Australian governments did not have the theory, the means or the will to adequately handle the Depression



By Thomas Dickson

Murdoch University (email: tommy@ois.net.au)
Reproduced from Newsgroup sci:econ (29 Sep 97)



Australian governments’ responses to the Great Depression were largely inadequate; however, it is necessary to identify whether inadequacies were due to the lack of theory, means or will. These influences, in varying degrees, effected many relevant decisions and policies and so these approaches are analysed individually. Scullin’s attempts to implement an effective policy response to the problems of the Great Depression were significantly impaired by a number of factors. Lack of support from London, New York and Australian Bankers, conflict with the Commonwealth Bank, large opposition in the Senate and limited spending powers meant Australian Governments did not have the statutory or political power to adequately handle the Great Depression.

Although the Federal Government and the Commonwealth Bank were the official monetary authorities, they had little direct influence on monetary policy. Monetary policy was controlled by private banks, and so monetary policy reflected their market response to economic circum-stances. Banks determined short-term interest rates through their competition for deposits and were key planners in the foreign exchange market during the early years of depression. Further-more, the Chairman of the Commonwealth Bank was Sir Robert Gibson. Gibson was a man of conservative financial opinions who, under existing legislation, was answerable to no one except the Bank Board, which he dominated. Therefore, the Government lacked the power to dictate to the board.

Australia depended heavily on overseas borrowing for new investment. However, the returns from the investments were not sufficient to satisfy debt repayments and so the government persistently used overdrafts. In the later half of 1929, Australia’s external debt position worsened. When the government approached the banks to extend further overdrafts, the banks refused. The banks argued that if sufficient funds could be found to repay the maturing Treasury bills, funds could also be found to reduce overdrafts (Schedvin 1970 p137). Australia began a near exhaustive sale of gold reserves which ended in the mid 1930s.

After a number of bankers’ conferences, the Mobilisation Agreement was signed. This provided a means for financing current public debt obligations in London. The banks were to provide sufficient funds (£3 million per month) to cover the interest repayments but not the principal of the debt. The banks now had a substantial level of control over the government which reduced the government’s means to deal with the problems of the Great Depression. This is exemplified by Scullin’s attempts to devalue Australia’s currency.

The Scullin Government was determined to honour foreign debt obligations; however it was faced with a trade-off. Maintaining parity with Stirling meant that Australia’s currency was overvalued. The Scullin Government believed maintaining parity to achieve external balance was deflationary and could lead to an increase in unemployment and demand for unemployment benefits. However, Scullin also believed parity would reduce demands on scarce revenues to meet foreign interest payments which would subsequently yield a greater degree of fiscal flexibility (Butlin et al 1985 p7). Furthermore, the Scullin Government recognised that an overvalued currency would depress export income further and cause an increase in demand for government assistance. For these reasons, the Scullin Government gave its support to devaluation.

On the other hand, the banks (including the Commonwealth Bank), were concerned about the inflationary consequences arising from devaluation. Devaluation was considered inflationary due to the money/price relationship and the fact that wage increases were based on the quarterly adjustments in the cost of living. The discordant relationship between the Scullin Government and the banks (including the Commonwealth Bank) began to deteriorate further.

The outcome of the banks’ disagreement with the Scullin Government was a delay in the devaluation. Despite the rapid fall of foreign exchange reserves, and the weakness of commodity markets such as wheat, the devaluation didn’t occur until January 1931. Had the currency devalued earlier, the burden of adjustment on other policies would have been smaller and the recovery might have commenced sooner (Butlin 1985 pp205). The low level of foreign exchange reserves was a major factor in the acceptance of contractionary fiscal policy. The delay in devaluation meant a delay in bringing about price competitiveness of industries in the traded goods sector. In particular manufacturing, which was thought to be the driving force behind recovery.

Why was this inadequate? The delay in devaluing had a significant adverse impact on the economy, on the incomes of exporters and on the process of recovery. The low level of foreign exchange reserves in 1930 was a major factor in forcing acceptance of major cuts in govern-ment spending which, in turn, withdrew a potential fiscal stimulus from recovery. Moreover, failure to devalue until 1931 deferred for a year the improvement in the price competitiveness of traded goods industries, notably manufacturing, that Schedvin and others have argued was the main engine of economic recovery.

