Insights - Issue 14

insights Melbourne business and Economics volume 14 november 2013

Mastering the markets: high frequency trading and dark pools

By Carole Comerton-Forde The truth about cannabis use

By Jenny Williams Technology and the bottom line: selection and implementation of supply chain management systems

By Damien Power, Terry Papadis and Richard Gruner Demystifying the Chinese economy

By Justin Yifu Lin Monetary policy and the exchange rate at the end of the mining boom: two different views

By Ross Garnaut and Peter Jonson Reflections on and lessons from a career as an economist

By Saul Eslake The role of collateral in global finance

By Annelise Riles Occasional Address Anthony Di Pietro

Insights: Melbourne Business and Economics ISSN:1834-6154 Editor: Associate-Professor Geoff Burrows Associate Editor: Ms Danielle Roller Sub-editor: Ms Rebecca Gleeson

Advisory Board: Professor Kevin Davis Professor Colin Ferguson Professor Emeritus Ian McDonald Design: Ms Sophie Campbell Illustration: Mr Nicholas Kallincos

insights vol 14 Table of contents 03 Welcome

By Geoff Burrows, Editor

05 Mastering the markets: high frequency trading and dark pools

By Carole Comerton-Forde Changes in global equity markets over the last two decades have been nothing short of transformational.

13 The truth about cannabis use

By Damien Power, Terry Papadis and Richard Gruner Implementations of supply chain technologies are frequently idiosyncratic instead of following logical, planned stages and processes.

By Ross Garnaut and Peter Jonson A report of proceedings of a Melbourne Institute forum.

45 Reflections on and lessons from a career as an economist

By Jenny Williams While many people try cannabis, only a small fraction become problem users.

In fact, the risk of addiction is quite low.

21 Technology and the bottom line: selection and implementation of supply chain management systems

37 Monetary policy and the exchange rate at the end of the mining boom: two different views

By Saul Eslake A solid grounding in economic theory is essential to provide a coherent, systematic way of thinking about how an economy works, how it responds to shocks, and how policy-makers are likely to think about responding to those shocks.

53 The role of collateral in global finance

By Annelise Riles Collateral is not only an artefact of national law, it’s also a way of getting around it.

Occasional Address 60 Anthony Di Pietro

29 Demystifying the Chinese economy

By Justin Yifu Lin China’s rise is the most intriguing economic phenomenon of our time.

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Welcome Insights publishes condensed and edited versions of important public lectures connected with the Faculty of Business and Economics. Its object is to share these lectures with the wider public, especially Alumni. The issues presented and developed generally relate to research findings on public economic and social policy. Insights also constitutes an archival source of an important part of Faculty life. Suggestions and comments from readers on any feature of the journal are welcome.

With its high national and international standing, a chair appointment in the Faculty of Business and Economics at the University of Melbourne is an important indicator of scholarly excellence.

Traditionally, newly appointed or promoted professors deliver inaugural lectures or conduct master classes based on areas of their expertise.

Insights is privileged in this edition to bring condensed versions of three events involving recently appointed professors.

First Carole Comerton-Forde examines two transformational developments in global equity markets – high-frequency trading and dark pools – and their implications for risk management and market regulation.

Next, Jenny Williams applies her econometric skills to provide (mostly reassuring) evidencebased insights into the truth about cannabis use, particularly in relation to mental health problems and educational attainments.

Finally, Damien Power, together with Terry Papadis and Richard Gruner, explains how appropriately selected and implemented supplychain management systems can produce enormous cost reductions and profit improvements.

A continuing theme in Insights is the economic consequences of China’s rise as an economic power. The puzzle of how China has been able to achieve this rise when other developing notions have failed to do so is demystified by Justin Yifu Lin in his Downing Lecture.

A major consequence for Australia of China’s rapid growth has been sustained upward pressure

on the exchange rate. A Melbourne Institute forum into ‘monetary policy and the exchange rate at the end of the mining boom’ provided Ross Garnaut and Peter Jonson with the opportunity to present contrasting views, prompting a lively Q&A session which is included in the summary of the forum proceedings.

For the faculty’s student body, an exciting event in 2012 was the formation of the Economics Student Society of Australian (ESSA), open to economics students at both the University of Melbourne and Monash University. In a lecture honouring Neville Norman’s role in the ESSA’s formation, Saul Eslake reflects on his own career as an economist in both the public and private sectors.

In the final featured article, international visitor Annelise Rise adopts both legal and anthropological perspectives to explore the ‘backroom’ personnel and processes associated with the management and implementation of ‘collateral’.

This issue of Insights also features an Occasional Addresses given by Anthony Di Pietro, chair of the Melbourne Victory Football Club, in which he reflects on the importance of adopting ‘long-haul’ perspectives in relation to business and career development.

Finally, thanks must go to Nicholas Kallincos, whose vivid illustrations give each article added character.

Geoff Burrows Editor ghb@unimelb.edu.au

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Article heading here

mastering the markets: high frequency trading and dark pools Changes in global equity markets over the last two decades have been nothing short of transformational. by carole comerton-forde

A condensed version of an inaugural lecture given at the University of Melbourne on 9 April 2013.

The first of the five topics that I will address concerns the objectives of equity markets. This will provide a framework for assessing the impact of the changes in markets over the last two decades. Second, I want to highlight some of the significant changes in global equity markets – which have been nothing short of transformational – and outline the drivers of these changes.

I will then turn to the two advertised topics – dark trading and high frequency trading (HFT). Dark trading has changed substantially in the last few years, and I want to talk about the impact of those changes, the risks they create, and the need for additional regulation relating to dark trading.

HFT is perhaps the most poorly understood topic in the market. There are huge amounts of misinformation and, to some degree, hysteria about its impact. I want to try and distil the facts from some of the fiction that is out there.

Finally, I will examine the need for evidence-based debate and policy making, processes in which both academics and industry have important roles to play.

Objectives of markets Equity markets provide three critical functions: capital allocation, liquidity and price discovery.

They permit companies to raise capital, fund

their businesses, fuel growth in the economy and generate employment. The capital-allocation process also enables investors who have surplus cash to invest in companies, again to generate growth and future returns, but the process only works if liquidity and price discovery also work well.

Liquidity captures how easy and cheap it is to buy and sell stocks. Fewer people would be willing to invest in companies if they didn’t anticipate being able to sell their positions either when they needed the cash or when they decided it was the right time to realise their returns.

We also require transparency in the pricediscovery process so investors can observe the prices at which stocks are trading; get the sense that market processes are fair and equitable; and generate the right prices for stocks.

Changes in the market Although market objectives remain unaltered, the way in which these objectives are delivered has fundamentally changed. In 1987 the Australian market became one of the first in the world to move away from a trading floor to electronic trading. By the early 2000s all major international equity markets were highly automated.

In the pre-automated era, stockbrokers standing on the floor negotiated face-to-face, establishing Insights Melbourne Business and Economics

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relationships that helped them observe developments in the market, which in turn facilitated effective pricing. Information was manually recorded and then disseminated to the wider market. While the mechanics of these operations have changed radically, the underlying processes remain the same. Electronic order books now collate trading interest anonymously and disseminate the information to the wider market.

Historically, stock exchanges operated as notfor-profit mutuals set up to enable stockbrokers to service their clients, investors and public companies. Traditionally, stock exchanges were national monopolies, with a single stock exchange in each country. We have now moved away from mutuals towards exchanges being publicallylisted companies with for-profit motives. As part of that process, regulators decided that exchanges needed to face competition and should no longer operate as monopolies. So we have seen significant competition for trading services in equity markets around the world.

Today, trading for equities, options and futures on the ASX occurs on the ASX’s trading system located five kilometres outside the Sydney CBD.

Brokers can co-locate their own trading services next to the exchange server – similar to the old days, when the brokers were co-located on the trading floor.

The technology serving the market is phenomenal.

The ASX’s trading system has the capacity to process five million trades and 500 million orderbook changes a day, and can process an order in 300 microseconds. It takes a human about 500 microseconds to click a mouse button – trades can be processed much more quickly than we can click a mouse.

The dynamics of the market have changed. One change is the rise of algorithms – trading generated by computer programs, with parameters and trading decisions based on sets of rules. Another is a decrease in the size of trades. The average trade these days on the ASX is about $6,000.

What do these changes mean in terms of our objectives for the market, particularly liquidity and price-discovery? To answer this question, it is useful to look at Figure 1, which provides an example of an exchange trading screen for Telstra Corporation.

Figure 1. Telstra Corporation exchange trading screen TLS – Telstra Corporation Limited. Ordinary fully paid.

Last/IAP +/-

%

Open

High

Low Volume

VWAP Status IAP

$3.885 -$0.005 -0.1% $3.890 $3.920 $3.880 18.23M $3.894743 Open $0.00 Buyers

Sellers

Level

Orders #

Quantity

Price

Price

Quantity

Orders #

Level

+

1

105

2,251,132

$3.880

$3.890

1,622,925

46

1

+

+

2

56

1,725,866

$3.870

$3.900

1,474,199

60

2

+

+

3

67

1,866,369

$3.860

$3.910

1,369,873

49

3

+

+

4

112

1,558,586

$3.850

$3.920

1,417,181

43

4

+

+

5

37

997,298

$3.840

$3.930

1,003,268

43

5

+

+

6

39

923,661

$3.830

$3.940

971,263

37

6

+

+

7

33

375,336

$3.820

$3.950

1,896,532

42

7

+

Source: ASX

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Mastering the markets: high frequency trading and dark pools

The trading screen shows us the trading interest in the stock – all the buyers and sellers in the market. The best bid price – the price the most aggressive buyer is prepared to pay – is $3.88. The most aggressive seller is prepared to sell at $3.89.

Trades will not occur until either a buyer or seller becomes more aggressive. The rules of the market determine that trades occur according to price then time priority. Whoever is prepared to pay the best price gets to trade first. If two investors are prepared to trade at the same price, then the party that put their order in the market first, trades first. Importantly, this screen demonstrates transparency – everyone knows the rules of the game and can observe the trading process and how much liquidity there is in the stock.

The trading screen shows that 105 buyers were prepared to buy about 2.2 million Telstra shares at $3.88. Going down the order book reveals enormous trading interest in this stock. It is a liquid order book. The price-discovery process is transparent. Every trade is reported to the market.

Dark trading One of the big issues in the market is dark trading – that is, trading that occurs without any pre-trade transparency. Dark orders do not appear in that electronic limit order book in Figure 1. We don’t see anything about the trading interest for a dark trader until after the trade is done, at which point the trade immediately gets reported to the market.

Contrary to perceptions, dark trading is not new.

The very early form of dark trading on the trading floor was when a floor broker kept order-tickets in his pocket because he didn’t want to reveal how much trading interest he had in a stock to traders he was negotiating with. Mechanisms have always existed, both on the trading floor and in the automated trading environment, to trade without pre-trade transparency.

Although a transparent market is very important for price discovery and liquidity, pre-trade transparency exceptions are needed to allow large institutional investors to engage in large trades with minimal information leakages and market impacts.

Consider a large superannuation fund wanting to buy a large amount of stock in the market. If the market becomes aware that the fund wants to buy the stock, what’s going to happen to the price? It is likely to rise because people see there is a large buyer who wants to trade the stock. People will assume the buyer is informed, and the stock is probably undervalued, and they’ll start to move the price away from the large buyer. For an institutional investor, that’s clearly a bad outcome. They want to be able to execute their trades with minimal leakage of information, and minimal price impact.

Dark trading is a very important part of that.

In recent years, technology has fundamentally changed the way dark trading occurs. When dark trading was handled manually, brokers were only willing to provide this service for large trades.

However, technology today means that dark trading can be offered to all investors trading in all sizes, providing liquidity to those not wanting to reveal their orders.

Dark pools are typically operated by brokers. In Australia we have 20 broker-operated ‘crossing systems’ currently registered with ASIC. Basically, every major broker, and some not-so-major brokers, operate these dark trading pools. They allow client orders to rest in the dark, and try to match-up orders internally before reporting to the market.

These crossing systems are not currently licensed as markets, but operate under ASIC’s Market Integrity Rules. There is also a lack of transparency about the way these crossing systems work. In the ASX order book, orders are matched according to price and then time priority. In the broker crossing-systems, the crossing operators currently have no obligation to report the rules of engagement to the market.

The ASX operates the largest dark pool in Australia.

It is, however, a licensed market with a set of rules around how it operates and the need to be very transparent in terms of how the market works.

Chi-X, Australia’s second stock exchange, which has been operating a licensed market since October 2011, does not operate a dark pool but allows dark orders to remain hidden in its displayed order book.

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Technology changes mean that dark trading is no longer reserved for institutional traders but can be offered to retail traders. Two large retail brokers in Australia operate dark pools.1 In the US, with close to 100 per cent of retail orders executed away from exchanges, the growth in dark trading has been far more extreme than in Australia. Retail order flows are neither displayed in exchange markets, nor made accessible to other investors in the market. This changes both the mix of participants in exchange markets and the dynamics of liquidity and price discovery.

What has been the impact of these technological changes on trading in the market? According to ASIC Report 331 the overall level of dark trading has not changed. About 25 per cent of the value of trading in Australia has always occurred in the dark. What has changed is the mix of those trades, between ‘block’ trades of over $1 million (clearly institutional investors) and ‘non-block’ trades of any size which can also be done in the dark.

Five years ago the average trade size in the dark for non-block trades was about $150,000. Brokers only offered these services for large trades. Today, we’ve seen a big shift away from block towards non-block trades demonstrated by a 388 per cent growth in the number of non-block dark trades being executed. There has also been a large decrease in the size of those trades. Today, rather than $150,000, those trades have an average size of around $6000 – the same size as the trades executed via the exchange limit order book. Surprisingly, the median trade size is $400! More than 50 per cent of trades are being executed in the dark for trades less than $400. But, if the median trade size is $400, is this really serving the objective of minimising market impact cost for institutional investors? This seems unlikely, but this is perhaps not the whole story, because institutions now use algorithms to slice up their orders into small sizes and then send those orders to dark venues. So most of these trades are still done by institutional traders, but clearly the dynamic of the market has changed.

