Alumni refresher lecture series
2009 – A tipping point
Learning from Australia's economic history
Examples on the theme of learning from history for the practical purpose of improving economic policy-making
(pages 49-53 of printed journal)
The history of economic history
Teaching of and research in economic history has a proud history at the University of Melbourne. However, the development of other discipline areas in the 1990s led to reduced student numbers for economic history, after which the Department of Economic History was merged into what was to become the Department of Management and Marketing. Teaching in economic history then virtually disappeared.
In the past six years, the Department of Economics has been trying to revive the teaching of economic history. Currently, I teach a first year subject in world economic history while Robert Dixon runs a research-based seminar on the history of economic thought; I also teach a second year subject in Australian economic history; Mike Pottenger teaches a second year subject about the history of the international economy and globalisation in the twentieth century; and John Creedy teaches a third year subject in the history of economic thought.
We have found there is a strong student demand for economic history. The first year subjects have combined enrolments of almost 300 students, there are about 200 students in the second year subjects, and usually 15 to 20 students at third year level. I have found that this demand grows when we teach on topics that students find not only interesting but also of practical relevance. One way I have tried to provide this sense is through the idea that we can learn from history. Both subjects I teach have a dedicated section of two to three weeks of lectures that show how lessons can be drawn from historical experience. In The Historian's Craft, Marc Bloch talks about how having knowledge of events and understanding what caused those events are very different things, and that humankind has rarely been satisfied with just knowledge. This theme - learning from history - is the subject of my lecture.
Learning from history
Margaret Macmillan, in her recent book The Uses and Abuses of History, describes the many ways in which we try to draw lessons from history, or in which history is used - for example, by ethnic or national groups in establishing identity, or by political leaders to support their legitimacy or policies. I propose to deal with something more specific. All my examples will be on the theme of learning from history for the practical purpose of improving economic policy-making. I should say at the outset that I'm certainly not claiming the historical episodes I have chosen tell us everything we could or need to know about the lessons I am drawing. Rather, the big lessons in history are likely to come from putting together our understanding of many events and episodes. Nevertheless, the examples I have chosen should give you a flavour of how learning from history can happen.
Early European land policy
My first example is quite general - an illustration of the difficulties that government regulation can have in trying to corral and direct people's self-interest. This relates to the policies the British government and Colonial governors in the nineteenth century used to control the take-up and take-over of land in eastern NSW, from the Indigenous population by British settlers. At that time the desire for land was being driven primarily by the emergence and rapid expansion of the pastoral industry in NSW.
There were three main phases of the land policy. First, from the mid 1820s to early 1840s, an attempt was made to control the boundaries of settlement to within a defined area known as the 'nineteen counties'. This was largely unsuccessful, and hence the period came to be known as the hey-day of squatting. Second, in the mid-1840s Governor Gipps sought to impose greater regulation. He proposed that some ownership rights should be provided to squatters while simultaneously winding back the extent of their access to land. This was opposed by the squatters, and the subsequent Waste Lands Occupation Act 1847 was more to the benefit of squatters - albeit while retaining a leasehold system for occupation of land by the squatters. In The Squatting Age in Australia, historian Stephen Roberts comments that: 'The pioneers had become a monopolistic minority.' The third phase was the era of free selection that began in the 1860s. Free selection was an attempt to open up access to land then occupied by squatters. Pressure for this policy came from the growth of a working-class population and the broad franchise in early colonial governments. The Alienation and Occupation Land Acts 1861 allowed that, within 'settled' and 'intermediate' land areas, anyone could select 40 to 320 acres on the condition of paying one-quarter of the purchase price, the balance being paid and freehold secured after three years. Squatters had what were intended to be limited pre-emptive rights to land that they occupied prior to the Acts.
A first lesson that comes from studying the outcomes from European land policy is the difficulty of preventing attempts by individual settlers to capture property rights through discovery and possession. With a strong economic incentive to establish farms on the best available land and little enforcement of government policy on allowable regions for settlement, the take-up of land by squatters in the 1830s raced far beyond the intended 19 counties. Governor Gipps mused: 'As well might it be attempted to confine the Arabs of the desert within a circle drawn on the sands, as to confine the graziers of New South Wales within any bounds that can possibly be assigned to them.'
A second lesson is the difficulty of designing effective regulation against the creativity of those seeking to avoid the regulation. Nowhere is this more evident than the ways by which squatters sought to overcome free selection, to increase the amount of land which they would themselves retain. Through various practices - such as 'dummying', or paying for other family members and workers to claim adjacent land; 'peacocking', pre-emptively choosing the highest quality land, for example, with river frontage and access to water; and falsely claiming improvements to land - squatters were largely able to stymie the intent of the free selection legislation.