From 1930 through to 1931, Australian governments faced severe declines in income and employment. Disputes on an appropriate remedy for the problem of mounting budget deficits grew between the Labour governments and the banking system. The main difficulty for the Commonwealth Government was the fall in customs revenue, on which its budget depended heavily. Another problem was the mounting interest on publicly owned debt which equalled around £54 million or 60 per cent of taxes; the foreign half of the debt equalled just under one-fifth of the value of exports (Pincus 1985 p82).

Three main policy initiatives emerged. Once policy option was to maintain the deficit at its present level while increasing expenditure on unemployment relief. Another proposal came from J.T. Lang, Premier of NSW, who proposed a default on the overseas debt, to allow increased expenditure on unemployment relief. The third was to decrease both government expenditure and real wages.

Had the £25 million worth of foreign public debt been used to reduce the current account deficit by default, then it is estimated that pressures on the exchange rate would have eased and unemployment may have been cut by half (Shedvin 1970 p373). Butlin argues that had the monetary authorities rescheduled or defaulted on payments of interest and principal on official external debt, the extent of the downturn would have been lessened and faster economic recovery would have been encouraged (Butlin et al 1985 p2). However these outcomes depend upon the assumption of no retaliation by the British, and no adverse effects on domestic confidence.

Be that as it may, the Labor Government was under considerable political pressure. Ted Theodore’s dismissal and re-instatement over the Mungana incident, and Scullin’s departure to the Imperial Conference did not create the environment required to ‘sell’ a default. The large Opposition majority in the Senate hampered government measures on every possible occasion. As it was unable to implement its own policy and unwilling to face a general election, the government had little alternative than to accept a compromise which favoured the opposition. This exemplifies the Government’s lack of will in the face of political ridicule and means to implement policy facing a Senate dominated by the opposition. Moreover, the Labor Party was going through a process of politically damaging fragmentation. This allowed the Bank and the Senate to apply pressure without fear of retaliation. These pressures culminated in the signing of the Premiers’ Plan.

The goal of the Premiers’ Plan was to bring domestic costs of production into line with lower international commodity prices. It was intended that this plan would restore profits to the trading sector and encourage investment at the same time (Valentine 1978 p165). It embodied five major provisions: A 20 per cent reduction in all adjustable government expenditure; conversion of the internal debts of the governments on the basis of a 22½ per cent reduction of interest; increased Commonwealth and State taxation; reduced bank interest rates; and relief for holders of private mortgages (Cook 1970 p99).

Scullin firmly announced on several occasions that he would not default, but he was also publicly committed to maintaining pensions. The limited means of the government meant that sufficient Australia could not afford the redemption of £5 million worth of Treasury bills that were to fall, due in mid 1931. The legislation to permit the sale of gold overseas (to cover these costs) was defeated in the Upper House. Scullin was forced to choose between pension cuts or loan default.

To influence Scullin’s decision, The banks pressured him with an ultimatum:

"……[the Board] cannot undertake to continue to accept further obligations unless, and until, it is placed in a position of definite assurance of arrangements whereby considerable relief is obtained overseas to ease the position……the Board is not prepared to proceed upon a course which the dictates governing real responsibility and common sense indicate as absolutely unsound…The Board…is of the opinion that the position is so serious as to indicate that reductions of expenditure should be made where such can be done without infringement of the Law"

Either the government undertake measures to implement a cut in the Basic Wage, increase the level of protection for secondary manufactures, freeze access to sterling balances, increase taxes and lower government expenditure or the bank would be unable to provide finance. To try to protect British interests, the Bank of England sent a team lead by Sir Otto Niemeyer to Australia. Niemeyer’s strategy was to cut wages and balance the budget at all costs. The breakdown of the sterling exchange standard, the near exhaustion of London funds, and the export of almost all available gold reserves meant that the government could do nothing else but agree to the Premiers’ Plan. The Premiers’ Plan was signed by Scullin and all six State Premiers on 10 June 1931.