Whether this change affects the objectives of the market and impacts on liquidity, price discovery and the capital allocation process are questions 08

Mastering the markets: high frequency trading and dark pools

I have been researching (Comerton-Forde and Putnins, 2013). We wanted to understand how this changing nature of dark liquidity in Australia has affected the quality of the price discovery process, and whether it has enhanced the market or made it less efficient.

Regarding block and non-block trading, we find that the two different types of trading have different impacts on price discovery. Block trades, facilitating the interests of large institutional investors, seem to have a beneficial effect on price discovery when executed in the dark. By making these large trades in the dark and simply reporting them to the market, the price-discovery process is more efficient. For trades below block size there is a tipping point. When the level of dark trading below block size exceeds 10 per cent then it starts to harm the price-discovery process.

Regulation addressing dark trading needs to consider carefully the differences in dark trading.

It needs to encourage the beneficial elements – the use of block trades – but discourage the harmful effects of high levels of trading in non-block sizes.

These notions underlie recent regulatory changes in the Australian market. From 26 May 2013 the block-trade thresholds will be reduced. Previously, to trade in a block in the dark you needed to be trading over $1 million. For a stock like Telstra, that’s not a lot of money. But for a smaller stock, $1 million could be a very big trade. For the majority of stocks on the market, the block-trade threshold will be $200,000, making it easier for institutions to find block liquidity.

Another change addresses non-block dark trading, mandating ‘meaningful price improvement’. To trade in the dark below block size, the new rule requires that you offer something better to the market than participants who are willing to display orders in the limit order book. The regulator wants to encourage the placement of orders in a displayed limit order book, thereby advertising liquidity and contributing to the price-discovery process. If investors don’t want to do that, they must offer a better price to the market. With Telstra, where we had the $3.88/ $3.89 spread, to offer price improvement you need to offer to trade

at the midpoint, i.e. $3.885. This requirement should have two effects: encouraging the display of liquidity in the order book, therefore enhancing the quality of the market, and placing downward pressure on the level of dark trading in the market.

If high levels of dark trading are harmful, then this should lead to some good outcomes for the market.

High frequency trading HFT is probably one of the most misunderstood issues in the market, generating a huge amount of hysteria which has been harmful in terms of perceptions about the market. Common complaints in the media are that HFT involves systematic manipulation, predatory behaviour, legalised frontrunning, insider-trading, and excessive volatility.

Generally these claims are based on anecdotal rather than empirical evidence, and are potentially harmful as they cause investors to question the quality and integrity of the market. What little empirical evidence we have paints a more positive picture of HFT. However, I should note that none of the academic work relates to the Australian market due to a lack of data. Evidence from the US suggests that HF traders provide liquidity and enhance the quality of the price-discovery process over short horizons.

To debate the merits of HFT, it is important to first understand what HFT really is. The first thing is what HFT is not – it is not a single trading strategy but a range of different speed-dependant strategies.

Some of the most common HFT strategies are Insights Melbourne Business and Economics

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electronic market-making and statistical arbitrage.

Electronic market-making is when someone is willing to buy and sell the stock and make money on the difference between the buying and selling prices. This is not a new strategy – it has existed in markets since the beginning of time. What’s new is the technology employed. Statistical arbitrage is where a trader seeks to exploit mispricing across different assets. Competition in markets has made it easier for statistical arbitragers to look for opportunities to trade across markets.

HFT refers to the use of high-speed computer programs to generate, route and execute orders.

That description also refers to a broader category of trading known as algorithmic trading, which is an enormous part of the market. Institutional investors use algorithms to manage their trading process. However, the trading that has attracted the most attention is HFT. HF traders typically send numerous orders to market, amending those orders and often cancelling them very quickly. Because they are trying to manage their risks in very short timehorizons, and each time the price moves they want to adjust their prices, HF traders take very small positions, leading to the criticism that they are offering no benefit to the market. HF traders tend to have very short holding periods, so they are in and out of the market most commonly within a trading day, sometimes many times within the trading day. Often, HF traders wish to leave the market at the end of the day, holding no inventory and carrying no risk overnight.

Due to concerns expressed about HFT, an ASIC taskforce spent nine months last year analysing the market in fine detail. Doing something that no other regulator in the world has done, they went down to the individual account level and identified accounts that exhibited HFT characteristics. In trying to identify HFT they looked at six different characteristics such as order-to-trade ratios, speed of order adjustment and turnover, and then ranked each account based on those characteristics. They 10

Mastering the markets: high frequency trading and dark pools

then compared the behaviour of the HFT-like accounts against the non-HFT-like accounts. The key findings were: – HFT in Australia represents 27 per cent of the market (cf. media reports of 75 per cent), which is in the mid-range relative to markets overseas; – This 27 per cent by dollar volume came from less than 0.1 per cent of all accounts examined; and – The top 10 HF accounts in Australia account for 16 per cent of all turnover in Australia.

The HFT contribution to trades is slightly higher at 32 per cent because they use relatively smallsize trades. Their contribution to the number of orders going into the market is also relatively high – some 46 per cent of the market. For every trade a HF trader does they are sending about 14 orders to the market compared to four by non-HF traders.

Around these averages there is a huge variation, and some non-HF traders are also sending massive numbers of orders to the market.

One of the concerns expressed about HF traders is that they are only trading in very small size, and that makes it difficult for people who want to trade in large size. However, the ASIC analysis showed that HF traders account for only 17 per cent of orders below $500, with 83 per cent of coming from non-HF traders. Although HFT accounts for 27 per cent of the market, their contribution to small trades is actually much lower than that. So other traders, most likely institutional investors using algorithms to slice up their orders, are trading very small sizes also.

The other interesting thing is that HF traders seem to be providing liquidity to the market more often than they demand it. So they are sitting in the electronic limit order book providing liquidity to other investors. They are most active in the ASX200 stocks. If it were possible to ban HFT, 27 per cent of trading in the market would be lost.

Trading doesn’t necessarily equate to liquidity, but that would have a very substantial impact on the market.

A key message from ASIC’s analysis is that many of the attributes that people associate with HF traders are actually exhibited by other traders as well. If this is behaviour we are concerned about – the use of small orders and high order-to-trade ratios – then attention should not necessarily be directed at HF traders but perhaps at the underlying behaviour.

Conclusion

Additionally, ASIC found no systematic evidence of misconduct by HF traders. That’s not to say that there is no misconduct, but that it is not systematic and not inconsistent with misconduct by lowfrequency traders. If misconduct is a concern, the focus should be on that misconduct and not the speed of trading.

The other big risk about this misinformation is that it creates uncertainty for investors. Reduced investor confidence means people are less willing to participate in the market, liquidity is lower and the capital allocation process is less efficient.

Institutions often trade in dark pools because they want to avoid HF traders. However, ASIC’s analysis shows that HF traders are also trading in dark pools, and investors in some cases seem to be unaware of this development.

So, in terms of regulating HFT, the evidence suggests that regulators should be targeting particular behaviours. Unquestionably, technology changes in the market have increased technology risk. Overseas markets demonstrate numerous instances of technology failures, and regulations need to address those potential issues. But these risks are not necessarily tied to HFT. ASIC has introduced a series of new regulations to address technology risks, which will take effect over the next 18 months.

It is noteworthy that the Australian and US markets are structurally quite different. HFT in the US accounts for 70 per cent of the market, and is a major concern. There are a number of reasons why the level of HFT in Australia is much lower. One is that last year Treasury introduced a fee on the market, essentially to recover the cost of conducting market surveillance, and a large part of that fee is based on order messages. So traders sending numerous order messages to the market, and imposing costs on the regulator, are paying commensurately.

This increases the cost of HF strategies and puts downward pressure on the growth of HFT.

One cause of media-reported misconceptions about dark pools and HFT has been the lack of empirical evidence to support particular positions, enabling anecdote and vested interest to drive the debate. Potentially, we end up with ill-informed regulation, if decisions are based on poor evidence or a complete lack of evidence.

There is a need for far more analysis and evidence on all of these issues, and there is an important role for industry to play in terms of providing that evidence. And perhaps more importantly, for industry to work with academia to provide data, to provide insights, and to allow academics to undertake empirical analysis into the impact of these changes on the market. This approach can help contribute to informed policy decisions and increase the quality of public debate.

Carole Comerton-Forde is Professor of Finance at the University of Melbourne. She has also acted as a consultant for a number of stock exchanges and market regulators around the world, including the Australian Securities and Investments Commission.

1 Subsequent to this lecture one of these brokers, E-Trade, announced the termination of its dark pool.

References ASIC Report 331, Dark liquidity and highfrequency trading, 18 March 2013.

Comerton-Forde, C and Putnins, TJ 2013, ‘Dark trading and price discovery’, http://papers.ssrn. com/sol3/papers.cfm?abstract_id=2183392

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Article heading here

the truth about cannabis use While many people try cannabis, only a small fraction become problem users. In fact, the risk of addiction is quite low. by jenny williams

A condensed version of a public lecture given at the University of Melbourne on 26 June 2013.

When it comes to drugs in general and cannabis in particular, the images in the media are typically of King Pins and Drug Lords, or hapless individuals facing severe penalties after being caught trafficking drugs in foreign countries. The lives and events behind the stories recorded in the media seem very far removed from the lives of most of us.

And while nefarious individuals undoubtedly play a part in the supply and trafficking of cannabis, the facts about the use of cannabis paint a picture that is more mundane and, for a large number of people, much closer to home.

Cannabis use in Australia and worldwide Cannabis is by far the most widely produced and consumed illicit substance globally. The United Nations Office of Drug Control reported in 2011 that between 2.8 and 4.5 per cent of the world’s population aged 15-64 used cannabis at least once in the past year. In this regard, Australia is an over-achiever, with 10 per cent of its population aged 14 or older having used cannabis in the past year (2010 National Drug Strategy Household Survey (NDSHS)). These individuals have done so despite the fact that cannabis use and possession is illegal in all states and territories of Australia; and its use and possession is a criminal offence except in South Australia, the ACT and the NT (where usage may lead to a fine but no criminal record if the fine is paid). In using cannabis, individuals are breaking the law and putting themselves at

risk of arrest. Indeed, in 2011-2012, over 61,000 individuals were arrested on cannabis charges in Australia, with 86 per cent of those charges relating to consumption offences only (Australian Crime Commission, 2013). So why do people choose to break the law, risking arrest and criminal justice sanctions in order to use cannabis?

The popularity of cannabis stems from the combination of the mild euphoria and relaxation associated with its use, and the popular belief that its use poses little risk to health. The two major constituents of the cannabis plant are THC, which is the principal psychoactive agent that produces the ‘high’, and CBD, a non-psychoactive compound that produces the feeling of relaxation and is thought to have potential medical uses.

To get a sense of the extent of cannabis use in the Australian population, it is useful, as a point of reference, to compare its usage to that of tobacco. According to the 2010 NDSHS, a similar proportion of the population aged 14 and over report having ever used cannabis and tobacco, with 35 per cent reporting having used cannabis at some point in their lifetime compared to 42 per cent for cigarettes.1 However, when we consider use in the past week, only 4 per cent of the population report using cannabis whereas 18 per cent report having used cigarettes over the same time period.

When it comes to daily use, a mere 1 per cent of the population report having used cannabis daily compared to 15 per cent for cigarettes. This shows Insights Melbourne Business and Economics

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that, while many people try cannabis, only a small fraction become problem users. In other words, the risk of addiction is quite low, around 10 per cent.2 Understanding the typical patterns of cannabis use is important for understanding the types of harms that users are at risk of. For example, the medical and epidemiological literatures identify long-term heavy use of cannabis as a source of risk for various cancers and respiratory diseases. However, as the typical user does not follow this pattern of use, they are not subject to an elevated risk for these diseases. It has been argued that cannabis is in fact less harmful than alcohol or cigarettes, as well as other illicit substances (Nutt et al., 2010).

So why do policy makers make a big deal out of cannabis? One reason may be the mounting evidence that early uptake is associated with significantly higher risks of several types of harm. This is where my research seeks to make a contribution. Specifically, I investigate what, if

Figure 1: Starting rate for cannabis usage

any, harms are caused by cannabis use. In doing so, the emphasis extends beyond simple correlations to identifying cause-and-effect relationships. If there are harms, I investigate what determines the extent of harms. For example, are harms greater for those who start at younger ages or use at higher intensities? Do the impacts of age at first use or intensity differ for males and females? My research focuses on harms that adversely impact on human capital such as education, mental health and well-being. In what follows, I summarise the findings of four of my published papers (all coauthored with Jan Van Ours) that speak directly to these issues.

Starting and quitting cannabis use First, I want to make the case for the importance of studying the decisions to start and quit using cannabis. While statistics for the prevalence of use in the past year provides a snapshot of cannabisusing behaviour at a point in time, they are

Figure 2: Probability of starting to use cannabis

0.14

1.0

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0.8

Starting rate

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The truth about cannabis use

10 13 16 19 22 25 28 31 34 37 40 43 46 49

Age (years)

less useful when we are attempting to identify the drivers and consequences of cannabis-using behaviour. This is because past-year prevalence of use conflates two distinct behaviours: the decision to start using by those who have not previously used, and the decision to quit using amongst those who have previously used. Inspection of the hazard for starting and quitting cannabis, depicted in Figures 1 and 2, shows that transitions into cannabis use typically occur in the teenage years and that if a person has not used cannabis by the age of 25, they are unlikely to start later in life. Figures 3 and 4 show that while around 50 per cent of individuals aged 25-50 in Australia have used cannabis, many are experimenters who quit within the first year, and more than half quit within 10 years of first use. As starting and quitting cannabis use are separate decisions, they are likely to have different determinants and may respond differently to policy. Understanding these distinct decisions and behaviours is therefore the key to designing efficacious policy.

The article ‘Cannabis prices and the dynamics of cannabis use’ (Van Ours and Williams, 2007) examines the decision to start and stop cannabis use by Australians aged 14-22. Two findings from this study have policy implications. First, we find that prices have a larger (direct) impact on the decision to start use than the decision to quit. For example, raising prices from $20/gm to $40/gm for high-quality cannabis reduces the proportion of 15-year olds who have used cannabis by 10 per cent while having no significant impact on quitting. The second important finding is that the age that people first use cannabis matters – those who start at younger ages use for longer durations.

