Ken Henry: 'The memory of that afternoon has troubled me for all of the last 30 years', Master of Economics 30 year reunion, ANU - 2001

21 September 2001, Australian National University, Canberra, Australia

Ken Henry was Secretary of the Department of Treasury at the time of this speech.

Dedicated to my father
John Henry, timber worker

Today, you are celebrating 30 years of the ANU’s Master of Economics program.  30 years is a long time.  Long enough to have a considerable impact on the fortunes of a country.  And long enough, too, to take a 13 year-old from his second year of high school in country New South Wales to the job of Secretary to the Treasury.

I want to say some things to you today about some of the changes that have taken place in Australia in the last 30 years.  My approach will be a little unusual: I’m going to tell you a little about some of the things that I experienced in this country 30 years ago; how those things affected me at the time, and over time; how I see things as having changed; and my perception of the role played by economics and economists in those changes.

I should warn you at the outset that my 30 year recall is far from perfect; so I’ll be begging a little licence.

At the age of 13 I didn’t know what economics was.  And I doubt that I had heard of an economist.

But I had already had my first lesson in economics - indeed, my first lesson in economic policy.  A lesson that has stayed with me these past 30 years.  And, quite plausibly, a lesson that may very well explain why I am where I am today.

Let me tell you a story.

When I was nearly 5 years of age, some 38 years ago, my parents walked off the dairy farm they had been leasing on the Mid North Coast of New South Wales, and my father returned to his earlier career in the timber industry - cutting railway sleepers and, later, cutting logs for a number of local sawmills.

For all but a few years of the remainder of his working life, my father worked in the timber industry - for most of that time felling logs.  Most of the timber my father cut came out of the State forests of New South Wales.

My father worked long hours, leaving for the bush at dawn and returning after sunset.  But one day, about 30 years ago, he arrived home in the late afternoon.  He had something he wanted to show to his three young sons.  He bundled us in the car and took us down to the sawmill.  There, lying on the ground - like the vanquished party in “Jack and the Beanstalk” - was the biggest log we had ever seen.  When our father stood at its base it was apparent that it measured some two metres in diameter.   And it was 12 metres in length - as long a log as a truck could carry.  All up, about 7,000 super feet of timber.

You can imagine our amazement.  We were even more amazed when our father explained that the tree from which the log came was a good deal thicker than two metres (he said ‘six feet’, of course) at its base - he had had to climb a fair way up the tree in order to get to a point at which he could fell it safely with his chain saw.  He was, understandably, very proud of his achievement: to have taken out a log of that immense girth, single handedly, with nothing more than his chain saw.

We three kids were very proud of our dad.  But we were also a little uneasy.  And it wasn’t long before the questions started coming:

“Dad, how old do you reckon that tree must have been?”  “Oh, very old.  At least a hundred years.  Anywhere up to five hundred.”  “Wow!”

“Where did you find it?”  “It came out of the Lansdowne State Forest.”

“How many houses do you reckon you could build out of that log?”  “Oh, it would make the framing for at least three houses.”

“Wow!  So how much would that log be worth?”

“I’m not sure, but certainly thousands of dollars.”

When I think about it now, it seems to me that it could have been at that instant that my future career was set.  The following sequence of Q&A went something like this:

“So how much do you get?”  “Not much, only a couple of hours’ wages.”  Now I knew that that wasn’t much.

“So the sawmill gets the rest?”  “Oh, not all of it; there are royalties too.”

“What’s that?”  “Well, the State Government charges royalties on all timber taken out of State forests.  Royalties are like a tax.”

“Oh, right.  So what would the royalties be on that log?”  “A few dollars I guess, perhaps not that much.”

I was young, but I wasn’t stupid.  There was something about this that troubled me.  I could see, too, that my father and brothers were troubled.

Our sense of unease only grew as our father told us that he had cut down hundreds of trees just like the one from which this log had come, but had had to leave them lying in the bush.  He explained that old hardwoods typically have hollow cores - ‘pipes’ he called them - and the saw mill didn’t consider it economic to pay the transport costs that would be required to bring in a log with less than one foot of solid timber around the hollow core.  That was one of the impressive things about the log we were looking at: it had a very small ‘pipe’.  The problem was that you couldn’t tell how hollow a tree was until you brought it down.  That didn’t trouble the sawmill, because it paid royalties only on what it took out of the forest.  The Forestry Department didn’t get a cent for what was left behind on the forest floor.  Hundreds of trees, hundreds of years old, torn down - their carcasses left to rot where they fell.

