an economist know very well about this.

Let’s look at some of the key implications, and there’d be many implications. But I think if China successfully invaded Taiwan, it fundamentally changes the Indo Pacific region, it gives China force projection. So, occupation of some of that first island chain, as we see that island chain along the eastern part of the South China Sea, it enables them to forward deploy military forces and to deny the US access, around the Philippine Sea, and more broadly threatens, they’re leaving implications, for us, us force disposition in Guam. Fundamentally, for Japan, this will be a profound concern for Japan because it effectively cut or deeply imperil Japan from US military assistance. So, in strategic terms, it provides Beijing with a forward presence to project military force and potentially control vital sea lanes and air space. So, I think also, it would have broader consequences, as we’ve seen it in Russia’s success in Ukraine, because it means authoritarian states can simply annex and occupy democratic ones. So, it’s more fundamentally a threat to democracies and those fundamental principles and values of democracies that we hold dear.

We hear about European values Gene, in the context of Ukraine, and Ukraine’s potential membership of the EU and NATO. And we talk about European values and what we’re talking about, there are the fundamental tenets of liberal democracy. And I think, more powerfully, in some respects, if the US did not successfully defend Taiwan, it’s the end of that post Second World War order, it’s very profound, it’s the end of basically US hegemony in the Indo-Pacific region, the US would lose credibility with allies and also mean the consolidation of a China centric order. And all that entails; I don’t know about you Gene, it doesn’t feel me, the prospect of living under a China dominated doesn’t fill me with great glee on a range of France from just environmental management. And I talked about maritime and the maritime domain about, exploitation of fisheries, you’ve got seabed mining emerging as a warrying prospect, but also, in terms of political liberties, surveillance, cyber intrusion, and coercion, it doesn’t fill me with confidence that if China could successfully take Taiwan, and then it would fundamentally impact on the balance of power and all that would entail.

I’d like to quote, Malcolm Turnbull actually on this, as what’s at stake here, more generally, with China’s revisionist tendencies, as Malcolm Turnbull, our former Prime Minister said, you, you can’t have a situation where the big fish eat the little fish and the little fish eat the shrimp. And that’s the basis of the international rules-based order, is making sure all sovereign states at least, have some equality in the international system. And I think China’s might and power is fundamentally eroding that rules-based order and this is the danger of highly destabilizing.

It’s hard to imagine; the economic implications are something you wouldn’t be able to talk about. But this would be profound, absolutely profound. And, the US has tripped itself up a little bit, particularly Biden on Taiwan, because there was a deliberate policy of ambiguity by Washington recognizing one China policy and ambiguity around whether the US would actually deploy military force to defend Taiwan. And I think Biden has, whether there were slips or not, is made it quite clear that the US will intervene, but I think it’s increasingly likely that we would be looking at essentially World War 3 if China did decide to attack Taiwan, because that would invoke Japanese involvement. And certainly, we’d be involved as well.

Gene Tunny  43:25

Right. Yeah. I mean, I just wonder what it would look like. Would it look like a block aid? I mean, I’m struggling to think of how they would respond; there’d be diplomatic pressure at first. I mean, we don’t know how it would go. Would the Chinese easily; would they take it over? I’m sure the Taiwanese have, I mean, they’ve probably been training for this, preparing for this. They would have their own military equipment to defend the island. So, it could be like Ukraine. I mean, that’s been a surprise that the Ukrainians have been able to push back on Russia so well. And I mean, the Americans have been supporting Taiwan, haven’t they? They’ve been arming the Taiwanese?

Greta Nabbs-Keller  44:13

Yeah. It’s been a number of congressional acts on Taiwan, the increasing number of US officials, much to Beijing’s consternation flying in into Taiwan. And that’s, of course, in China’s eyes, undermining one China principle. I mean, Taiwan, has some formidable military capability. So indeed, that the Taiwanese and Americans are looking very closely at Ukraine.

What has surprised strategic analysts about Russia’s invasion of Ukraine is that the Russian military was always considered, a formidable, and highly capable military force. But the Ukrainians in asymmetrically have been able to impose significant costs on Russia. You’ve got issues around morale, conscription with the Russian military, the use of drones; successful application of drones and sophisticated anti-tank missiles and anti-aircraft missiles. Ukrainians have; they’re defending their homeland and they’ve done surprisingly well.