For example, amongst those who start using cannabis at age 13, 14 per cent have quit after 5 years compared to 39 per cent amongst those who start at age 17. This suggests that it is not simply if but when cannabis use starts that is important, and interventions that prevent early uptake should be a focus of policy.

Figure 3: Quitting rate for cannabis

Figure 4: Probability of quitting cannabis 0.30

0.27

0.27

0.24

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Cumulative quit probability

0.30

Quit rate

0.21

0.18

0.15

0.12

0.21

0.18

0.15

0.12

0.09

0.09

0.06

0.06

0.03

0.03

0.00

0.00 1 3 5 7 9 11 13 15 17 19

Duration of use (years)

1 3 5 7 9 11 13 15 17 19

Duration of use (years)

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Cannabis use and educational attainment As discussed above, the age at which cannabis use first occurs is typically in the teenage years – a critical period in which decisions are made with respect to education. This issue has long been recognised and a correlation between lower educational attainments of cannabis users in general, and early starters in particular, is well documented. However, it is not clear that these associations imply a causal relationship running from cannabis use to lower educational attainment. This is because people self-select into cannabis use on the basis of characteristics that are not observed and are therefore unaccounted for. For example, those with an external locus of control – those who believe there is little

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The truth about cannabis use

connection between the choices they make and the outcomes they experience – may not fully perceive the consequences of their own actions, making them less likely to work hard at school and more inclined to party and use cannabis. Accordingly, individuals with an external locus of control will be observed to have lower educational attainments and greater cannabis use, although no causal relationship exists. The correlation between the two simply reflects the fact that the unobserved confounder – external locus of control – drives both outcomes. In order to determine whether cannabis use actually causes reduced educational attainment, the potential for unobserved confounders must be controlled for.

The aim of our article ‘Why parents worry: initiation into cannabis use by youth and their

educational attainment’ (Van Ours and Williams, 2009) is to determine whether cannabis use does in fact cause early school exit. More than this, the article examines whether there are critical ages at which this occurs, and whether there are gender differences in the impact and/or critical ages. Using Australian data, we find that after accounting for the potential correlation in unobserved factors determining educational attainment and cannabis uptake, cannabis use does cause reduced years of education, if uptake occurs before critical ages.

We also find that the critical ages differ for boys and girls. Specifically, we find that educational attainment for boys is reduced if they start using cannabis before the age of 17, and for girls before the age of 19 (although most of the effect is for uptake before the age of 17). For both boys and girls, cannabis uptake after the critical ages has no impact on educational attainment. To give some indication of the magnitude of the effect of early cannabis use, we find that the causal impact of starting cannabis use at age 15 is a reduction in the expected years of formal education by 0.8 years for males and 1.3 years for girls.

Cannabis and mental health Turning to the relationship between cannabis use and mental health, there has been growing public interest in the question of whether cannabis use adversely affects mental health. This question has been widely studied in epidemiology and medical literature following the publication of Andreasson et al (1987), which found that among Swedish conscripts, the risk of developing schizophrenia post-conscription was higher for those who used cannabis more often prior to conscription. While the potential for unobserved characteristics that make individuals susceptible to both cannabis use and schizophrenia precludes a causal interpretation to this finding, it nonetheless provides suggestive evidence, and in a direction that was not in line with the beliefs of many researchers of the day. In fact, as late as 1995, a Lancet editorial stated that ‘the smoking of cannabis, even long term, is not harmful to health’. While a negative relationship between mental health and cannabis use is well documented, the core of the debate about whether cannabis use adversely affects one’s mental health

lies in the proper interpretation of this evidence.

Plausible alternative interpretations include: (i) self-selection into cannabis use on the basis of some unobserved characteristic, for example childhood trauma, that also negatively impacts on mental health, and (ii) reverse causality whereby those with mental health problems self-medicate with cannabis (in which case the relationship runs from poor mental health to cannabis use).

Either (or both) alternative explanations may fully explain the association between cannabis use and poor mental health.

Our 2011 article ‘Cannabis use and mental health problems’ (Van Ours and Williams, 2011) sought to address these issues to determine whether or not cannabis use does have a detrimental effect on mental health using data on Australians aged 25-50 years. While we find some evidence that those who are susceptible to cannabis use are also susceptible to poor mental health (self-selection), we also find evidence of an adverse causal impact of cannabis use. By and large, these adverse effects are experienced by those who use cannabis weekly or more often. For example, our model estimates that 8 per cent of men who never use cannabis will experience mental health problems, compared to 14 per cent of males who use cannabis weekly, and 15 per cent of males who use cannabis daily. These estimates are net of the effect of self-selection.

With the data used for this study, however, we are unable to account for the potential of reverse causality (self-medication).

Accounting for both self-selection and reverse causality demands extremely rich and detailed longitudinal data. Jan Van Ours and myself are fortunate to have been able to work with David Fergusson and John Horwood, and the data they have been collecting for over 30 years for the Christchurch Development Study, in order to address these issues. In particular, we study the relationship between the onset of suicidal ideation (suicidal thoughts) and the onset of regular cannabis use amongst young New Zealanders.

Using this extremely rich, high-quality data, we find no evidence of reverse causality whereby suicidal thoughts lead to an uptake in regular cannabis use. As with the study using Australian Insights Melbourne Business and Economics

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data, we do find evidence of a selection effect. This means that those vulnerable to regular cannabis use are also vulnerable to suicidal thoughts.3 Finally, we found evidence that using cannabis intensively – at least several times a week – causes vulnerable males to start having suicidal thoughts at younger ages than they would if they used cannabis less intensely. For example, our estimates suggest that going from monthly cannabis use to using at least several times per week at the age of 17 increases the probability of starting suicidal thoughts at the age of 18 from 50 per cent to 77 per cent amongst vulnerable males. We also find that the earlier a person vulnerable to suicidal thoughts starts intense use of cannabis, the earlier they will first experience suicidal thoughts. Importantly, we find that using cannabis less than several times per week does not cause suicidal thoughts.

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Conclusion

First, most people will try cannabis and do so before they are 25. Second, many quit cannabis use soon after they first try it. Third, problematic use is rare and is restricted to perhaps 10 per cent of those who ever use. However, those who use weekly or more often do face a substantially increased risk of mental illness as a result of their cannabis use.

Using less often than weekly appears to have little or no impact on mental health and well-being of adults. The final point, and one which may be of substantial interest to policy makers and parents alike, is that there exists an elevated risk of several harms for those who start using cannabis before the age of 15. Early use of cannabis leads to longer durations of use (and hence increased exposure to risk factors for respiratory diseases and various cancers), reduced educational attainment, and amongst those who are susceptible, an increased risk of extreme mental distress, as measured by suicidal thoughts.

So, what should one take away from the findings of these studies? I suggest there are four main points.

The overarching goal of this research is to contribute to the evidence base on the impact of

The truth about cannabis use

cannabis use. Creating an evidence base is essential for understanding the circumstances under which various interventions may be warranted given policy goals, and more broadly for informing the policy debate. Along these lines and in light of the evidence presented here, the interested reader might ask: how well do the current cannabis policies in Australia serve the stated goal of harm minimisation?

Jenny Williams is Professor of Economics in the Department of Economics, University of Melbourne.

1 The NDSHS report considers a person to have never smoked if they have never smoked 100 cigarettes (manufactured and/or roll-your-own) or the equivalent amount of tobacco. I define smokers as current smokers and ex-smokers.

Van Ours, JC, Williams, J, Fergusson, D & Horwood, LJ 2013, ‘Cannabis use and suicidal ideation’, Journal of Health Economics 32(3): 524-37.

Van Ours, J & Williams, J 2011, ‘Cannabis use and mental health problems’, Journal of Applied Econometrics 26 (7) : 1137-56.

Van Ours, J & Williams, J 2009, ‘Why parents worry: cannabis use by youth and their educational attainment’, Journal of Health Economics 28(1): 132-42.

Van Ours, J & Williams, J 2007, ‘Cannabis prices and dynamics of cannabis use’, Journal of Health Economics 26(3): 578-96.

World Drug Report 2011, United Nations Office on Drugs and Crime (UNODC), Vienna, Austria.

2 It is also interesting to note that, while lifetime tobacco use is more prevalent amongst low socioeconomic status individuals, lifetime cannabis use is more prevalent amongst high socioeconomic individuals.

3 Amongst males, 31 per cent were estimated to be vulnerable to suicidal ideation.

References Andreasson, S, Allebeck, P, Engstrom, A & Rydberg, U 1987, ‘Cannabis and schizophrenia: a longitudinal study of Swedish conscripts’, Lancet 2: 1483-86.

Australian Crime Commission, 2011-12 Illicit Drug Data Report, http://www.crimecommission. gov.au/sites/default/files/files/IDDR/2011-12/ IDDR-2011-12-FINAL-HR-020513.pdf Australian Institute of Health and Welfare 2011, 2010 National Drug Strategy Household Survey Report, Drug statistics series no. 25, Cat. no.

PHE 145, AIHW, Canberra.

The Lancet Editorial 1995, ‘Deglamorising cannabis’, Lancet 346: 1241.

Nutt, DJ, King, LA, Saulsbury, W & Blakemore, C 2007, ‘Developing a rational scale for assessing the risks of drugs of potential misuse’, Lancet 369: 1047–53.

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Article heading here

technology and the bottom line: selection and implementation of supply chain management systems Implementations of supply chain technologies are frequently idiosyncratic instead of following logical, planned stages and processes. by damien power, terry papadis and richard gruner

An edited version of an alumni master class presented at the University of Melbourne on 10 April 2013.

When firms implement technologies designed to facilitate efficient and effective operations within their supply chains they confront a number of dilemmas. While on the one hand the application of technology promises to automate information transfer between trading partners, firms need to collaborate more closely with trading partners to leverage investments to the full. Such collaboration, though a pre-condition for getting the maximum out of said investments, can be problematic in practice. In particular, divergent objectives and priorities of firms determine that ‘collaboration’ may in many cases be subject to pressures such that the idea is more attractive than the reality.

Technologies of interest

Technologies that facilitate more effective tradingpartner interaction have been available for over 30 years, are based on global standards and, in more recent times, have become more user-friendly by leveraging open internet protocols. Yet, empirical data gathered from Australian firms over a 10year period – employing both survey and casestudy methods – shows that implementation in Australia is often idiosyncratic and subject to significant local constraints. This article summarises these findings – including verbatim conversations with some of the firms using these technologies – and provides some plausible explanations for why this is the case.

GS1 Australia enables over 17,000 members from businesses of all sizes across 22 industry sectors to enhance their efficiency and cost-effectiveness by adopting GS1 global supply chain best practices including barcode and numbering standards, services and solutions. In 1973, the first barcode was commercially scanned in a retail environment.

In 1983, GS1 Australia became the Australian member of the global GS1 organisation and is the only organisation exclusively authorised to administer the GS1 System in Australia. Today, 40 years later, businesses worldwide are interlinked, in one way or another via the GS1 System. This fact amply justifies the claim that the GS1 System is the global language of business.

GS1 (Global Standards ONE) was established by industry for industry. It is an international notfor-profit organisation based in Belgium with 111 member organisations worldwide, one of which is GS1 Australia. GS1 facilitates collaboration amongst trading partners, organisations and technology providers, in order to solve business challenges that leverage standards and to ensure visibility along the entire supply chain. GS1 manages the most widely used supply chain standards system in the world serving almost two million companies across 150 countries in multiple sectors and industries.

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The GS1 System of standards allows companies all around the world to globally and uniquely identify their products and services, assets, logistic units, shipments, attribute data (e.g. serial numbers, best-before dates, batch numbers), physical locations and more. When this powerful identification system is combined with various data-capturing and informationsharing technologies, improvements in supply chain efficiency and effectiveness are enabled.

Ultimately, the GS1 System of standards enables the identification, capture and sharing of business data/information within and between trading partners, locally and internationally.

The four key areas of the GS1 System are: – Global data and application standards for barcodes that use the globally recognised GS1 Identification Keys (identification numbers) to uniquely identify things such as trade items, locations, logistic units, and assets.

– Global standards for eCom (Electronic Business Messaging) for the rapid, efficient and accurate electronic transmission of agreed business data between trading partners.

– The Global Data Synchronisation Network™ (GDSN), an automated, standards-based, global environment that enables secure and continuous data synchronisation, allowing all partners to have consistent item data in their systems at the same time. In Australia, GDSNcertified data synchronisation is achieved via GS1net, incorporating the National Product Catalogue for the Healthcare industry.

– GS1 EPC (Electronic Product Code) global standards which enable globally-unique identification numbers to be used for RFID (Radio Frequency Identification), with major benefits in the tracking and tracing of products, services and other items in supply chains.

Methods for data collection ‘Ten Years After’ Project This project (Power and Gruner, 2012, Gruner and Power, 2013) comprised two stages. The first was 22

gathering data in 2011 from GS1 member firms which had participated in two surveys conducted in 2001/2002 and 2011 within the membership of GS1 Australia. Respondents to the earlier surveys were identified and 62 responses were gained providing a T1 / T2 comparison. The focus of the surveys was on the extent of adoption of GS1-based technologies, collaboration with trading partners, strategic focus and drivers of adoption, and firm performance as a result of use of these technologies.

The second phase of the project involved conducting 17 case studies in firms identified from their survey responses as either increasing or decreasing their use of these technologies over the 10-year period. This phase identified firms on the basis of the extent to which they were pursuing supply chain integration through the use of standards-based technologies, with particular focus on the factors determining changes in adoption patterns over time.

Culture/capability/technology usage survey A survey was conducted in 2012 focusing on usage of the GS1 standards-based technologies.

In particular, the following factors influencing adoption were included: data quality; integration with trading partners; innovative capability; firm culture (captured by a range of constructs); extent of use of GS1 standards-based technologies; and firm performance. In total, 310 responses from GS1 members were collected.