The memory of that afternoon has troubled me for all of the last 30 years. 

I don’t know if I managed, at the age of 13, to discover the source of the sense of unease I felt at the time.  But if I did, I hope that as I looked at that enormous hardwood log I found entirely unacceptable the fact that somebody could legally appropriate, for only a few dollars, this extraordinary asset of the people of New South Wales - an asset that would take perhaps hundreds of years to replace.  I hope that this smacked to me of highway robbery.  I hope that I was less than impressed that the elected representatives of the people of New South Wales appeared to be demonstrating such disregard for the protection of their citizens’ property.  I hope I wondered about the ability of governments - and not just the venal - to redistribute wealth so arbitrarily, and to disenfranchise future generations.  And I hope I vowed that one day I would do something about it.

Certainly, if not at age 13, then at some point in the last 30 years I came to hold all of those views.

Growing up on the Mid North Coast of New South Wales, I had occasion to be reminded, constantly it now seems, of the failure of economic policy.  I recall my disquiet on learning that ancestors on both sides of my family were ‘cedar getters’.  “What’s a cedar getter dad?”  And though he surely didn’t use these words, what I heard him say was something like: “Well that’s why we don’t have any cedar trees any more.” 

These ancestors of mine settled places with curious names like Cedar Party - curious, at least, to a kid: there was no party, and no cedar either. 

I remember being concerned when I learned that every generation of Australians caught fewer and smaller fish than the preceding generation.

I remember learning that weeds were not native plants, and that rabbits that destroyed riverbanks and foxes that killed chooks were not native animals.  I remember learning that soil erosion was caused by humans.  I remember being horrified by the apparently wanton destruction wrought by the rutile miners who ripped through the sand dunes and the beach where I used to surf - leaving a moonscape in their wake, a moonscape devoid of the stunning Christmas bells that used to grow there in profusion.

Even closer to home, I remember being perplexed when the Killabakh Creek that tumbled down through the rainforests of the Comboyne Mountain and then swept around the periphery of my maternal grandmother’s dairy farm simply dried up.

I remember being absolutely staggered to learn that one of the conditions of my paternal grandfather’s retaining possession of his 600 acre ‘soldier settler’ block of rainforest timber standing on the other side of the Comboyne Mountain was that he clear a certain number of acres each year - and watching over the years as the trees were replaced by bracken fern and lantana, and as the soil washed into the creeks and gullies, replacing the native fish that had long since been exploited to extinction.  And I remember too that as the weeds spread and farming became too difficult my grandfather turned to more facile means of making a quid - stripping the native orchids out of what was left of his rainforest property.  Years later I learned that he had never had any interest in farming anyway.

And if I didn’t understand the ‘how’ or ‘why’ of these things at the time that I became aware of them, I did at least develop a deep conviction that something was horribly wrong with the world. 

I became aware of economic policy through observing a succession of its abject failures.

When I studied economics I learned of the importance of property rights, and the important role for governments in their establishment and protection.  I learned that free markets might fail: That economists had analysed at length the possibility that economic agents engaging in mutually beneficial commercial exchange might, perhaps inadvertently, impose costs on others - including on people not yet born.  That some things that everybody valued might nevertheless not be provided by the market because of the absence of ‘divisibility’ and ‘exclusion’.  I learned that governments might have a role in managing the common wealth, in the common interest. I learned about the importance of prices in guiding resource allocation.  And I came to the view that peoples’ behaviours had a lot to do with their pursuit of self interest, and that a lot of what I might have found objectionable about the things humans did could have had something to do with the opportunities and incentives established by governments.

When I ‘phoned my father a couple of days ago to check my recollection of some of the things I have related here today, he expressed considerable remorse for the part he considers he played in the destruction of some of our hardwood forests and the spectacular collateral damage inflicted on soils and eco systems.  He said that he feels sick in the gut every time he thinks about those years spent logging the Lansdowne State Forest and surrounding areas.  More collateral damage.

