Look to Britain and hold the champagne
Published in The Sydney Morning Herald, 25 April 2011
The UK property bust provides worrying parallels for our self-congratulatory local economy.
Does history repeat itself? If you believe Karl Marx, history always happens twice. First as tragedy, then as farce. The longer I live in Australia the more I feel that Marx was right, if only about this.
Australia is now in its 20th year of uninterrupted year-on-year growth. Neither the north Atlantic financial crisis nor recent natural disasters closer to home could blow the Australian economy off course. Unemployment is low by international standards; inflation is under control; and the Australian dollar is stronger than ever.
Clearly, there are good reasons why Australians can be relaxed. A whole generation only knows bad economic news as something that happens on SBS World News. Australia is still the lucky country. And anyway Australia, so they believe, is different.
The current mood in Australia triggers eerie memories for me. I feel as if I have experienced this scenario before – not in Australia but in Britain.
I moved to London in 2004. The ”cool Britannia” euphoria had ebbed away during the Iraq War but, at least domestically, the country was still at ease with itself. Gordon Brown, the Chancellor, celebrated prudence as the guiding principle behind his fiscal policy. The City of London was rivalling New York as the world’s financial capital, and the British housing market was booming.
It was difficult not to be lured by the propaganda coming out of Brown’s Treasury that Britain was going through the longest period of growth in its history. However, the more I looked behind the facade of the growth phenomenon the more unreal it all looked.
In mid-2007, when the GFC was still just an American subprime mortgage crisis and Britain believed it had no bearing on its own fortunes, I wrote a short research note for the think tank Policy Exchange. My colleagues Briar Lipson and Holger Schmieding, then Chief Economist (Europe) at Bank of America, and I argued that Britain’s glitzy economy was more mirage than miracle.
In our short paper we pointed out that Britain’s growth had been built on four pillars that were all unsustainable. First, strong migration, particularly from eastern Europe, had boosted nominal GDP. Second, rising house prices had eroded the savings culture. Third, the private sector had become dependent on the property market to finance its consumption. Fourth, public debt had risen almost every year despite a booming economy.
We concluded that the ”UK’s economic performance over the past 15 years was boosted artificially by some exceptional circumstances” and that ”it would be unwise to rely on them any further”. Perhaps it was not what the British wanted to hear. The Daily Telegraph headlined our report: ”German team damn UK economic ‘miracle’ as a sham”.
Since then the British economy has indeed demonstrated how unsustainable its foundations really were. If anything, our predictions had not been gloomy enough. The British experience was also a vindication of Herbert Stein’s Law: ”If something cannot go on forever, it will stop.”
Australia is not Britain. There are several factors that differentiate the countries. The two most important are Australia’s far healthier public finances and the fact that Australia is a giant quarry with a country attached to it. Britain, on the other hand, is the Square Mile in the City of London, with not much else around it.
But there are worrying parallels as well. Although Britain had experienced big swings in its housing market in the past, the British had bought into Gordon Brown’s creed that the era of booms and busts was officially over. Consequently, they could no longer imagine significant corrections in the housing market. But that did not stop the property crash in 2008.
In Australia, there is much debate about a potential housing market bubble. There is only agreement that property is expensive. Whether it is also too expensive is hotly disputed.
It is nevertheless surprising how fiercely some economists and analysts fight the notion of a housing bubble. They point to strong demand, artificially limited supply, and the preferential tax treatment for real estate to justify their view that Australian housing is not fundamentally overvalued and thus not heading towards a correction. Although their arguments have merit, the very same arguments were also used by British analysts before the British housing market went into free fall.
The most frightening parallel between pre-crisis Britain and Australia today is more fundamental. In both cases, there was a dominant understanding that the countries had found their steady and stable growth model. In Britain it was based on financial services and house prices, in Australia on minerals and China.
Such growth models may work well for years or maybe even a few decades. But they are dangerous when they foster complacency in other areas. The British forgot to reform the public sector, which became more wasteful by the year. In Australia, the lessons of the reform era are being ignored.
Looking at Australia today, I would still maintain that it is more miracle than mirage. But I cannot help a feeling of unease when analysts, commentators and economists become too self-congratulatory. And maybe I just don’t want Karl Marx to be right.