Technology attributes – economics of adoption survey A second survey was conducted in 2012 comparing technology attributes with the economics of adoption. Attributes of the technologies included superiority over prior technologies, compatibility with current technologies, ease of understanding, trial ability, and ease of understanding and communicating benefits. Factors representing the economics of adoption included prior technology drag, irreversibility of investments, powerful sponsorship, expectations of widespread adoption and strength of the business case. Overall, 295 responses from GS1 members were collected.

Technology and the bottom line: selection and implementation of supply chain management systems

Some findings of interest

Is implementation of these technologies increasing over time?

Are these technologies becoming more userfriendly over time?

The evidence from both the survey and case study research indicates that many of the technologies are becoming more easy to use, implement and understand over time. The survey results from the ‘Ten Years After’ project indicated that levels of understanding of the technologies had increased significantly. However, when these results were broken down by extent of implementation, this growth in understanding was found to be almost exclusively in the high-implementation group.

Respondents from firms where implementation was either moderate or low indicated little change in knowledge of the technologies, and in some instances indicated that although the technologies were now based on open standards and should be cheaper to implement exogenous factors often conspired against this: ‘… we’re not really ready to integrate his system with our system because I don’t have a way to integrate a thousand different retail systems with my back end.’

So is the diversity of retail systems a problem?

‘Absolutely yes. I mean, if there was some simple way to link up our accounting system or our website, because that’s probably more easy that you have some glue in the middle, to make it easy for them to integrate their system, I’d love that.’

Evidence of increased use of the technology indicated that there was just as much support for reduced levels of use as for increases. Of the 62 respondents to the ‘Ten Years After’ survey in both 2001 and 2011, only 25 per cent registered an increase in usage over this time period. At the same time, 15 per cent indicated a reduction in usage and the balance of 60 per cent had not changed. Given that the majority of this last group was made up of firms using these technologies at low levels (33 of 37 respondent firms where no change was recorded) evidence of significant increases in the use of these technologies over this time period was at best mixed.

The case research also confirmed that for many firms the will to implement was not necessarily enough to ensure more implementation over time.

In supply chains the actions and motivations of trading partners act to moderate the ability of firms to implement further. ‘… trying to do business with your Retailer X and your Retailer Y and Retailer Z and all the rest of them … it is just too hard, the cost of compliance with their systems is too much of a burden for a company of our size, it’s just a cost/benefit scenario.’

Figure 1: Extent of implementation of technologies 2001–2011 Extent of Implementation 2011

Extent of Implementation 2001

Low

Low 33

Medium

High

Total

8 3 44

Increase (25%)

Medium

4

2

5 11

No change (60%)

High

0 5

2 7

Decrease (15%)

Total

37 15 10 62

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Do firms implement Supply Chain Management enabling technologies in a staged, logical and progressive manner?

Much of the literature dealing with the implementation of technologies that facilitate communication and exchange of information between trading partners assumes a model of implementation following logical progression over time. This concept also promotes the idea that implementation can be broken down into clearly identifiable stages. Our findings indicated that implementation across all the case companies – whether those increasing usage, decreasing usage, or remaining static – was actually characterised by idiosyncratic and non-standard implementation of standards-based technologies.

Idiosyncratic implementation more the norm The case studies provided ample evidence that implementations are idiosyncratic, instead of

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following logical, planned stages and processes. In fact, the most common scenario for implementation was a discontinuous approach over time driven by potential short-term benefits from either extending implementation or reducing it.

‘They still placed their orders by fax, would you believe, but we had to send their invoices through an EDI [Electronic Data Interchange] system, so we had to sort of cobble up some software so that our Greentree accounting system could produce – it was just an ASCII file.’

But they don’t do that anymore, do they? ‘Yes they still do … until recently they would fax their orders through.’

But they don’t use a shipment notice? ‘No, not ASN [Advance Shipping Notice] we just produced our own invoice and it was sent to them in an ASCII file, that they had obviously dragged into their accounting system.’

Technology and the bottom line: selection and implementation of supply chain management systems

Was there a purchase order, sponsor acknowledgement, or anything like that, such as an EDI invoice? ‘Well they referred to it as an EDI invoice but I didn’t really think it was.’

pay us, which is (how) Retailer Y do it, and they launched it as being a more advanced system than every other retailer but they seem to require so much more work and paperwork so that’s weird.’

Non-standard implementation of standards-based technologies

Is there any rationale for this? ‘They just say they are not ready, I think it’s because it delays the process and it means they’ve got longer to pay, but that’s me being cynical.’

Another emergent theme was the implementation of standards-based technologies (i.e. based on global standards) with local nuances and adaptations to suit the local, short-term objectives of the most powerful players. ‘… the only weird thing about it is how the retailers differ in their use of the information. As an example, Retailer X still need us to send an invoice with every shipment and email or fax them an invoice to their accounts payable office”.

On top? ‘On top of the fact that we are EDI trading and they would be able to scan a label when they receive the goods which should theoretically tally the fact that the order has been received and they should

Why is this so?

There are four major reasons why the implementation of technologies – which are based on global standards and designed to facilitate more effective trading-partner interactions – are subject to a high degree of variability in both the form and focus of their implementation.

Collaboration – the collaborator’s dilemma Use of these technologies in a supply chain assumes a commitment to collaboration with trading partners. The importance of collaboration was confirmed in the cross-sectional exploration

Figure 2: Collaboration and drivers of technology use GS1 Technology Usage Firm Culture Data quality Objective / quantitative decision making

External collaboration focus

% Shipments despatch advice sent using EDI % Shipments receiving advice sent using EDI

Trading partner integration

% SKU’s master data loaded in GS1 certified data pool % Orders transacted using EDI % Invoices transacted using EDI

Long term horizon

Dynamic management ethos

Innovative capability

% Pallets labelled with SSCC’s

Order fulfilment lead time (days)

% Invoices all information correct

% Annual growth rate

% Locations with global location numbers

Strong positive effect Moderate positive effect

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of the relationships between data quality, integration with trading partners, innovative capability, a range of constructs capturing firm culture, extent of use of GS1 standards-based technologies and firm performance. In a model testing the relationship between firm culture, drivers of technology adoption, extent of use of the technologies and firm outcomes, the single cultural characteristic having a significant positive effect on all three drivers of adoption was ‘External Collaboration Focus’.

At the same time, further evidence from both the case studies and the ‘Ten Years After’ study indicated that the levels of collaboration required to leverage these technologies was problematic and restricted growth in collaboration over time. In fact, between 2001 and 2011 we found no significant increase in the average levels of collaboration. The cases provided examples of why this may be so:

and do it that way. I don’t think at this particular point in time there would be too many that would actual avail themselves of that. Because a lot of them, they are halfway to a job, then ah I’ve got to go to Alvins because I need ahhh (they are not that organised) ... it would be nice if they were.’

Complexity Compounding the structural problems limiting collaboration, we found that the complexity inherent in trading-partner arrangements provided a further constraint. Case examples illustrating this included: ‘Most of them, you know, after 24,000 independent customers, most of them, are local bottle shops that will ring you up and place their orders.’

They just fax their order through or call up? ‘Yes, they don’t have the technology and they probably can’t afford the technology.’

‘Yes, we see them as two separate issues at the moment, our customer base, as I said, isn’t all necessarily computer savvy, pen and paper men a lot of them. So we would have to have a consensus amongst us that this is actually going to be a benefit if we allow our existing clients to jump on our website, place an order,

Value proposition

Figure 3: Collaboration compared with technology use

Figure 4: Management perceptions of technologies

The survey research also provided evidence indicating that, for managers, the perceived strategic value of the technologies was more strongly associated with use of the technologies rather than collaboration with trading partners.

Favourable

Collaboration with trading partners

Barcodes

Weak positive (0.143) Perceived strategic value

Use of enabling technologies

Attributes of technologies

EDI XML GDSN

Strong positive (0.334)

RFID

Functional manager

Unfavourable

Unfavourable

Favourable

Economics of adoption

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Senior manager

Technology and the bottom line: selection and implementation of supply chain management systems

As a result of this perception and the problems inherent with investing in collaborative links with trading partners, it would appear easier to just invest in the technologies and expect that more effective trading-partner interactions will follow as a result.

Divergent perceptions of senior and functional managers When comparing the attributes of these technologies and the economics of adoption, significant differences were found between the perceptions of senior and functional managers on the favourability of attributes of EDI, GDSN and XML (Extensible Markup Language). In all three cases, functional managers were significantly more optimistic about the potential of each of these technologies. Whatever the rights and wrongs of these perceptions they point to conflict within firms relevant to the adoption decision and the commitment to implement over time. Given that senior managers will likely be in control of the purse strings when proposals for investment are put forward from within the functions, then this divergence in perceptions represents a significant potential constraint on investment.

It was also interesting to note that there was agreement on the favourability of the economics of adoption and that these were seen to not be unfavourable. This finding is significant as there is a recurrent theme in the literature, particularly in relation to the adoption of EDI, that unfavourable economic factors have been a major constraint on extended adoption.

Conclusions Managers are aware of the need to work more closely with trading partners to facilitate more effective management of supply chains. Yet they are hampered by significant challenges. The GS1 suite of technologies, based on global standards, has been developed specifically to facilitate more effective supply chain arrangements. This study shows that the implementation and use of these technologies is far from a simple capital expenditure investment exercise. A complex

array of human, structural and commercial factors combine to make implementation more problematic than may be expected. This further leads to an implementation approach over time which is typically more discontinuous, idiosyncratic and emergent than planned, rational and following identifiable stages.

Damien Power is Professor of Operations Management in the Department of Management and Marketing, University of Melbourne.

Terry Papadis is Manager, Training and Operations Services, at GS1 Australia.

Richard Gruner is postdoctoral research fellow in the Department of Management and Marketing, University of Melbourne, and a former marketing manager of a large European media company.

References Gruner, RL and Power, DJ 2013, ‘Emergent strategic thinking among small and medium sized enterprises: The case of standards based inter-organizational systems’, Proceedings of the 20th International EUROMA Conference, Dublin, Ireland, June 10-12.

Power, D and Gruner, RL 2012, ‘Supply chain integration over time: Comparing technology adoption, integration and trading partner collaboration over a ten year period’, Proceedings of the 4th World P&OM Conference / 19th International EUROMA Conference, Amsterdam, Netherlands, July 1-5.

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Article heading here

demystifying the chinese economy China’s rise is the most intriguing economic phenomenon of our time. by justin yifu lin

A condensed version of the Finch Lecture given at the University of Melbourne on 4 June 2013. A longer version of the lecture appears in the September 2013 edition of the Australian Economic Review.

Before the transition from a planned to a market economy dating from 1979, China had been trapped in poverty for centuries. Its per capita income was US$154 in 1978, less than one-third of the average in Sub-Saharan African countries.

China was also inward-looking with a trade dependence (trade-to-GDP) ratio of only 9.7 per cent. Growth since then has been miraculous – GDP growth averaged 9.8 per cent during 19792012, and annual growth in international trade was 16.6 per cent. China is now an upper middleincome country with a per capita GDP of US$6,100 in 2012, and more than 600 million people who have escaped poverty. Its trade dependence ratio is around 50 per cent, the highest among the world’s large economies. For three decades China has been both a driver of development and a stabilising force in the world economy.

This lecture draws on my new book, Demystifying the Chinese Economy (Lin, 2012a), which seeks to answer six related questions: Why was it possible for China to achieve such extraordinary performance during its transition? Why was China unable to attain similar success before its transition started? Why did most other transition economies, both socialist and non-socialist, fail to achieve a similar performance? What costs does China pay for its extraordinary success?

Will China sustain a similar dynamic growth in the coming decades? And can other developing countries achieve similar economic performance?

China’s extraordinary performance in transition Average annual per capita income in the West grew at only 0.05 per cent before the eighteenth century, jumping to 1 per cent in the nineteenth century and reaching about 2 per cent in the twentieth century (Maddison, 2001). Per capita income in Europe took 1,400 years to double before the eighteenth century, about 70 years in the nineteenth century, and 35 years thereafter.

A continuous stream of technological innovation is the basis for sustained growth in any economy.

Before the industrial revolution, technological innovations were generated mostly by the daily experiences of craftsmen and farmers. With the industrial revolution, experience-based innovation was increasingly replaced by field experimentation and, later, by science-based experiments conducted in laboratories (Lin, 1995; Landes, 1998). This shift accelerated the rate of technological innovation, contributing to dramatic income growth in the nineteenth and twentieth centuries (Kuznets, 1966).

The industrial revolution also transformed industrial, economic and social structures. Hitherto, every economy was agrarian. Industrialisation was accompanied by labour moving from agriculture to manufacturing and services. The manufacturing sector gradually moved from very labour-intensive industries to more capital-intensive heavy and high-tech industries. Finally, the service sector Insights Melbourne Business and Economics

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came to dominate. To exploit the potential unleashed by new technologies and industries, and to reduce transaction costs and spread risks, requires both innovations and improvements in an economy’s hard infrastructure, such as power and road networks, and its soft infrastructure – legal frameworks, financial institutions, and education systems (Lewis, 1954; Kuznets, 1966; North, 1981; Lin, 2011, 2012b).

China, which started its modernisation drive in 1949, has had the potential advantage of backwardness in its pursuit of technological innovation and structural transformation (Gerschenkron, 1962). In advanced high-income countries technological innovation and industrial upgrading require costly and risky investments in R&D, because technologies and industries are located on the global frontier. Moreover, the institutional innovation required to successfully commercialise new technologies and industries often proceeds in a costly trial-and-error, pathdependent, evolutionary process (Fei and Ranis, 1997). By contrast, a latecomer country can borrow technologies, industries and institutions from advanced countries at low risk and cost, and potentially grow at an annual rate several times that of high-income countries for decades before closing the income gap with those countries.

In the post–WWII period, 13 of the world’s economies achieved average annual growth rates of 7 per cent or above for 25 years or more. The Commission on Growth and Development finds that the first of five common features of these 13 economies is their ability to tap the potential of the advantage of backwardness – ‘they imported what the rest of the world knew and exported what it wanted’ (World Bank, 2008, p. 22).