The third lesson is the tendency for 'inefficient' regulation to be undone by the market - an idea represented formally in the Coase theorem. It quickly emerged that land allotments allowed to selectors under the Alienation and Occupation Land Acts 1861, were generally too small and too far from cities to make farming on them profitable. Wool production was viable only on more than 640 acres, and the high cost of transporting dairy produce or wheat to Sydney from rural areas limited the returns to those activities. Hence, the most valuable economic use of land taken by the selectors was in most cases to integrate it back into land-holdings of the squatters. This is what happened. By 1881, eight selections out of nine had passed from their original occupants, and 96 individuals in NSW owned eight million acres of land.
The need for governments to regulate property rights, in the way that occurred in Eastern Australia in the eighteenth century, has been a recurring theme. As the economist John Kay has recognised in his book, The Truth About Markets: 'Every generation must extend the rules of a market economy. In America and Australia, settlement demanded the creation of land rights. Larger-scale production made it necessary to invent corporate organisation. Today new rules are needed for the new technologies of the Internet and the genome.' Hence it is interesting to ponder on whether there are parallels between the Australian experience with land policies and the more recent race for property rights in the human genome. Very briefly, it seems to me that such parallels do exist. One example has been the difficulty of implementing effective regulation. With an inherent desire for knowledge by researchers, and the potential value of applications of knowledge about the human genome, scientific activity has not always respected established property rights. This is illustrated by the case of Myriad Genetics, owner of a patent on the BRCA1 gene, which found 2,500 research papers on this gene in contravention of its patent.
External shocks in an open economy
My second example of learning from history is understanding how 'external' shocks affect an open economy. More specifically, I want to consider the effect of a resource boom on an open economy, using the 1850s Gold Rushes in Australia as a case study. Because of the small size and relatively simple structure of the Australian economy at that time, the effects can be easily observed. In the current mining boom in Australia, the share of mining activity in GDP has increased from around five per cent in the late 1990s to seven or eight per cent of GDP at present. This compares with the Gold Rush era where, for example, gold mining increased from 2.8 per cent of GDP in 1850 to 36.4 per cent in 1852. Hence the effects of the gold mining boom of the 1850s were 'writ large' on the Australian economy; and through this example we will see how history can allow us to trace out with particular clarity the effects of a major 'shock' to an economy.
To understand the effects of a resource boom, the following analysis may help. In the 1850s we can think of the Australian economy as consisting of three main sectors - wool, gold and services. Gold and wool were traded on international markets at fixed world prices. Services were traded only within Australia, with prices being determined in the domestic market.
Consider what happens in this economy when, as occurred in the 1850s, there is an increase in the return from gold-mining. Workers will shift to this activity. Hence wages paid in the other sectors will need to increase in order to retain workers. This causes a 'price-cost squeeze' in the wool sector. Costs have increased, but the price of wool set in the world market stays fixed. Therefore, profitability of wool production declines and as a consequence the share of wool production in overall economic activity in Australia falls.
This process is now commonly referred to as 'Dutch disease', the 'Gregory effect', or a 'resource curse' effect - whereby a booming resource sector crowds out an economy's other export sectors.What actually happened in Australia? It turns out that the analysis above is a very good guide. The Australian economic historians Ian McLean and Rod Maddock have shown that the Gold Rushes were initially associated with a five-fold increase in the return to gold mining. Wages for shepherds then more than doubled in the early 1850s, and for some other occupations such as carpenters and servants more than tripled. What followed was a significant decline in the share of economic activity accounted for by the wool sector. The annual growth rate of sheep numbers fell from 13 per cent in the 1840s to three per cent in the 1850s. However, soon thereafter, the return from gold mining fell and wage costs decreased, thus restoring the profitability and central role of wool production in the Australian economy. The fall in the return to gold mining is largely explained by rapid growth in the number of gold miners following massive migration to Australia. With fixed exchange rates, higher nominal wages in Australia meant higher real wages in comparison to Britain, and hence an incentive for migration. From 1851 to 1860, Victoria's population grew from under 100,000 to almost 550,000.
My third example relates to speculative episodes - periods where there are changes in asset prices that appear 'excessive' when judged against new information about their future income flows.
Australian experience suggests a common set of factors associated with the onset of speculative episodes. One is the existence of 'easy money' - a period of favourable economic conditions with easy access to credit. Second, is the taking on of 'high risk' by participants in asset markets. This can be due to a number of influences: the asset being associated with a new or not easily understood economic activity; the existence of 'wrong' incentives for lending in the banking sector; psychological factors such as envy that promote speculation; and occasionally 'corrupt' practices by market participants. The third factor is the poor prudential regulation of financial markets by government.