You could imagine, Gene, this would be quite devastating. I think the inevitability of war, as sad as it seems, it’s very hard to see this not being on a trajectory towards war, because there’s so much at stake as, as I stated, for the US and other countries in Taiwan. And from China’s perspective, they fundamentally see Taiwan as part of the Chinese mainland and homeland. Again, what makes it dangerous is there’s a sense of domestic political legitimacy in reunifying, with Taiwan for Xi Jinping regime, which perhaps makes it more dangerous and as economic trends and deterioration, the global economic environment will buffets China, as it will other states. Does that make Xi Jinping, more inclined or less inclined to consider an attack on Taiwan?

The longer the US leaves it, China grows inexorably stronger and more military capable as the years tick by. So, there’s very, very high risks at the moment, Gene, of a conflict or regional conflict emerging. And that’s what worries countries in Southeast Asia feel so much, you feel sort of, pawns and caught in the middle of these kinds of dynamics?.

Gene Tunny  47:12

So we’re recording this on the 23rd of June, 2022. On 22nd of June, 2022, CNN reported China sends dozens of war planes into skies near Taiwan. So, it’s acts like this that make people very concerned about the future.

Can I ask about the other sort of players in the region, the major countries, Indonesia and India? So where do they fit in this because they’ve traditionally been nonaligned. We’ve been in, was it Bandung? Did have a famous conference there. We were there on a course for the Indonesian Ministry of Finance and stayed in the Padma on the Gorge there, which was beautiful. But there was, was it the East West Conference? I’m trying to remember it. There’s that old colonial building in downtown Bandung where they had a famous conference back in the 50s.

Greta Nabbs-Keller  48:09

You right Jean, that’s the Asia Africa conference of 1955, still lauded as one of Indonesia’s greatest diplomatic achievements and out of the Asia-Africa conference, which was essentially, that was in a cold war environment, but it brought the newly independent countries of Asia and Africa together. And it was the birth of the nonaligned movement. Of course, these countries who are effectively post-colonial states, didn’t want to be two sides between the US and the Soviet Union; a Soviet bloc in the Cold War, and they wanted to forge an independent path. And out of that, emanated the peaceful principles of coexistence and it was historically a significant development in an international political history.

There’s one thing I just want to pick up from your previous comment about the Chinese planes, PLA Air Force planes are flying into Taiwan border area air identification zone. This is what makes it so dangerous too, it’s not just the rhetoric, and the polemic around Taiwan, It’s China’s increasing willingness to engage in that kind of conduct both in the maritime domain and the air domain that make the risk of miscalculation and escalation so high, you can foresee a situation where, missiles are locked on and in this game of brinkmanship, you can see how something could go terribly wrong and escalate very quickly. And indeed, the ABCs reported this morning on more details of PLA Air Force interception of rafts Australian Air Force planes are flying out from the Philippines over the South China Sea around the Paracel Islands, challenging them in some very dangerous midair maneuvers. Things are escalating.

Now, Indonesia and India, very interesting states – pivotal states, of course. India is the second largest country in the world in population terms. And Indonesia, many people overlook is the fourth largest country in population terms and the world’s third largest democracy. So, India and Indonesia are pivotal states to the Indo-Pacific. And you’ll see India’s been very, interesting and you’d said, of course, they’re both formally nonaligned. India and Indonesia have a lot of historical and cultural similarities.

India, of course, has become increasingly concerned about Chinese actions on its Himalayan border there around Ladakh, in the line of actual control. There’s been physical skirmishes up there between PLA and Indian troops that saw at least, I think around 25, roughly, Indian soldiers killed, and the Chinese China never released the number of their troops killed in the physical skirmish up there.

So, that’s been of increasing concern. And certainly, India’s responded with increasing its military presence at Himalayan border significantly. They’ve banned dozens and dozens of Chinese apps. I’m talking about mobile phone apps around the risks of surveillance and intelligence collection, and intrusion.

And you’ve seen India move; although it’s formerly nonaligned, India has moved much closer to Washington, and indeed Japan and Australia, as those four states of the quadrilateral security dialogue or the quad, look to act in coalition and it’s not a formal military alliance with note, because of the nonaligned status of India. But you see, you’re increasing coordination between the quad members, around vaccine diplomacy and vaccine infrastructure, economic technological cooperation.

Now, the military component of the quad is probably the Malabar naval exercises. There’s sort of a tenuous link with the quad and as I said, the quadrilateral security is a dialogue. It’s not a military path or alliance, but perhaps the Malabar exercises for nation exercises and conducted in the Indian Ocean between those four states. You can see is the kind of the military defence component of the quad.