From 1979, China adopted the opening-up strategy by importing what the rest of the world knows and exporting what the world wants. While in 1979 primary and processed primary goods accounted for more than 75 per cent of China’s exports, by 2009 the share of manufactured goods exceeded 95 per cent. China’s manufactured exports upgraded from simple toys, textiles and other cheap products in the 1980s and 1990s to 30

Demystifying the Chinese economy

high-value and technologically-sophisticated machinery and information and communication technology products in the 2000s. By exploiting the advantage of backwardness, China has emerged as the world’s workshop and achieved extraordinary economic growth by reducing the costs of innovation, industrial upgrading, and social and economic transformation.

Factors holding China back from growth pre-1979 Before 1979, China adopted the wrong development strategy. In pre-modern times China was the largest economy and among the most advanced, powerful countries in the world (Maddison, 2007). The first-generation revolutionary leaders in China, like many other Chinese social and political elites, were inspired by the dream of achieving rapid modernisation.

The lack of industrialisation – especially in the heavy industries that were the basis of military strength and economic power – was perceived as the root cause of the country’s backwardness. Thus it was natural for China’s elites to prioritise the development of heavy, advanced industries after the Revolution. In the nineteenth century, France, Germany, the US and other Western countries effectively pursued the same strategy, motivated by the contrast between the UK’s rising industrial power and the backwardness of their own industries (Gerschenkron, 1962; Chang, 2003).

From 1953, China adopted a series of ambitious Five-Year Plans to accelerate the building of modern advanced industries – with the goal of overtaking the UK in 10 years and catching up to the US in 15 years. In 1953, 83.5 per cent of its labour force was employed in the primary sector, and its per capita income was only 4.8 per cent of that of the US (Maddison, 2001). The country did not possess a comparative advantage in the modern advanced industries of high-income countries, and Chinese firms in these industries were not viable in open competitive markets.

To achieve its strategic goal, China needed to protect the priority industries by giving firms in those sectors monopolies and by subsidising

interest and exchange rates and input prices.

These price distortions created shortages, and the government was obliged to use administrative measures to mobilise and allocate resources directly to non-viable firms (Lin, 2009; Lin and Li, 2009).

These interventions enabled China to quickly establish modern advanced industries, test nuclear bombs in the 1960s, and launch satellites in the 1970s; but the resources were misallocated, the incentives were distorted, and the labour-intensive sectors in which China held a comparative advantage were repressed. Consequently, economic efficiency was low and growth before 1979 was driven mainly by an increase in inputs.

Where other transition economies fell down After WWII, other socialist countries and many developing countries and ex-colonies adopted development strategies similar to China’s. All had extremely low per capita income, high birth and death rates, low educational attainments, and very little infrastructure – and were heavily specialised in producing and exporting primary commodities while importing manufactured goods. Developing modern advanced industries was perceived as the

only way to achieve rapid economic takeoff, avoid dependence on Western industrial powers, and eliminate poverty (Prebisch, 1950).

It became a fad after the 1950s for developing countries in both the socialist and the non-socialist camps to adopt a development strategy oriented toward heavy industry and import substitution (Lal and Mynt, 1996). But the capital-intensive modern industries on their priority lists defied the comparative advantages determined by the endowment structures of their low-income agrarian economies. To implement their development strategies, many developing countries introduced distortions and government interventions like those in China. This strategy made it possible to establish some modern industries and achieve investment-led growth for one or two decades into the 1970s. Nevertheless, economic efficiency was unavoidably low. Stagnation and frequent social and economic crises began to beset most socialist and non-socialist developing countries by the 1970s and 1980s. Liberalisation from excessive state intervention became a trend in the 1980s and 1990s.

The academic and policy communities in the 1980s did not realise that those distortions came

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from second-best institutional arrangements, endogenous to the need to protect firms in the priority sectors. Without such protection, those firms would not have been viable.

Consequently, policymakers and academics recommended that socialist and other developing countries immediately remove all distortions by implementing simultaneous programs of liberalisation, privatisation and marketisation with the aim of quickly achieving efficient, firstbest outcomes.

But if those distortions were eliminated immediately, many non-viable firms in the priority sectors would collapse, causing a contraction of GDP, a surge in unemployment, and acute social disorders. Accordingly, many governments continued to subsidise and protect non-viable firms (Lin and Tan, 1999), leading to even poorer growth performance and stability in the 1980s and 1990s than in the 1960s and 1970s (Easterly, 2001).

During the transition process, the Chinese government first improved incentives and productivity by allowing workers in collective farms and state-owned enterprises to be residual claimants and to sell at market prices after delivering state quotas at fixed prices (Lin, 1992).

It also continued to protect non-viable firms in the priority sectors and simultaneously liberalised the entry of private enterprises, joint ventures and foreign direct investment in labour-intensive

sectors in which China had a comparative advantage but that were repressed before the transition. This transition strategy allowed China both to maintain stability by avoiding the collapse of old priority industries and to achieve dynamic growth by simultaneously pursuing its comparative advantage and tapping the advantage of backwardness in the industrial upgrading process. Further, the dynamic growth in the newly-liberalised sectors created the conditions for reforming the old priority sectors.

Through this gradual, dual-track approach China achieved ‘reform without losers’ (Lau, Qian and Roland, 2000; Lin, Cai and Li, 2003; Naughton, 1995) and moved steadily to a well-functioning market economy.

The cost of success In 1979, China was a relatively egalitarian society.

Subsequently, income distribution has become increasingly unequal. The Gini coefficient, measuring income inequality, increased from 0.31 in 1981 to 0.47 in 2008 (Ravallion and Chen, 2010). Meanwhile, household consumption dropped from about 50 per cent down to about 35 per cent of GDP, whereas fixed-asset investment increased from around 30 per cent to more than 45 per cent of GDP (see the left-hand panel of Figure 1), and net exports increased from almost nothing to a high of 8.8 per cent of GDP in 2007 (see righthand panel of Figure 1). Such disparities are the by-products of the dual-track approach to transition.

Figure 1: Contributions of household consumption, fixed asset formation and net exports to GDP 60

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Demystifying the Chinese economy

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During the transition process, the Chinese government retained some distortions to provide continuous support to non-viable firms in priority industries. Remaining distortions include the concentration of financial services in four large state-owned banks, negligible royalties on natural resources, and monopolies in major service industries including telecommunications, power and banking.

These distortions helped stabilise China’s transition process. They also contributed to the rising income disparity and other imbalances in the economy because only big companies and rich people have access to credit services provided by the big banks, and interest rates are artificially repressed, penalising poor depositors with no access to bank credit.

In general, the marginal propensity to consume decreases with income. Therefore, if wealth is disproportionately concentrated in higher-income groups, the nation’s consumption-to-GDP ratio will be lower and the savings ratio will be higher.

The concentration of wealth in large firms has a similar effect. A consequence is relatively high household savings and extraordinarily high corporate savings in China, as shown in Figure 2.

Figure 2: China’s corporate, household and government savings as percentage of GDP 60 Households

Non-financial business

Domestic financial sectors

High household and corporate savings in turn lead to high rates of investment and expansion of production capacity. A large trade surplus is a natural consequence of limited domestic absorption capacity. Therefore, it is imperative for China to address structural imbalances by removing remaining distortions in the finance, natural resources and service sectors so as to complete the transition to a well-functioning market economy. It will achieve this by: – Removing financial repression and allowing the development of small and local financing institutions, including local banks, to increase financial services, especially access to credit, to household farms as well as small- and mediumsize enterprises in the manufacturing and service sectors; – Removing the old retired-worker’s pension burden from the state-owned mining companies and levying appropriate royalties on natural resources; and – Encouraging competition in the telecommunications, power and financial sectors.

It is also timely for China to remove remaining distortions to complete the transition to a wellfunctioning market economy. Most firms in the old priority industries are now competitive in domestic and global markets.

Dynamic growth in China set to continue No country in human history has ever grown so fast for so long as China did in the past three decades. However, looking forward, China still has the potential, based on the advantage of backwardness, to grow at around 8 per cent annually for another 20 years. This is due to two reasons.

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Firstly, in 2008, China’s per capita income was 21 per cent of US per capita income measured in purchasing power parity. This gap indicates that there is still a large technological gap between China and the advanced economies. China can continue to enjoy the advantage of backwardness before closing the gap.

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Secondly, China’s current status relative to the US is similar to Japan’s in 1951, Singapore’s in 1967, Korea’s in 1977 and Taiwan, China’s in 1975. The annual growth rate of GDP reached 9.2 per cent in Japan during 1951-71, 8.6 per cent in Singapore during 1967-87, 7.6 per cent in Korea during 1977-97, and 8.3 per cent in Taiwan during 1975-95. China’s development strategy since 1979 is similar to that of Japan, Korea, Singapore and Taiwan. China has the potential to achieve another 20 years of 8 per cent growth.

After 20 years’ dynamic growth, Japan’s per capita income measured in purchasing power parity was 65.6 per cent of that of US in 1971; Singapore’s was 53.9 per cent in 1987; Korea’s was 50.2 per cent in 1997; and Taiwan’s was 54.2 per cent in 1995. If China maintains 8 per cent growth in the coming two decades, by 2030 its per capita income may reach about 50 per cent of the US’s.

Measured by purchasing power parity, China’s economic size may then be twice as large as the US; and measured by the current market exchange rates, China may be about the same size as the US. This potential from the advantage of backwardness, if realised, will enable China to achieve the eighteenth Congress of the Communist Party’s targets of doubling per capita GDP and household income over 2010/2020 and becoming a highincome country by 2049. But China also needs to become an innovator in its own right. In many sectors – such as consumer electronics – China has a comparative advantage. Other higherincome countries have graduated, or are close to graduating, from these sectors. To maintain leadership in these sectors, China will need to develop the technology and product innovation when it reaches the frontier.

Lessons of China’s development for other developing countries Every developing country has the opportunity to accelerate its growth if it knows how to develop its industries according to its comparative advantage at each level of development, and if it can tap the advantage of backwardness in its technological innovation and structural 34

Demystifying the Chinese economy

transformation. A well-functioning market is a precondition for developing an economy’s industries according to its comparative advantages.

Only then can relative prices reflect the relative scarcities of factors of production in the economy.

Such a well-functioning market naturally propels firms to enter industries consistent with the country’s comparative advantages. If a developing country follows its comparative advantage in technological and industrial development, it will be competitive in domestic and international markets. When the endowment structure is upgraded, the economy’s comparative advantage changes and its industrial structure and hard and soft infrastructures need to be upgraded accordingly. In the process it is desirable for the state to play a proactive, facilitating role by compensating for externalities created by pioneer firms in the process of upgrading. Through the appropriate functions of competitive markets and a proactive, facilitating state, a developing country can tap the potential of the advantage of backwardness and achieve dynamic growth (Lin 2011, 2012b).

Many developing countries, as a result of previous development strategies, have numerous existing firms that are non-viable in an open competitive market. In the reform process, developing countries should remove various distortions of incentives to improve productivity and at the same time adopt a dual-track approach, providing transitory protections to non-viable firms to maintain stability, but liberalising entry into sectors of comparative advantages. Such an approach can improve resource allocation and tap the advantage of backwardness. By adopting such an approach, other developing countries can also achieve stability and dynamic growth in their economic liberalisation processes.

Justin Yifu Lin was Chief Economist and Senior Vice-President of the World Bank during 2008-12. Previously he was Professor and Founding Director of the China Centre for Economic Research, Beijing University.

References Chang, H 2003, Kicking Away the Ladder: Development Strategy in Historical Perspective, London: Anthem Press.

Easterly, W 2001, The Elusive Quest for Growth: Economists’ Adventures and Misadventures in the Tropics, Cambridge, MA: MIT Press.

Fei, J & Ranis, G 1997, Growth and Development from an Evolutionary Perspective, Malden, MA: Blackwell.

Gerschenkron, A 1962, Economic Backwardness in Historical Perspective: A Book of Essays, Cambridge, MA: Belknap Press of Harvard University Press.

Kuznets, S 1966, Modern Economic Growth: Rate, Structure and Spread, New Haven, CT: Yale University Press.

Lal, D & Mynt, H 1996, The Political Economy of Poverty, Equity, and Growth: A Comparative Study, Oxford: Clarendon Press.

Landes, D 1998, The Wealth and Poverty of Nations: Why Some Are So Rich and Some So Poor, New York and London: Norton.

Lau, LJ, Qian, Y & Roland, G 2000, ‘Reform without losers: an interpretation of China’s dual-track approach to transition’, Journal of Political Economy, 108 (1): 120-43.

Lewis, WA 1954, ‘Economic development with unlimited supply of labour’, Manchester School of Economic and Social Studies, 22 (2): 139-91.

Lin, JY 1992, ‘Rural Reforms and Agricultural Growth in China’, American Economic Review, 82 (1): 34-51.

Lin, JY 1995, ‘The Needham puzzle: why the Industrial Revolution did not originate in China’, Economic Development and Cultural Change, 43 (2): 269-92.

Lin, JY 2009, Economic Development and Transition: Thought, Strategy, and Viability, Cambridge: Cambridge University Press.

Lin, JY 2011, ‘New structural economics:

a framework for rethinking development’, World Bank Research Observer, 26 (2), Sep 2011: 193-221.

Lin, JY 2012a, Demystifying the Chinese Economy, Cambridge: Cambridge University Press.

Lin, JY 2012b, The Quest for Prosperity: How Developing Economies Can Take Off, Princeton, NJ: Princeton University Press.

Lin, JY & Li, F 2009’ ‘Development strategy, viability, and economic distortions in developing countries’, Policy Research Working Paper 4906, World Bank, Washington, DC. Lin, JY & Tan, G 1999, ‘Policy burdens, accountability, and soft budget constraints’, American Economic Review, 89 (2): 426-31.

Lin, JY, Cai, F & Li, Z 2003, The China Miracle: Development Strategy and Economic Reform, Hong Kong SAR, China: Chinese University Press.

Maddison, A 2001, The World Economy: A Millennial Perspective, Paris: OECD Development Centre.