Even 30 years ago, my father was clearly uncomfortable with our forestry management practices.  As he reminded me a couple of days ago, those involved in forest management at the time were practicing something called ‘timber improvement’.  This involved cutting down every tree of a slow growing variety to make way for the faster growing species.   My father witnessed the destruction of thousands of red timber hardwoods, including the majestic grey gum and the extraordinary turpentine.  These trees, too, were simply left on the forest floor.

30 years ago my father would argue that there was a need for this country to develop hardwood plantations ¾ that if we didn’t do so there would come a time when our stocks of hardwood timber would be insufficient to support the timber industry.  I have since learned that this view was not novel ¾ even if I may have thought so at the time.  A few years ago my wife came across a copy of a classic text on Australian hardwood timbers, The Hardwoods of Australia and their Economics, written by one Richard T. Baker, Curator and Economic Botanists, and Lecturer on Forestry at Sydney University.  The book was published in 1919 - 82 years ago - by the Department of Education of New South Wales.  The introduction to this magnificent text concludes as follows: 

‘Generous nature has given us a good soil and a perfect tree climate over a vast extent of country, and the duty therefore devolves upon Australians to show their appreciation of these gifts by entering upon and carrying out to a successful issue a vigorous system of reafforestation.

Many woods are illustrated which are only occasionally on the market, and this has been done intentionally in order to show what a great variety of hardwoods are to-day growing in Australia, and especially to bring them under the notice of this and other State Forestry Departments, so that these remarkable timbers may figure largely in future systems of Sylviculture before the species are finally exterminated.

For these to be allowed to pass away without any attempt at their propagation would be bordering almost on criminality, for not many countries can boast of such a wonderful natural heritage as our marvellous hardwoods.’

I wonder how many of these species have been exterminated in the intervening 82 years. 

It didn’t take much study of economics to figure out why we had so little plantation hardwood, why there were no red cedars left on the north coast of New South Wales, why our creeks and rivers were drying up, why our soil was degenerating through erosion and salinity and why our fish stocks were dwindling.  From an economic perspective, these things didn’t have so much to do with an absence of ‘duty’ as they had to do with the understandable pursuit of self-interest, the exploitation of opportunity and the predictable response of economic agents to a set of incentives structured, at least in part, by governments.  

I found it easy to accept, as a student of economics, that for the most part Australians were pretty good at pursuing their own private interests.  And I found it easy to accept that Australian governments had not always been very good at protecting the common, or public, interest.  Rather, or so it seemed to me, they spent a good deal of effort directing economic advantage to particular individuals and special interest groups.

Evidence of policy failure was easy to find.

The conduct of economic policy in Australia today is not without fault, but a lot has changed in the past 30 years. 

Only a few years ago, when I was leading the Tax Policy Division of the Treasury, I was lobbied by multinational oil exploration interests seeking Resource Rent Tax concessions.  The sales pitch was along the following lines: ‘We are weighing up a potential investment in Australia with alternative investments in the Gulf of Mexico.  And your secondary taxation regime is tipping the balance in favour of the Gulf.  If Australia wants our investment dollars you will have to forego secondary taxation.’

My guess is that 30 years ago, a Treasury officer would not have been able to respond to this proposition in wholly satisfactory terms.  But I, at least, was able to respond that the fact of other governments being prepared to hand over, for no charge, the assets of their citizens to a consortium of private multinationals was not much of an argument for the Australian government’s doing the same thing.  We had a resource rent tax because we were of the view that the citizens of Australia should be compensated for giving up that part of their material wealth.

We couldn’t say that we have the incentives quite right yet - I worry still about the royalties being charged on State forest timbers and the Molonglo River on which I now live still runs brown when ever it rains - but at least today, natural resource management is a very high profile policy project, involving all Australian governments.  That is just as well, of course: Environmental issues are likely to be among the most challenging issues confronting policy makers ¾ especially economic policy makers - over the next 30 years.

