Published in Business Spectator (Melbourne), 14 July 2011

http://www.businessspectator.com.au/bs.nsf/Article/Australia-productivity-competition-economy-federal-pd20110712-JP4C6?OpenDocument

One of the classic questions of economic history is how the West grew rich. And the classic answer to this question was given many years ago by economist Nathan Rosenberg and lawyer L. E. Birdzell. Where previous generations of historians had speculated about the role of science, culture and religion in the rise of Europe after the Middle Ages, Rosenberg and Birdzell offered a very different explanation.

Europe’s fragmentation into hundreds of free cities, principalities, kingdoms and duchies, they argued, had fostered a creative competition between places. In this way, new political and economic ideas could be tried and tested. People could move to places that offered better opportunities, and through this process the more superior ideas prevailed.

What was a radically new interpretation of European history when Rosenberg and Birdzell published their book How the West Grew Rich in 1986 has since become a widely accepted analysis. In his Nobel Prize lecture, economic historian Douglass C. North put it like this: “The remarkable development of Western Europe from relative backwardness in the tenth century to world economic hegemony by the eighteenth century is a story of a gradually evolving belief system in the context of competition among fragmented political/economic units producing economic institutions and political structure that produced modern economic growth.’

Of course, you can say it much more simply, as historian and TV presenter Niall Ferguson did. In his new TV documentary series Civilization: Is the West History? Ferguson identified competition between political entities as one of the ‘killer apps’ of Western capitalism.

It would be cheeky to compare Europe’s escape from the dark ages to the turmoil of modern European or Australian politics. Nevertheless, there are lessons in history so important that it would be foolish to ignore them in current debates. The importance of competition for economic development is one of them. And yet historical amnesia is widespread, both here and in Europe.

The whole project of European integration and unification was an attempt to limit competition between EU member states. Far from competing with one another, they were meant to be ‘harmonised’. Never mind that ‘harmonisation’ often amounts to little more than the prevalence of laziness. It is the opposite of the kind of competition that had once made Europe rich.

For Australians, however, there is no need to feel smug vis-à-vis Europe. Political competition within Australia is in no better state than it is within the European Union. In fact, the situation in Australia may even be worse.

In Europe there still are at least remnants of national sovereignty combined with the free movement of people. Europeans have a choice of where they can live and work, and they can choose (slightly) different bundles of taxes, regulations and government services.

In Australia, on the other hand, centralism has been rising for decades. Australian federalism has been on the wane since income tax powers were seized by the Commonwealth during World War II. Even before that, the High Court’s jurisdiction was instrumental in shifting powers from the states to Canberra. It still is. What’s left of federalism in Australia today is hardly worth celebrating.

National curricula and national hospital policies all point in the same direction of even more centralism and less competition. No wonder that the question of abolishing the states is such a popular issue in opinion polls. Still, this move would only conclude the assault on the type of competitive federalism that was originally enshrined in the Constitution.

But it is not just in the slow and steady demise of federalism that the lack of competition within Australia manifests itself. Competition is also absent at the levels below the states, especially in local government. Under a competitive system, local councils would be rewarded for growing and punished for shrinking their populations. In a study I just concluded with my colleague Adam Creighton, we found evidence that under Australia’s system of local governance the very opposite is happening.

We surveyed the mayors and chief executives of all Australian local government authorities and had a good response with answers from every state, council type and size. What we wanted to find out was the effect of population growth on councils’ finances. The result was evidence of the inadequacy of Australia’s local government finance system.

More than 90 per cent of the respondents in our survey stated that the current financial arrangements were partially or completely inappropriate for dealing with population growth. We also found that nearly two thirds of Australia’s councils had to increase rates over the past decade in order to cope with population growth. The bigger and the faster growing a council was, the more likely population growth had a negative effect on its bottom line.

Our survey revealed an economic perversion: for an Australian local council, it does not make financial sense to grow. The extra infrastructure costs typically outweigh the additional revenue, and residents are then asked to make up for the difference through rate increases. This almost amounts to a recipe for non-competition between councils – the very opposite of an environment in which dynamic economic growth can happen.

Throughout Europe’s economic rise, towns and cities were instrumental. It was at this very local level that experimentation with different ideas and policies took place. The rivalries between European cities that spurred economic development are legendary. Think of Hamburg and Bremen, Siena and Florence, or Amsterdam and Rotterdam. These rivalries are so strong they have survived to the present day.

Of course there are such city interstate rivalries in Australia as well, most notoriously between Sydney and Melbourne. However, competition between local government areas within the states is grossly underdeveloped. That is because for local government leaders there are no incentives for making their own areas perform better than their neighbours’. But without incentives there can be no competition.

Competition between political entities, whether they are countries, states or cities, has correctly been identified as one of the fundamental conditions for creating prosperity. But in Australia, we have abolished the possibility of such competition at both the federal and the local level.

If we want to prepare Australia for future growth it is high time to reinstall the ‘killer app’ that once made the West – and Australia – rich.