It is argued that Australian Governments did not have the theory to adequately handle the great depression. "Fiscal policy [when] judged from the perspective of Keynesian multiplier analysis … did intensify the effects of the depression" (Maddock 1985 pp17). Keynesian macroeconomics suggests that in order to recover from depressions or recessions, a stimulus to aggregate demand is required. Examples of measures to bring this about are: increases in government expenditure, reductions in taxation, and reductions in interest rates. Classical economics, on the other hand, focuses on the supply-side of the economy. Classical economists such as Niemeyer, prescribed reductions in wages and improvements in productivity to remedy depressions and recession.

Many argue that Keynesian alternatives were not available until Keynes’ General Theory was published in 1936. However many economists world-wide were prescribing government spending and public investment to relive unemployment, while supporting expansionary fiscal policy and scorning wage reductions for fighting depression (Clark 1981 p179).

Keynes’ promotion of public investment programmes was included in his book A Treatise on Money which was available to Australian Governments in 1930. Premier Lang borrowed quotes from A Treatise on Money in his organisation pamphlets. The book demonstrates that a lack of investment will lead to falls in output and employment. Keynes argues that financing investment through an expansion of the money supply (not wage reductions) would lead to greater employment. Scullin was indeed aware of the need for credit creation and he proclaimed this only a few weeks after becoming Prime Minister. The arguments above highlight the simple lack of funds to carry out this task. The government could not borrow from London or New York, Australian Bankers would only cover the day to day running costs and the large opposition in the Senate meant Scullin did not have the statutory or political power to carry out public investment programmes.

Prior to mid-1931, the level of revenue expenditure was well maintained and the growth of budget deficits tended to compensate for the fall in loan expenditure. During most of the contraction, it would appear that by substantially eliminating deficits and by further reducing loan expenditure, the effect of the plan was to hinder recovery (Schedvin 1970 p295).

Another theoretical debate among government authorities concerned the role of tariffs. Supporters of free trade suggest that protection hindered our exporting industries and reduced are export income. However, tariff preference under the Ottawa Agreements of 1932 diverted British demands toward Australian goods with visible exports destined for Britain rising by 13.2 per cent (Eichengreen, 1985, pp51). Protectionists argue that the presence of higher tariffs maintained a larger manufacturing base. This may be true in the sense that many manufacturing industries were born out of manufacturing protection during depression. Examples include companies such as Kelloggs, Nestle, General Motors and ICI. Therefore, although modern theory suggests that tariffs reduce national income, in reality it assisted a number of manufacturing firms.

References:

Butlin M.W, Boyce M.W, (1985), ‘Monetary Policy in Depression and Recovery’, Working Papers in Economic History, The Australian National University, Australia.

Cook, P (1970), ‘Labour and the Premiers’ Plan’, The Great Depression in Australia, Australian Society for the Study of Labour History, Australia.

Clark D (1981), ‘Fools and Madmen’, The Wasted Years?, George Allen & Unwin, Australia.

Copland D.B, (1934) Australia in the World Crisis, 1929-1933, Cambridge, UK.

Eichengreen B, (1985), ‘The Australian Recovery of the 1930’s’ In International Comparative Perspective, Working Papers in Economic History, The Australian National University.

Green A.G, Sparks, G.R, (1985), ‘A Macro Interpretation of Economic Recovery’ from The Great Depression, Working Papers in Economic History, The Australian National University.

Maddock R (1985), ‘Australian Fiscal Policy in the Thirties: A Reappraisal’, Working Papers in Economic History, The Australian National University.

Pincus, JJ (1985), ‘Australian Budgetary Policies in the 1930s’, Recovery from the Depression, Cambridge University Press, England.

Schedvin C.B (1970), Australia and the Great Depression , Sydney University Press, Australia.

Sinclair W.A (1985), ‘Relative Contributions of Public and Private Investment to the Recovery Process’, Working Papers in Economic History, The Australian National University.

Valentine T.J, (1978), ‘The Battle of the Plans: A Macroeconomic Model of the Interwar Economy’, paper presented to Seventh Conference of Economists, Sydney.

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If you would like to comment on this paper, please email me at tommy@ois.net.au OR tom.thumb@mailcity.com OR t.dickson@student.murdoch.edu.au
Any comments are always appreciated.
Thomas Dickson