Maddison, A 2007, Chinese Economic Performance in the Long Run – Second Edition, Revised and Updated: 960-2030 AD, Paris: OECD Development Centre.

Naughton, B 1995, Growing Out of the Plan: Chinese Economic Reform, 1978-1993, New York: Cambridge University Press.

North, D 1981, Structure and Change in Economic History, New York: W.W. Norton.

Prebisch, R 1950, The Economic Development of Latin America and Its Principal Problems, New York: United Nations. Reprinted in Economic Bulletin for Latin America 7, no. 1 (1962): 1-22.

Ravallion, M & Chen, S 2007, ‘China’s (uneven) progress against poverty’, Journal of Development Economics, 82(1): 1-42.

World Bank (on behalf Commission on Growth and Development) 2008, The Growth Report: Strategies for Sustained Growth and Inclusive Development, Washington, DC: World Bank.

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Article heading here

monetary policy and the exchange rate at the end of the mining boom: two different views A report of proceedings of a Melbourne Institute forum by ross garnaut and peter jonson

A condensed version of a Melbourne Institute forum held at the University of Melbourne on 24 May 2013.

The two different views Ross Garnaut: Between the recession of 1990-91 and mid-2013, Australia enjoyed the longest period of economic expansion unbroken by recession of any developed country ever. Expansion in the 1990s was built on rapid increases in productivity, originating in the far-reaching reforms from 1983.

The next decade’s expansion was built at first on a housing and consumption boom funded by bank borrowing from international wholesale debt markets, and then on an unprecedented lift in the terms of trade, leading eventually to a resourceinvestment share of the economy that is unmatched since Federation.

The increase in the terms of trade and then resources investment was caused by China’s ‘catch-up’ economic growth, the strongest and longest such episode that the world has ever seen, using energy and metals more intensively than other countries had done. China completed the investment-led period of its economic growth around 2011, and entered a new period of transition to a modern economy which should see continued strong increases in output just 2 or 3 percentage points below the 10 per cent average of reform’s first 33 years, but probably with no growth in domestic use of thermal coal, and much slower growth in demand for metals and metallurgical coal (Cai, Garnaut and Song, 2013).

Through the first dozen years of the twenty-first century, Australian businesses and households became accustomed to easy increases in incomes, ever-lower taxation and rewards that bore no close relationship to effort or achievement. The increase in the real exchange rate over the past decade is of historic dimension.

Why Australia Prospered (McLean, 2012, p. 217) cites Adrian Pagan on the aftermath of the resources boom of the early 1970s: ‘...real exchange rate appreciation (1972 to 1974) was disastrous... (and)...quickly brought the long (postwar) boom to an end’. According to Reserve Bank of Australia (RBA) data, the real effective exchange rate rose by 16 per cent from June 1970 to its peak in September 1974, and was back to its 1970 levels by 1977. The real effective exchange rate rose by 69 per cent from December 2002 to its peak in March 2013. The Australian dollar has appreciated by large amounts in real terms even against other resource-rich developed countries: by 29 per cent against Canada and 33 per cent against Norway in March 2013 relative to 1983-2003.

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high. The real exchange rates of Australia and other developed countries should be depreciating against these countries at these times to maintain overall competitiveness.

The real exchange rate appreciation has caused the contributions to the economy of investment and exports in the trade-exposed industries outside the resources sector to fall sharply from the early twenty-first century, after vigorous expansion through the reform era to 2000.

Our external position is weaker now, after the China resources boom, than it was during and immediately after the Great Crash of 2008, so a substantial part of the growth henceforth must come from the tradables industries. While a smaller contraction of investment in resources would ease the adjustment, there is no realistic hope that reignition of a resources boom could substantially reduce the challenge that Australia faces.

Real exchange rate depreciation is the most influential path to slowing the decline in resources investment in the period ahead – as it is for expanding investment and exports in other tradeexposed industries.

Australia will, of course, experience historically strong growth in energy and metals export volumes following the resources investment boom. This will influence Australia’s capacity to sustain expenditure almost exclusively through the contribution to government revenue. The increased volumes are likely fully to compensate for price reductions in contributions to State royalties, which are mostly based on sales values.

Commonwealth revenue from the resources sector derives overwhelmingly from taxes based on profits or cash flows. For these Commonwealth sources of revenue, the accumulation of capital deductions and to a lesser extent interest deductions in the resource investment boom is likely to hold revenues below earlier peaks for many years, despite rising export volumes.

The recent fall in the foreign exchange value of the Australian dollar is merely the beginning and not the end of the adjustment that Australians must 38

make to the end of the long boom. What matters is the real exchange rate. A fall in the exchange rate raises average prices. This reduces living standards – the amount of goods and services that Australian incomes and expenditure support – unless there are corresponding increases in the productivity with which Australians use resources.

There will be pressures on government to compensate for the effects of the depreciation on other incomes and prices. If everyone is protected from the rise in import prices, a lower exchange rate generates inflation and no improvement in competiveness. The protection of incomes or profits or prices for some interests increases correspondingly the fall in real incomes that must be absorbed by others.

Higher productivity growth would lessen the required reduction in living standards, but productivity growth has natural speed limits.

Australia enjoyed total factor productivity growth around 2.5 per cent per annum for a period in the 1990s – about a percentage point higher than other developed countries. That is as good as it gets. It is unrealistic to think that the required improvement in competitiveness can come from productivity growth alone.

So there has to be downward adjustment in real incomes and expenditure as well as an increase in productivity and reduction in regulatory and monopolistic guarantees to prices and profits, all immensely difficult. It will only happen within a set of policies that are widely seen as equitable in their distribution of adjustment costs across the community.

Peter Jonson: I agree with practically everything that Ross says about economic policy and the grim prospects we are facing, but we differ about monetary policy. I’m going to say a bit about global monetary policy because the current approach is likely to end badly.

Whether we can avoid a serious recession depends on many things going right from here.

Government rhetoric aside, economic policy hasn’t done all that well in recent years. A vital bit of the jigsaw that’s been missing is what

Monetary policy and the exchange rate at the end of the mining boom: Two different views

Keating and Hawke then Howard and Costello did well – communicating with the people, not suddenly saying ‘we’re going to put things in your ceilings’ or ‘we’re going to spend money on schools’ out of the blue. It looked like they were saving us from recession at the time, but it set a very bad precedent.

Because we’ve had responsible monetary policy, and the rest of the developed world has had irresponsible monetary policy, our problems have been compounded with a high real-exchange rate.

This is partly due to a high nominal exchange rate and partly it’s that our costs have been rising faster than everyone else’s, making us very uncompetitive.

Australia is such a wealthy nation because we’ve got a lot of resources, both land and what we dig up from the land. We’ve been moderately well run. We’re free trade now, except when it comes to people. And, while we believe in free trade for agriculture most other countries do not. News of fruit trees being bulldozed because Coles and Woolworths can buy fruit from abroad more cheaply is extraordinary. How should any of us think that’s a good idea?

But if you try to control both the currency and the economy or inflation with monetary policy you’ll muck it up. While it perhaps (temporarily) suits the RBA to do both, except for short periods of time, you need some other way to control the exchange rate. So I get to the obvious and simple explanation – we can do what some others have done at some times, which is to have a way of directly influencing the exchange rate. The simplest and plainest way to do it is to have a tax on capital inflow.

Then there is the GFC. Arguably, free trade was overdone in the build-up to the crisis. I’ll always remember George Bush saying, in a hangdog way on global television, ‘I didn’t want to bail them out, but I’d been told there would be a great depression if I didn’t’. That illustrates what economists call moral hazard, and it isn’t free trade. What central bankers call ‘regulatory policy’ needs to be substantially reformed to temper the adverse effects of excessive free trade in finance.

With respect to ‘monetary policy’, practically every developed country now is operating with almost zero interest rates, buying bonds in order to keep long-term bond yields down. What will these countries that have utterly unsustainable monetary policies do to get back to normal? Even a hint that this will happen ‘sometime’ causes equity markets to slump, bond yields to spike and currencies to gyrate scarily.

In Australia, because the RBA is much more sensible, we have avoided getting to a ludicrous state with monetary policy. However, I am concerned that the latest cut in interest rates – which I don’t think was necessary or desirable – was the first sign of us saying ‘it’s too hard to stand out as a responsible central bank in this world’.

Now I know that the RBA wouldn’t admit it, but it’s interesting that after the latest cut the press said that this was to lower the exchange rate.

This offends the free trade fanatics. But we as a nation have said through a previous prime minister that we reserve the right to decide who comes here and on what terms. If we can take that view about people, what about capital inflow? Do we want all this money pouring in, raising the exchange rate and keeping it up?

Now free markets will eventually fix this. The dollar will go down, perhaps very low. I remember when it was under US$0.50. So the question I want to ask is: can it be helpful for key industries to grapple with a very high exchange rate for years at a time and then post-crisis to grapple with a very low exchange rate?

Another problem when the dollar falls a long way arises from the RBA’s famous inflation target.

Recently, non-traded goods inflation has been bumping along at 4–4.5 per cent. A high dollar, and a rising dollar has kept traded-goods inflation low, on average 1–2 per cent and ‘on target’ overall. Now if the dollar falls a long way, and if non-traded goods inflation stays at 4 per cent or rises (which it probably will), it will be impossible to achieve the 2–3 per cent target overall. No one is going to burn the whole economy to get 2–3 per cent inflation.

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So the RBA would be just as embarrassed as they were in my day when we had to abandon the ‘monetary projections’. British economist Charles Goodhart once proposed an economist’s version of Murphy’s Law: ‘whatever policy rule is relied upon will eventually fail’. The sooner the RBA begins to spell out its views about this matter, the more likely it will emerge with its reputation intact, even enhanced.

Further discussion John Freebairn (Department of Economics): I agree that export commodity prices will fall, but also that the several hundred billion dollars of investment will turn into large increases in the quantity of commodity exports which will offset at least in part, and possibly even more than offset, the fall in prices so that commodity export receipts fall only a little, or possibly rise, relative to current levels over the next few years.

Ross Garnaut: I wish that were so. That the external balance curve comes in because prices come down. But it also comes in because government revenue per unit of value comes down for quite a while. By the time this boom’s over we’ll have put several hundred billion dollars of extra capital into the resources sector, all to be depreciated or amortised for tax purposes over future periods.

There’s also a lot of extra debt on miners’ balance sheets and the interest is tax-deductable.

What the economy gets out of the export phase of the resources boom is not much more than government revenue. There’s some extra employment, but not much. Likewise with earnings and dividends paid or accruing to Australians. About three-quarters of the equity in the resource sector is owned abroad, even for companies headquartered here. It’s the tax component that we hold onto. If the substantial fall in prices were fully balanced by increased volumes we’d still be in negative territory because of the extra deductions from income tax going forward.

Also, through the resources boom, there’s been a blow-out of costs of all kinds. That’s actually rational when prices and margins are sky high; when you’ve got a very big margin on every ton you export, it takes management effort and risks to production to focus too much on costs.

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Now how much will commodity prices fall? I don’t know, but the falls could be very large.

Overwhelmingly, Chinese demand has driven the high prices. Since the GFC, some 90 per cent of the growth in iron ore and oil consumption globally, and more than 100 per cent of the growth in global consumption of some other metals, has been in China. Chinese demand stopped rising in 2012 for thermal coal and grew much more slowly for other commodities. Slower growth in demand for energy and metals will continue with the new model of Chinese growth. However, structural changes in the Chinese economy will affect some commodities more than others. Thermal coal has probably reached something like a peak in consumption.

Iron ore and coking coal will grow only slowly.

Natural gas demand will grow more quickly – China is trying to substitute gas for coal because of lower emissions and reduced environmental impact. Worldwide, in all of these commodities, big expansions in supply are occurring: iron ore in Brazil and West Africa; and coal in Indonesia and Mozambique, often supplied by the same companies that produce coal here.

In natural gas, the story’s more complex but not more reassuring. Demand will grow strongly from a very low base. But China itself is trying to apply the new technologies to extract unconventional coal-seam and shale-gas. It does seem to have geologically prospective areas. So there’s a reasonable chance of major new supplies from China. We are the largest supplier in the seaborne market to Northeast Asia. But recently there’s been a big expansion of land-based transport pipelines from Central Asia into China and the two presidents of China and Russia have just discussed a pipeline from Russia into China.

Then there’s the US gas revolution. The US and Australia have both had very large increases in gas reserves through unconventional technologies, although they have adopted opposite approaches to their development. The US effectively banned exports, whereas we encouraged them. So Australian east-coast gas prices are in the process of rising by a couple of hundred per cent as exports expand whereas in the US, domestic gas prices

Monetary policy and the exchange rate at the end of the mining boom: Two different views

have collapsed, encouraging the replacement of coal by gas. US industries that use the gas want those low prices to continue, but even if the US does not open up the export market enough to raise the domestic price and increase supplies into East Asia, there’s no way of stopping low US prices eventually coming out through the pipelines into Canada and Mexico. So the gas that used to go from Canada to the US will end up in Japan and China via British Columbia.

In today’s globalised world, it’s not sustainable to have very low prices for American gas and very high prices for East Asian and Australian gas. They will converge over time. That’s a big reduction in Australia’s terms of trade. While we are shaking off the excess capacity in iron ore, coking coal and, especially, thermal coal, prices might be very low

for a while, low enough to force a lot of capacity – either new or old – to close. So terms of trade will be lower. It’s possible that they could go a long way back towards the old prices at least for a while. Hence my pessimism about export-stage income at least for a while.

Ken Atchison (Atchison Consultants): Peter, competitive devaluation is the story of markets and countries at the present time, plus zero interest rates.

How can Australia reduce its exchange rate in an environment where the world is in competitive devaluation?

Peter Jonson: We can do two things. We can join the world game by getting close to zero interest rates, or we can do something directly to get the exchange rate down. That’s Milton Friedman’s

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point really – you’ve got to do something different because monetary policy ought to be about low inflation and economic stability and that’s what it can contribute to best. You’ve got to get something else to handle the currency problem. Ross’s point is that there is a conventional model in which you can do both of those together at this point in the cycle. But I feel that it’s too complicated for us in the longer run.