Now Indonesia, of course, is a country that’s been very much at the forefront of my research and professional interests for decades. Indonesia is an interesting country. It’s again, formerly nonaligned, it’s effectively the largest state in the Association of Southeast Asian Nations and Southeast Asia and effectively the veto actor. Indonesia has a foreign policy doctrine, a free and active foreign policy doctrine, and it seeks strategic autonomy and to manage the influence of what it considers external powers and I mean, the powers external to the Southeast Asian region. Although China’s proximate in Indonesia’s foreign policy conceptions, China, Japan, US and other countries are external to those ASEAN states.

And I think, Indonesia and many of the major Africa; the go back to Bandung Conference were born out. They were decolonized within this Cold War, polarized global political context, and they don’t want to be seen as pawns in great power rivalry. So, this is increasing policy complexity to Jakarta.

You’re acutely worried about rising geopolitical tensions and what that means for decades of stability and growth in Southeast Asia and you know, ASEAN as a bloc is a significant economy collectively. Over around 650 million people in ASEAN; significant collective strength in ASEAN.

So, Indonesia hedges and balances; it has close and constructive relations with China and very close and constructive relations with Washington, and of course, Canberra and Tokyo. Tokyo, and one cannot forget Japan; Japan is still a significant global economic power. And Japan before China was the engine of growth in Southeast Asia, for decades. It was Japanese investment – FDIs, you know, Gene, in Southeast Asia that really spurred, Southeast Asia’s growth there, for decades.

Gene Tunny  55:40

And so now China has taken up that role, has it? Within Southeast Asia, it’s engaging a lot of foreign investment. And so that’s giving them political leverage..

Greta Nabbs-Keller  55:51

Absolutely. As I said, don’t underestimate Japan, as an economic partner and political partner for Southeast Asia. But of course, like China, is a major trading partner of all Southeast Asian states.

It’s much more China and Japan are both very good in comparison to Washington I’d say through ASEAN mechanisms are more integrated than the US is into Southeast Asia, through ASEAN Plus mechanisms and economically. And also, I’d say, Gene, in the context of the COVID pandemic, as young countries turn to Beijing, because Beijing was able to roll out very quickly; the Sinovac vaccine was most readily available and cheaper to Southeast Asia, then, AstraZeneca or Pfizer, and even though Southeast Asian states knew that the efficacy of those vaccines was higher than the Sinovac or the Chinese manufactured variants, China, to be fair, has been able to offer the public, goods and the investment vaccines that the education opportunities that US has neglected to do, and I think you see, increasingly in Washington’s or regional policies that they’re looking to make up ground, and that it’s not only about the importance of military partnerships between Washington and Southeast Asia.

And I must say that for Indonesia, for Jakarta, Washington is a much more important strategic military partner than China. They know they have to do more work in infrastructure, in trade, in economics and climate finance to basically compete with China in the region. The US knows that too. And of course, Australia as well.

Gene Tunny  57:50

I think they’re finally woken up to the threat in the region. Or it’s become more apparent with what happened in Solomon Islands, because they sent one of the very senior State Department officials over, didn’t they? To go and visit Honiara, if I remember. Yes, I just remembered, we’ll wrap up soon. But I just remembered when we’re talking about the FDI, the Foreign Direct Investment, we were talking about Bandung before, there was that rail line; they were going to rebuild that line or was it a fast train high-speed rail from Jakarta to Bandung? That’s a Chinese Indonesian Consortium. But now, that’s been thrown into disarray, because the Indonesians are looking at moving the capital away from Jakarta, because apparently, Jakarta is sinking isn’t it? Do you know what’s going on there?

Greta Nabbs-Keller  58:42

Yeah. That’s been really interesting, Gene. As you know, we both worked on infrastructure courses and finance public policy courses that considered the Jakarta bundle high-speed rail. And, in many respects, I think the problem has been at Indonesia and to be fair, rather than China’s. Their huge problems from the start, I think when President Joko Widodo Giancoli turned over the soil; the groundbreaking ceremony, which was a number of years ago, I think even back to around 2017, 2018 If I’m not mistaken. There have been problems from land acquisition problems, these transport infrastructure corridors. They might identify the anticipation; but the land acquisition has not been resolved, which is one of the fundamental impediments to infrastructure projects in Indonesia, more generally.