I'll consider three Australian examples. The first is from the 1830s and 1840s when the prices of both sheep and land increased spectacularly and then fell just as spectacularly - for example, the price of sheep falling from sixty shillings to sixpence. Each of the factors I mentioned was present in this period. Easy money was available due to the rapid increase in the number of new banks and from the flow of funds to banks from government land sales and British investors. Between 1830 and 1835 loans made by the Bank of NSW increased by 700 per cent. The novelty of sheep farming and wool production made it difficult to estimate their long-run returns, and a lack of supervision of bank lending in Australia by British investors meant that there was a high risk of default with many loans. There was also little regulation of banking practices.
The second example is the 1880s property boom in Melbourne. For much of the 1880s, the average annual increase in the value of land for investment was 50 per cent; and when the crash came in the early 1890s, land prices fell in a matter months to less than a third of their previous levels. Here again, easy money came from a rapid growth in bank lending for land buying, new land banks had been created, and there was a high inflow of British capital. Corrupt activity by politicians, bankers and business people added to the risk of borrowing. Further, innovations such as the introduction of the hydraulic lift for high rise buildings and the growth of a public transport network into suburban areas, made it difficult to judge the value of land. There was still little regulatory control of banking and investment practices at this time.
A third example is the 'double whammy' episode of speculation in the late 1980s. First, from early 1986 to 1987, the All Ordinaries Index of share prices more than doubled, before losing all those gains in three weeks, commencing on 20 October. Second, from around 1985 to 1990, commercial property prices in Australia grew rapidly - doubling in Sydney and Perth, and almost doubling in Melbourne - but then falling rapidly to below their 1985 levels by 1993. Easy credit was again in the picture. Financial market deregulation in the mid-1980s caused a substantial expansion of bank lending. For example, business credit as a share of GDP increased from 25 per cent to 55 per cent from the early to late 1980s. The unfamiliarity of banks with corporate expansion and takeover activity made it difficult for them to establish appropriate lending standards - for example, the overall extent of leverage of some borrowers who were borrowing from several banks seems not to have been taken into account. Moreover, there was a deliberate emphasis by banks on market share rather than the quality of loans. John Phillips, Deputy Governor of the Reserve Bank, noted at the time: 'Regrettably.performance supplements, bonuses, commissions etc., were all too prevalent in the 1980s. These were seen as an incentive in the race for market share.These types of practices are legitimate in the sense that they are within the law.However, they are at least ill-conceived and often downright dangerous.' It also seems that this was a period where the Government's capacity to effectively regulate financial markets and the banks lagged behind the new environment1.
Does history repeat itself?
Each of my examples shows how we can learn from history. Understanding the specific causes of past events, or the role of particular influences, provides historical analogues of the present. This can allow a better appreciation of present circumstances and what may happen in the future, thereby assisting in framing appropriate personal and public policy.
There are, however, limits to what we can learn from history. First, learning from history does not mean finding a situation in the past that matches the present followed by events unfolding in exactly the same way. Instead, as the historian E.H. Carr has put it in his book What is History? '.the specific is unique'. The best we can do is to discern patterns in the past that give us a general guide to the forces that are likely to be important in determining what happens in the present. Second, we cannot ever think of the past as holding objective lessons for us about the present. Historians are likely at any time to disagree about which events or episodes in the past are relevant to understanding the present; and even when they agree about where in the past to draw lessons from, they may have quite different interpretations of that past. Third, we always need to be aware of how history can be mis-used in its application to the present.
These ideas - learning from history and the limits on that learning - have been nicely expressed by the historian John Lewis Gaddis in his book The Landscape of History: 'This gets us close to what historians do.it is to interpret the past for the purposes of the present with a view to managing the future, but to do so without suspending the capacity to assess the particular circumstances in which one might have to act, or the relevance of past actions to them.'
Some suggestions for reading
Readings on the historical examples:
Stephen Roberts (1935), The Squatting Age
Maddock, Rod and Ian McLean (1984), 'Supply-Side Shocks: The Case of Australian Gold', Journal of Economic History, 44, 1047-1067
Michael Cannon (1966), The Land Boomers
John Simon (2003), 'Three Australian asset price bubbles', in A. Richards and T. Robinson (eds) Asset Prices and Monetary Policy (Reserve Bank of Australia)
Charles Calomiris (2008), 'The Subprime turmoil: What's new and what's next', mimeo, Columbia University
General readings on Australian economic history:
Sinclair, William (1976), The Process of Economic Development in Australia
McLean, Ian (2004), 'Australian economic growth in historical perspective', Economic Record, 80, 330-45Macfarlane, Ian (2006), The Search for Stability (ABC Books)
E.H. Carr (1961), What is History?
J.L. Gaddis (2002), The Landscape of History
Margaret MacMillan (2009), The Uses and Abuses of History
A condensed version of an Alumni Refresher Lecture delivered at the University of Melbourne on 16 September 2009.