Michael Foley: In relation to the mineral resource rent tax (RRT), I believe that the government’s future estimates are over-estimates because they’re missing out on the huge depreciation deductions. As to cash flows, although the companies will pay very little tax, and have low reported profits and retained earnings, in an accounting sense, their cash flows will be quite significant. Now, this comes back to the arcane world of current account deficit accounting processes whereby foreign companies are deemed to have capital outflows even though the cash actually remains within the country. Large multi-nationals often reinvest back in countries in which their proceeds originate, so there might not be any real financial flows.

Ross Garnaut: With the RRT, if you take literally the statements made about the postArgus version of the tax – that companies will be able to depreciate the whole of market values of established businesses – by definition you’ve protected the untaxed rents. So you should collect no tax, except perhaps for gas which won’t experience over-capacity and therefore low prices.

On the balance of payments dimensions of the resources investment boom, one thing that’s made it relatively easier for us to fund continuing current account deficits has been, as you say, retained earnings. There’s capital inflow to offset the current account deficit which means that our banks haven’t had to go to the wholesale markets internationally to the extent that they otherwise would have. A point of great vulnerability leading up to the GFC was that our current account deficit was being funded mainly by the banks going to wholesale markets; come the GFC they couldn’t roll-over their debts.

The Australian Government fortunately in an afternoon did something I never expected – putting 42

on the balance sheet of the Australian nation nearly $180 billion of contingent liabilities, guaranteeing the banks their overseas debts. The banks would have gone down otherwise. It was an extraordinary thing to do, but it would have been worse not to do it. Well, it’s harder now to take on the proportions of overseas debt into the banks that we were accumulating then. Banks themselves have become more cautious. International markets have become more cautious. The Australian regulator, APRA, is more cautious.

We’ve been able to fund what’s not a tiny current account deficit by global standards, relatively easily, partly because a big chunk of that has been coming through the retained earnings of the resource companies. Once you get into the production phase the depreciation allowances will start going back out as repayment of debts, capital repatriations or dividends if we don’t have new projects to invest in. Consequently, any balance of payments current-account deficit will be more difficult to finance than in earlier times.

John Spark: We hear a lot about our internal debt compared with other countries, but we hear very little about our foreign debt. There was a Spooner cartoon in the Age last week warning Tony Abbott that he’s going to inherit a $1.5 trillion overseas debt. This seems to be going up all the time. It must be a very high percentage of our GDP compared with other countries. How serious is this situation and what should be done about it?

Peter Jonson: Don Argus wrote a long paper on this topic. To get that number he aggregated government debt, household debt and business debt. We can handle that debt if all goes well.

That’s the whole idea – you get better returns if you borrow a lot and spend. That’s terrific while everything goes up. It’s when it goes down that you run into a problem. If we have a period of major downward adjustment, Ross’s analysis implies that living standards will fall. How many Australians expect living standards on average to fall? I don’t know, but debt will be harder to fund.

What I’m really encouraged by is that households and businesses have started to pay off their debt.

Every month just before the RBA meets, everyone

Monetary policy and the exchange rate at the end of the mining boom: Two different views

says, ‘there’s no consumption; the poor retailers; we should cut interest rates again’, so that people will spend rather than save. We should all be cheering the fact that people are saving after 30 years of not saving, because that is the answer in the end.

Ross Garnaut: Australia’s net debt is about 50 per cent of a GDP of about $1.5 trillion. Nearly all of that is private – mostly business – net debt.

While it might be above average for a developed country, it’s not off the scale. Does it matter? It’s going to be one more thing making life harder if and when we get normalisation of international monetary policy and international finance.

Currently, riskless borrowers can borrow in US dollars at less than 2 per cent over 10 years. BHPBilliton would be issuing bonds in the US at not much more than that. For a while the US Treasury has been issuing 10-year bonds at 1.5–1.75 per cent. Well, look at long-term history and it’s 4–6 per cent, sometimes much higher.

With the end of these extraordinary circumstances in international monetary policy – the end of quantitative easing and the normalisation of interest rates – then it would be amazing if we didn’t get large increases in global interest rates, for example, with 10-year debt priced at least 2 per cent and maybe 4 or 5 per cent higher than it is now. If we add 4 per cent of average interest to half a GDP of debt – three quarters of a trillion – we’d be adding 2 per cent of GDP to annual debt-servicing costs and therefore to the current account deficit. That’s just one more thing that could make life harder a few years out.

Jim Minifie (Grattan Institute): If I were to adopt a Panglossian perspective, I’d say that the trade balance is approximately zero and the current account deficit is half what it was in the mid-2000s.

Obviously, the capital inflows are smaller than they were during the period when banks were expanding their balance sheets. So I don’t see much evidence that hot money is driving up the exchange rate. Also, crosscountry evidence shows that net exports actually jump back within two or three years from big changes in the real exchange-rate. So while I thought Ross’s quote in the press about not being able to fatten the pig on

market days is perfectly true, maybe you can fatten it the day before rather than the season before.

Ross Garnaut: The day before is now. The hard thing is to get a big real depreciation. The currency will fall a lot one day, but if we have not started to make a big adjustment in advance of that, there will be one massive job preparing Australians for the big downward adjustment in real expenditure and real incomes that’s necessary to turn it into a real depreciation. The period of fattening the pig – when a pig is universities exporting education services or hotels in Queensland increasing their capacity to take in more tourists – is lots of years.

That’s why I think that if we left the adjustment until the markets heap it upon us anyway, we are guaranteeing deep recession and high unemployment.

Peter Jonson: I’d just endorse that. The numbers you quote look a little bit better than they have been, but it’s at the end of a massive boom. Sadly, we’ve wasted a lot of that.

Ross Garnaut AO was Australian Ambassador to China during 1985–88. He is currently Vice-Chancellor’s Fellow and Professorial Fellow in Economics at the University of Melbourne.

A sometime senior economist with the Reserve Bank of Australia, Peter Jonson’s current board appointments include Village Roadshow Ltd and Paranta Biosciences Ltd (Chair). Previous board positions include Bionomics Ltd (chair), ANZ Funds Management (chair) and Melbourne Institute Advisory Board (Chair).

References Cai, F, Garnaut, R & Song, L (forthcoming 2013), ‘The new Chinese growth model’, in Cai, F, Garnaut, R & Song, L (eds), The New Chinese Growth Model, Canberra: ANU E-Press.

McLean, I 2012, Why Australia Prospered: The Shifting Sources of Economic Growth, Princeton, NJ: Princeton University Press.

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Article heading here

reflections on and lessons from a career as an economist A solid grounding in economic theory is essential to provide a coherent, systematic way of thinking about how an economy works, how it responds to shocks, and how policy-makers are likely to think about responding to those shocks. by saul eslake

An edited version of the inaugural Neville Norman Lecture given at the University of Melbourne on 16th April 2013.

I came to the study of economics by a ‘process of elimination’. Before I left school I had already decided that I didn’t want to do what kids who had done reasonably well at school were ‘supposed’ to end up doing, like law or medicine. Nor did I want to study anything that meant leaving Tasmania (aged 17) for that purpose – which excluded dentistry, veterinary science and (perhaps ironically) forestry.

Ultimately, it came down to a choice between engineering and commerce. Lacking the mathematical proficiency to get into engineering, I enrolled in first-year commerce, assuming that I would emerge in three years’ time qualified to be an accountant. However, I soon discovered that economics was much more interesting than accounting – so I elected to do an economics major, even though I wasn’t entirely sure what economists actually did.

Entering the workforce What would I actually do with this degree?

This issue was solved when I obtained a Treasury cadetship at the end of third year – which meant that I would get paid a modest stipend during my honours year. The downside was that the job

was in Canberra, but given that I had written my honours dissertation on the subject of teenage unemployment, which had only begun to emerge as a significant policy concern in the mid-1970s, I took the view that ‘beggars can’t be choosers’.

I began my career in the Commonwealth Treasury during what has since become known as the ‘Stone Age’ – not because it was that long ago (although 34 years seems long enough!), but rather because the Treasury Secretary at the time was the formidable John Stone.

Although Treasury was then at the height of its bureaucratic power – well before the Reserve Bank gained the independence which it now enjoys – I didn’t especially enjoy my time there.

As a newly recruited graduate, I was expected to ‘serve my time’ proof-reading draft publications, checking more-senior officers’ arithmetic, and drafting answers to letters from members of the public who were naïve enough to think that their letters complaining about the level of the age pension, the price of petrol, or the way that (in their words, sadly) the Jews were manipulating the international monetary system, received the Treasurer’s personal attention.

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In retrospect, however, I did acquire some other skills and experiences which turned out to be useful later in my career, namely:

overseas. However, I left Canberra in order to fulfill what was then a very strong desire to return to Tasmania.

– The ability to read upside down. This developed from the number of times I would be called into some more-senior person’s office to be given some tedious task, but would observe a document marked ‘top secret’ on his desk, which naturally prompted my interest about its contents;

While I enjoyed the work I did in Tasmania at the Advisory Council for Intergovernment Relations, which was established in Hobart by the Fraser Government but abolished by the Hawke Government, I realised that I ultimately had to choose between living where I wanted to live, and pursuing a career that was intellectually challenging and reasonably financially lucrative – neither of which was going to occur in Tasmania.

In early 1983 I accepted an offer from Jeff Kennett, who had just been elected, rather to his surprise, as Leader of the Opposition in Victoria, to become his economic advisor.

– An appreciation of the importance of checking and rechecking work that was to be published for arithmetic accuracy, spelling and grammatical correctness, for ease of reading, and for substance; – An understanding of how economic policy is actually formulated and implemented, and the pressures under which economic policy decisions are made (including the intersections and trade-offs between economic objectives and political considerations – something you don’t generally get from university economics courses); – A capacity to write and speak about economics for and to people who aren’t trained economists – something which you certainly don’t acquire from university economics courses; and – A range of connections with people who in a variety of ways have been helpful at different moments of my career.

For all but the first of these reasons, I unfailingly recommend to economics students that if they want to pursue a career like mine, they should seek to begin it at one of the nation’s key policymaking institutions such as Treasury or the Reserve Bank.

There are times when I think it would have been sensible to have stayed at Treasury for longer than two-and-a-half years – especially when I think about the one genuine regret I have about my life, which is that I have never, as an adult, lived or worked overseas. At Treasury there are opportunities for overseas postings to Paris, Washington and more; and for postgraduate study 46

Reflections on and lessons from a career as an economist

After I had been working for Jeff Kennett for a little over a year, I ran into someone whom I had met during my time in Treasury, who was an early example of former Treasury economists finding jobs as economists in what were then Australia’s newly-deregulated financial markets. I became the junior member of a two-person economics team at Chase-NBA, a joint venture investment banking operation between Chase Manhattan Bank and the National Australia Bank.

Two years later I became chief economist at stockbrokers McIntosh Hamson Hoare Govett (later McIntosh Securities Ltd), leaving in 1991 to enter the ‘buy side’ of the investment industry as chief economist (international) at National Mutual Funds Management (which was later taken over

by AXA, and then by AMP).

A bank economist In 1995 came an offer to join ANZ as their chief economist – a role which I had aspired to since my very first day in Melbourne almost 13 years earlier, when I attended a seminar at which one of the guest speakers was the then chief economist of ANZ, Alister Maitland. ANZ was particularly attractive to me because of its Melbourne base and unique Asian franchise.

At that time, ANZ differed from the other three major banks in that it saw the chief economist’s

role as being a ‘stepping stone’ for people to come out of Treasury or the Reserve Bank with a view to forging careers as senior bank executives. When I commenced in that role in August 1995, five of my predecessors were still there in various other senior positions.

By contrast, I never had any desire to be anything other than an economist. I often remarked that being chief economist at one of the four major banks was a bit like making partner in a law or accounting firm – that if you hadn’t made it by the time you were 40, you probably never would; but that once you had, that’s what you did for the rest of your career.

However, the fact that I had no desire for any role at ANZ other than that of chief economist sometimes complicated my relationships with more-senior people. One of the nine different bosses I had in my 14 years there was someone who had previously been a chief economist himself, and who had subsequently gone on to very senior positions within the Bank. A source of frustration for both of us was that, whereas one of his proudest boasts was that, as chief economist, he had reduced the number of people working in the economics department, I would always ‘push back’, saying that I had not the least desire to prove my suitability for more senior (and better paid) jobs by showing how enthusiastic I was about terminating other people’s employment. I had similar conversations with most of my other bosses.

That said, I acknowledge the prerogative of employers to manage their businesses, including by adjusting the number of people they have on their payrolls. Nor am I necessarily advocating that others should take the same view of their careers as I have done. It is perfectly legitimate for someone with an economics degree to strive towards a career that takes them into senior management roles – roles that don’t call for any particular training or expertise in economics.

In fact, the branch of the economic profession in which I have spent most of my career is a declining one, notwithstanding the comparatively greater

prominence which financial-market economists enjoy in the media and the relatively higher salaries they command than economists working in other areas. There are three reasons for this: – Very few organisations other than financial institutions nowadays employ economists to undertake the kind of tasks that economists in financial institutions typically undertake – that is, analysing and interpreting major ‘macro’ variables such as GDP growth, inflation and employment, or financial variables such as interest rates and exchange rates, and forecasting or interpreting major economic policy decisions such as the annual Budget or the monthly meetings of the Reserve Bank Board; – With consolidations and mergers among financial-market participants, there are fewer organisations in the financial-services sector that employ economists; and – Advances in computing and information technology mean that organisations don’t need to employ as many economists to achieve the same level of understanding of the economic environment and financial markets as previously.

These trends have been more readily apparent in Melbourne than in Sydney. Once, there were almost as many jobs for macro-economists in Melbourne as there were in Sydney. Most of Australia’s leading private-sector macro-economists now live and work in Sydney.

One of the aspects of my career from which I’ve derived enormous personal satisfaction is that I have been able to interpret my ‘brief’ as a macroeconomist fairly broadly. That is, I have been able to think, write and speak about a broader range of issues than simply what next week’s unemployment figure might be, whether the Reserve Bank will raise or lower interest rates, or what the value of the Australian dollar might be at the end of the year – important though such things are to the businesses for which I’ve worked, and to their clients and customers.