 So, there’s been a range of problems with the Jakarta bundle high-speed rail. Part of it is built, I’m not up with the absolute latest, but I know there have been ongoing challenges which are blown out the timeline for delivery of that infrastructure project.

You mentioned about the move or relocation of the Indonesian capital to East Kalimantan Province, which many people know as Borneo, Kalimantan is Indonesian. Borneo, of course, you have Brunei and the Malaysian states of Sabah and Sarawak in the northern part of Borneo. There’s fundamentally some environmental challenges with Jakarta, it’s a capital that is widely understood to be to be sinking. Anyone who’s been to Jakarta knows that there are infrastructure challenges, some of the basic infrastructure has not been updated since the Dutch colonial times. There’re issues around governance and corruption and things.

So, Jokowi, the infrastructure president has announced and that’s been recently legislated to relocate the capital to East Kalimantan, a very, very ambitious project. And I think there are also benefits and risks, although it’s going to be a smart and Green City. I think there are broad implications for the environment and biodiversity and ecology up there. Whether this will be a white elephant project, Gene, which won’t outlast Joko Widodo’s presidency; we know the presidential elections will be in 2024. Whether this capital, I guess what I would say, if you take the, at a micro scale, the Jakarta bundle high speed rail project and extrapolate that to a much more ambitious infrastructure project in the new capital city, how successful and how protracted and how problematic? Will it be? It remains to be seen?

Gene Tunny  1:01:59

Yeah. One of the things that economists have observed over the years is that any mega project brings big risks of cost blowouts. So, you just see it all the time. I’ll have to cover that on the show in the future. Right oh! Greta, this has been fabulous. I think we’d like to wrap up have picked your brain for nearly an hour. Any. Any final thoughts? Before we wrap up? Anything we should we should have covered?

Greta Nabbs-Keller  1:02:27

No, look, I think you could talk for hours about strategic developments and regional dynamics, Gene, and there’s so much going on at the moment. It’s barely possible to keep abreast of all the developments. So, I’d like to thank you very much for having me today.

Gene Tunny  1:02:46

Oh, pleasure. Where can we find more about your work? Do you publish your work on, is it LowE Institute from time to time or SB?

Greta Nabbs-Keller  1:02:56

Yeah, I publish but it’s on that SB’s blog, the strategist and the Low E Institute for International Policy. The interpreter recently I’ve had some analysis published with the conversation and Australian foreign affairs, AFA on Indonesia and particularly the new government, Albanese governments, Indonesia policy settings.

Gene Tunny  1:03:20

Ah, right. Okay, I forgot to ask about that. I guess it’s early days. So, I’ll put a link to your article in the show notes so people can have a read of that.

Very good. Okay. Dr. Greta Nabbs-Keller, thanks so much for being on the program, really enjoyed it. Thank you. Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com And we’ll aim to address them in a future episode. Thanks for listening. Till next week, goodbye.

Credits

Thanks to the show’s audio engineer Josh Crotts for his assistance in producing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au

Please consider signing up to receive our email updates and to access our e-book Top Ten Insights from Economics at www.economicsexplored.com. Also, please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple Podcasts, Google Podcast, and other podcasting platforms.

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What is the Economy? And Why It Matters to You | EP121

What is the Economy? And Why It Matters to You is a new book from UK economics writers Beth Leslie and Joe Richards, who are interviewed in episode 121 of Economics Explored. Legendary music producer Brian Eno has endorsed the book, writing “This clear and comprehensible book is long overdue.”

About this episode’s guests – Beth Leslie and Joe Richards

Beth Leslie is a writer and editor. She became interested in economics when she realised it was a great way to better understand the world around her. Beth is currently the Editor for Economy, a charity that seeks to make economics more understandable for everyone.

Joe Richards is an author, educator and economist. After the financial crash of 2008, Joe’s family lost their business and the home they grew up in. Spotting a lack of public understanding in the economy, Joe’s journey in economics began. Joe campaigned to make economics more accessible for everyone, working with organizations from the Bank of England and BBC News, to local schools and the UK government.

Where you can purchase What is the Economy? And Why it Matters to You:

US https://www.bloomsbury.com/us/what-is-the-economy-9781786995605/

UK https://www.bloomsbury.com/uk/what-is-the-economy-9781786995605/

Australia https://www.booktopia.com.au/what-is-the-economy–beth-leslie/book/9781786995605.html

Thanks to the show’s audio engineer Josh Crotts for his assistance in producing the episode. 

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple Podcasts, Google Podcast, and other podcasting platforms.

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