A reasonable description of the last 30 years, from a public policy perspective, is of a continual debate about the role of government.  This debate should never end. Right now, it is probably fair to say that the more influential view is that governments should not, in the main, do what private interest should be able to do, but instead should concern themselves with undertaking the tasks that cannot be left to private interests and creating the macroeconomic, regulatory and institutional framework - the set of opportunities and incentives - to best support dynamic, but sustainable, private activity.

Many people have described this as the triumph of economics.  And there is something in that.

The second half of the last 30 years has seen the introduction of a comprehensive economic reform program.  The, largely bipartisan, objective has been to build an efficient, flexible, competitive economy, better able to adapt to shocks.

The reform program has been ambitious, establishing or matching world’s best practice in many areas, including in the regulation of financial markets, corporate governance, competition policy, fiscal and monetary policy arrangements, and in the transparency and accountability of government.  Much has been achieved also in the area of labour market reform, in tax policy and attention has turned more recently to addressing issues at the interface of the tax-transfer system.

Much has been said and written about the details of Australia’s economic reform program, and most of that will be familiar to this audience.  So I won’t spend time on that subject today.  Instead, I want to say just a few things about the plausible outcomes of the reforms, to set the scene for some final remarks on the role of the economics profession.

In addressing another ANU conference a couple of weeks ago, I noted that to the September quarter last year Australia had recorded nine years of positive growth - at an average annual rate of a little over 4% - indeed, a period that included 13 consecutive quarters of through-the-year growth above 4%. This is the longest run of such growth recorded in the history of the quarterly National Accounts (ie, since September 1959), and is all the more remarkable for its having spanned the period of the Asian financial crisis.  Moreover, even allowing for the recession of the early 1990s, that most recent decade proved to be much less volatile in GDP terms than any of its three immediate predecessors, and was the only one of the last four decades in which Australia’s average annual rate of growth of GDP per capita exceeded the OECD average.

Relative to earlier decades, the 1990s proved to be a period of high output growth, high productivity growth, high employment growth and high real wages growth.

The sectors that experienced the strongest productivity growth were, generally, those that had been subject to the most economic reform and those most exposed to competition.

As I noted earlier, it is unlikely that we have, yet, a policy framework that deals effectively with all of the negative externalities that might be associated with economic activity.  A rigorous accounting of welfare improvement would discount GDP growth by some amount to reflect the otherwise unmeasured costs affecting present and future Australian citizens.

But I have a sense, too, that the extent of such discounting would, overall, be somewhat smaller in the 1990s than in earlier decades.

On almost any accounting, then, I would suggest that Australia’s economic performance in the 1990s was much superior to its performance of the earlier two decades.  And it is plausible that that lift in performance was due, overwhelmingly, to the sustained economic reform program.

I would, however, caution against declaring victory in the battle of ideas in economic policy.  Economic reform is not irreversible.  For those who think it important that the gains of reform be preserved there are some things to worry about.  Reform has its detractors.  As I noted in an address to the Australian Business Economists in Sydney on 29 May of this year, liberal market economics is under attack, and not just in the streets.

What are the detractors saying? 

First, it is asserted that while it may be true that aggregate GDP has grown strongly, its distribution has become more unequal - some have been left behind.

Second, it is asserted that while material living standards may have improved, broader measures of wellbeing would reveal a decline in welfare - at least for some.  This is a complex argument.  Sometimes it is presented as a general criticism of economics ¾ that economists are focussed narrowly on the material, to the exclusion of the important.  At other times the argument is that while policy change may have lifted incomes, it has had other affects that have more than offset the impact of higher incomes on wellbeing.

And third, it is asserted that even if reform produces aggregate (efficiency) gains of GDP, these will usually be swamped by unmeasured transitional and adjustment costs or net losses of community welfare due to there being asymmetries in the valuation of gains and losses: it is asserted, that is, that the optimal reform is to do nothing.

I doubt the distributional assertion can be substantiated.  Empirical studies have been interesting, and many of high quality, but those claiming to support the assertion have been unconvincing.  Moreover, the policy implication of the assertion is far from clear.  Australian governments have good reason to believe that their market liberalising reforms have lifted aggregate incomes.  They would find it difficult - some might say courageous - to accept a proposition that they should reverse their market liberalising reforms, thereby intentionally - if only in their minds - reducing the incomes of most, and perhaps even of all, in pursuit of a more equal distribution of income. 

This is not to dismiss the importance of distributional issues.  Perceptions of the equity of a policy change affect its public acceptability.  If only for that reason, major reform proposals should be accompanied by an assessment of their distributional implications.  But I would go even further and concede that in some cases the distributional consequences of a policy change should have the status of ‘objective’ rather than ‘constraint’.  I would not, however, accept the proposition that we should dismiss any policy proposal that might plausibly widen the income distribution.

I don’t accept, either, the ‘materialist’ label’s being applied to economists.

When I studied consumer theory and neoclassical welfare economics in my undergraduate days, the basic tool of analysis was the neoclassical utility function.   Point one: utility is not a material concept. Point two: I don’t recall anything in my studies that said that the set of arguments in a person’s utility function should be confined to the obvious material variables like that person’s present and future consumption of various products, including personal leisure time, and that person’s wealth (including wealth accumulated for the benefit of children).   Indeed, I recall that my lecturers told me, for example, that one person’s utility might well be affected - positively or negatively - by their perception of the level of utility being enjoyed by another.  I remember too accepting, if a little reluctantly at first, that altruistic behaviour was not inconsistent with utility maximisation.

At some stage, I learned that uncertainty might be an important argument in a utility function; and, if rather more recently, complexity also.  And I learned too - including from reading some of the eighteenth century writings of Adam Smith - that people might value other essentially abstract things like liberty, opportunity and freedom. 

As I have learned these things I have absorbed them into my understanding of economics.  Perhaps I have been in error to do so.  But knowing that I have, you will understand that I have always found it exceedingly odd to be told that economics is deficient for its having ignored these non-material things.  In any event, here at least is one tried and convicted economist who does not accept that he ignores any of this stuff.

Moreover, there would be few - if any - among the 400 or so policy advisers in the Treasury who would accept that they are focussed narrowly on the material.  All of them would accept that uncertainty and complexity are important determinants of welfare.  And most of them would, as I claimed of most liberal market economists in my speech earlier in the year to the Australian Business Economists, have little difficulty with Amartya Sen’s emphasis on the substantive freedoms of political and civil liberty, social inclusion, literacy and economic security, as ‘constituent components’ of development and welfare.

Finally, let me say something about the proposition that the optimal reform is to do nothing.  One such argument is that the present state of the world is capitalised in asset prices.  For example, it is, so the argument goes, illegitimate to regard those who hold assets taxed preferentially as in any sense ‘benefiting’ from a tax concession.  The removal of a tax concession therefore produces an arbitrary set of windfall gains and losses.  Even if the winners are made to compensate the losers, the heightened uncertainty associated with the policy change will usually swamp the anticipated efficiency gain.  Another such argument, based on some findings in behavioural economics, is that people place a higher (negative) value on the loss of a dollar than they do on the gain of a dollar.  Thus, even if all people are identical, a policy change that simply transferred wealth from one person to another must reduce community welfare.  Since most reforms do involve wealth transfers the proposition is that in order for community welfare to be improved, the efficiency gain would have to be much larger than is commonly found in empirical studies.

I have already indicated that there is often a strong case for policy advisers’ considering the distributional implications of their proposals.  But it would be a tragedy if this were to prevent governments from undertaking economic reform.  I dread to think what might have become of the Australia of 30 years ago had these arguments been found persuasive.

Let us ensure, by all means, that our policy makers understand all of the likely implications of policy proposals before them - including the distributional implications.  But let us ensure also that the right policy proposals are indeed in front of them.  And, even more importantly, let us ensure that our policy makers understand all of the implications of policy inaction.  If we are going to do that, mainstream economic policy advisers are going to have to get a lot more knowledgeable about a lot of things.

When I asked my father the other day why the Killabakh creek dried up when I was a school kid, I suggested that unpriced access to irrigation water was surely the culprit.  He thought that that might have had something to do with it.  “But don’t forget” he added, “we felled timber all over the Comboyne mountain, pushing in dozer and snigger tracks and roads for the log trucks.  That’s where the water would have gone.  You can see it from the erosion left behind.”

My question for economic policy advisers, then, is this: How much erosion are we going to leave behind?