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which I work, its customers and, to the extent possible, the broader community understand the environment in which they operate, and thus to make better-informed business and investment decisions. These should at least make some people better off than they otherwise would have been, hopefully without making anyone worse off.

In interpreting my role in that way, I’ve been motivated by the thoughts of some of the giants of the economics profession. I didn’t read Maynard Keynes’ General Theory until some three years after I’d graduated, and have always thought that his (1936: 383-4) assertion that ‘the world is ruled by little else’ than ‘the ideas of economists, both when they are right and when they are wrong’ is an exaggeration, both when he made it and since.

However, I do think there is rather more truth in another Keynes homily – that ‘the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas’ and that ‘soon(er) or late(r), it is ideas, not vested interests, which are dangerous for good or evil’.

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In the same spirit, I’ve taken to heart James Tobin’s (1981) declaration that the study of economics ‘offered the hope, as it still does, that improved understanding could better the lot of mankind’. That’s a perspective that these days too few economists seek to defend. More commonly, economics is derided as ‘the dismal science’, in the words of the nineteenth century Scottish writer Thomas Carlyle. Too few economists appreciate that Carlyle directed this criticism at economists like John Stuart Mill because of their opposition to slavery, the abolition of which he (Carlyle) deeply regretted.

This perspective of economists as upholders of freedom has been eloquently elaborated in our era by another Nobel Prize winning economist, Armatya Sen (1999, 285), who argued that the focus of economists should not be on ‘GNP or technical progress or industrialization’, but rather on ‘our capability to lead the kind of lives we have reason to value’. Sen’s thinking has been a major influence on the ‘well-being framework’ which the Australian Treasury has developed to guide its work.

Finally, Paul Krugman (2000) wrote, ‘economists may make lots of bad predictions, but they do have a method – a systematic way of thinking about the world that is more true than not, that gives them genuine if imperfect expertise. That is also why lay commentators and other social scientists tend to hate them’.

I’ve certainly made plenty of bad forecasts myself, but I’ve never regarded forecasting as the most important thing that I do, and I have always tried to encourage people who make use of my work to treat my forecasts, and those of others, with a very healthy degree of caution and scepticism.

Building a successful career in economics I want to conclude by offering a few thoughts about what it takes to build a successful career in the particular field of economics where I have pursued mine. Hopefully you will find them helpful in thinking about your own careers.

First, you need a solid grounding in economic theory, not because you will be talking or writing about economic theory every day, but rather because you will need a coherent, systematic way of thinking about how an economy works, how it responds to shocks, and how policy-makers are likely to think about responding to those shocks – which is what economic theory gives you.

While I have an enormous amount of respect for the work that’s required to earn a PhD (which I don’t possess), I don’t believe you need a PhD to acquire that grounding, although I suspect you do need the equivalent of at least four years’ study at university level. You should also be aware of the weaknesses and flaws of the theories that you use, particularly the extent to which the assumptions they are based on depart from reality (as they all do to at least some degree).

Second, you should understand quantitative methods at least to the extent that you can tell when someone is trying to pull the wool over your eyes with fancy econometrics; and you probably need to be able to do at least a simple OLS regression on an

excel spreadsheet without needing the assistance of someone fresh out of university.

Third, you need to be intimately familiar with the data – where it comes from; how it’s collected; what the quirks of particular data series are; whether they lead, lag or are roughly coincident with the broader business cycle; how volatile or prone to revision they are; and their importance as deemed by financial market participants and policy-makers. In my experience, this is something you learn ‘on the job’.

Fourth, you have to understand how policy-makers think and react to economic shocks and other developments. A very large part of a financialmarket economist’s job is to predict how policymakers will respond to changes in the economic environment, and to explain the likely impact of the decisions which governments and central banks make. That’s one reason why the Reserve Bank or Treasury are very good places to start your career if you’re aiming to become a financialmarkets economist.

Fifth, it’s important to have some understanding of the political process, and the constraints under which policy-makers operate. Fiscal policy decisions are unavoidably political in nature – and even monetary policy decisions, although these days formulated and implemented by an ‘independent’ central bank, nonetheless often have political dimensions.

Sixth, it’s extremely helpful to have some grasp of economic history: a knowledge of what happened in previous economic cycles, what policy-makers got right or wrong, what lessons they drew from those experiences, what warnings showed that major turning points were imminent, and in what ways current circumstances are different from earlier episodes. Regrettably, economic history is less widely taught in university economics courses now than it once was, and much of what you need to know, you will have to acquire through your own reading.

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financial system. Once, that meant being familiar with what was happening in the US economy and having at least a passing understanding of developments in Japan. Latterly, it hasn’t been necessary to know much about Japan (although Japan may be coming into focus again), but for at least the past 10 years, it’s been essential to have a well-informed view about China, and it will probably become increasingly important to know something about India as well. It’s also been rather useful to be able to write and speak knowledgeably about economic developments in Europe during the last four years or so.

Eighth, you need to come to terms with the fact that from time to time you are going to be wrong about something. You need to establish your own ‘mechanisms’ for recognising when you are wrong; for acknowledging to your employers, your colleagues and your clients or customers that you have been wrong; and for learning from those mistakes so that they don’t recur. Even if you are right more often than you’re wrong, you need to accept that people will have a clearer recollection

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of when you were wrong than when you were right, and will be more than happy to remind you of those occasions. If you can’t deal with that, you need to consider a different career.

Ninth, you need to be able to speak and write about economics to and for people who are not themselves trained economists. To reiterate, this is not a skill that universities are particularly good at imparting – whereas, by contrast, Australia’s major policy-making institutions are quite adept at it, which is another good reason to start your career there if you want to end up as a financialmarkets economist.

The key point is that the people who will be paying you aren’t, in most cases, going to be interested in pages of incomprehensible equations; they aren’t going to be impressed by the number of references you make to the academic literature or the length of your bibliography; and they’re not going to want to hear about the caveats that you might want to put around your conclusions in an academic paper.

They’re going to want to know things like: are interest rates going to go up or down, and when; should we be hedging against a possible depreciation of the Australian dollar; what should we do if the government implements the changes to the tax treatment of superannuation that were discussed in this morning’s newspaper; won’t all this massive printing of money by the US Federal Reserve or the Bank of Japan eventually lead to hyper-inflation, and how can we protect against that – and so on. Unless you can relate your forecasts to actionable conclusions or recommendations, you won’t have earned what your employer pays you.

Harrod, R 1951, The Life of John Maynard Keynes, Macmillan, London.

Finally, and perhaps most importantly, you have to believe in the value of what you’re doing. As economists we don’t save people’s lives, don’t fight for justice, don’t invent new devices or discover new technologies that free people from drudgery; and don’t leave things that future generations will look at, listen to or admire. But we do try to improve people’s lives by helping them to better understand the environment in which they make important decisions for themselves and their businesses. We also, occasionally, advocate for better economic policies that will in turn make for a more prosperous and/or fairer society. I think they are worthy things to be doing with one’s life. I hope at least some of you will also find it a satisfying and rewarding vocation.

Moggridge, D 1992, Maynard Keynes: An Economist’s Biography, Routledge, London.

Saul Eslake is chief economist, Bank of America-Merrill Lynch Australia.1

Kelly, CR (‘Bert’) 1978, One More Nail, Brolga Books, Adelaide.

Keynes, JM 1936, The General Theory of Employment, Interest and Money, MacMillan, London.

Keynes, JM 1931, ‘The Future’, Essays in Persuasion, Macmillan, London, Ch 5.

Krugman, P 2000, ‘Why I Am an Economist (Sigh) – Notes During Textbook Revision’, at http://web.mit.edu/krugman/www/Serfdom.htm.

Sen, A 1999, Development as Freedom, Oxford University Press, Oxford.

Skidelsky, R 1983, John Maynard Keynes: Hopes Betrayed, Macmillan, London.

Skidelsky, R 1992, John Maynard Keynes: The Economist as Saviour, Macmillan, London.

Skidelsky, R 2000, John Maynard Keynes: Fighting for Britain, Macmillan, London.

Stevens, G 2011, ‘On the Use of Forecasts’, Address to the Australian Business Economists Annual Dinner, Sydney, 24 November, available at http://www.rba.gov.au/publications/ bulletin/2011/dec/pdf/bu-1211-10.pdf.

Tobin, J 1981, ‘Autobiography’, at www.nobel. se/economics/laureates/1981/tobin-autobio.html.

1 The opinions expressed in this Oration are entirely those of the author, and do not necessarily represent those of his employer or any of its other associated entities.

References Boyce, J 2011, The Founding of Melbourne and the Conquest of Australia, Black Inc., Melbourne.

Coleman, W, Cornish, S and Hagger, A 2006, Giblin’s Platoon: The Trials and Triumphs of the Economist in Australian Public Life, ANU E-Press, Canberra.

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Article heading here

the role of collateral in global finance Collateral is not only an artefact of national law, it’s also a way of getting around it. by annelise riles

A condensed version of a public lecture given at the University of Melbourne on 28 May 2013. The author thanks Eudes Lopes for his substantial edits on an earlier draft of this essay.

Let me first take you back to 2008 when the financial crisis in the US got going. On 18 September of that year, insurance company American International Group (AIG) was in deep trouble. It had a London subsidiary that was engaged in over-the-counter swap transactions.

The way this works in stock markets is that the parties protect themselves against the risk of default from the other party during the time of the swap by posting collateral with each other. If the notional value of the swap is, say, $1 million, the collateral to be posted will also be $1 million.

If prior to the fruition of the swap one side goes belly up, the other is still protected because it can keep the collateral.

Goldman Sachs said this to AIG: ‘We think you’re under-collateralised. Your positions are not as good as you say they are and therefore post more collateral please.’ This is called a collateral call or margin call.

Once everyone hears of this, what do they do? They also make collateral calls, because if Goldman Sachs thinks that AIG is undervalued with them then they must be undervalued with us too. So AIG pays out more, which means its credit rating goes down because it has fewer assets, which in turn leads to more collateral calls. Within 24 hours, AIG is in massive trouble. Ultimately, US taxpayers were on the hook to the tune of $130 billion.

What’s interesting about this story is this little device, collateral, or collateral calls. As a lawyer and law professor, I’ve been taught, and I teach my students, that when money is on the table there is always a legal argument to be made about the fact that contracts are unenforceable. What’s really puzzling about the AIG story from the standpoint of the critical law world is that although there was a lot of debate about the financial valuation of these transactions and what kind of collateral to put on the table, there was no debate about the legal obligation to post collateral and the enforceability of the deal. So even though you would think that both AIG immediately, and the US government later, would have had a very large stake in asking, ‘Wait a minute, do we really owe this money, and why do we owe this money? And is this contract really enforceable in the first place? What law is it governed by? Is it governed by London law because the transactions happened in London, or New York law, and is it really legal in London?’

Turns out, no one in the legal department of AIG asked those questions. They simply asked ‘How much were those portfolios worth?’

Next came grumbling in the US press about paying $130 billion of taxpayers’ funds to bail out AIG to make these payments to counterparties, most of which were in Europe. Lawrence Summers, Obama’s Director of the National Economic Insights Melbourne Business and Economics

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Council, came out and said, ‘We are a country of laws, not of men.’ So there’s this argument about the rule of law as being fundamental to who we are and the obligation on us to meet our obligations under law. But what is meant by ‘a country of law’? What law? What law and what obligation?

None of that fancy legal debate that you might have expected occurred. Why not?

This story is a good example of what is at the heart of my book, which is the legitimacy of collateral, and collateral as a sign of a kind of political legitimacy. Gramsci tells us that hegemony is when something is incontestable. Perhaps collateral is a kind of hegemony in that sense. It’s something that nobody thinks to even fight about or ask, ‘Why is it like this’?

Collateral As a legal device, collateral is just a little humdrum legal technology, something that finance lawyers play with all the time. It’s an artefact of all kinds of national law – bankruptcy law, securities law, plain old contract law – but it’s also conceived of in the market as a device for running an end-game around national laws. You collateralise transactions to avoid going to a bankruptcy court and claiming the other side went bankrupt and now you need to be paid along with all those other national creditors. You don’t want to do that. It’s expensive.

You don’t trust the courts. It’s better to just have collateral in your pocket that you can keep if you have to. So collateral is not only an artefact of national law, it’s also a way of getting around it.

The title to my book Collateral Knowledge has a double meaning. One is of collateral as a particular tool of law in the market; the other is a sense of collateral as something on the sidelines. Crucially, the law itself is extremely integral to markets in a way that hasn’t always been taken into account in economic and financial theories of markets. Law exists on the sidelines as a kind of collateral.

Legal governance in the global financial markets?

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The role of collateral in global finance

by legislators, perhaps enforced by administrative agencies. But to market participants, market regulation often means private, technical stuff to which they’re actually very committed, and which has a great deal of legitimacy in the market. So when we think about market governance we should also be thinking about all of this ‘technical stuff’. In fact many of the state laws that we normally think of are actually ways of influencing or moving this technical stuff which we don’t know very much about.

I started this research back in 1997-98 when Alan Greenspan chaired the Federal Reserve. Then, markets were imagined as totally self-functioning.

Greenspan’s position was that the state should stay out of markets completely. Any self-correcting regulation was entirely superfluous. In law schools our students were abandoning the law, trying to become traders. They didn’t want to be lawyers because there seemed to be no point to law because law is unnecessary if markets are self-correcting.

There was a sense in legal scholarship that all you could do was show that markets were self-correcting and that the law inhibited efficient allocation of whatever you wanted to allocate. American freemarket ideology was being exported worldwide as the solution to everybody’s problems. So again, this was very much an orthodoxy – a hegemony.

One of the strengths of anthropologists is that we’re very interested in orthodoxies. Just as an anthropologist around at the time of the pyramids would ask, ‘Why did they build those funny shaped triangular things?’ If you lived in the time of Alan Greenspan you’d say how interesting, everyone believes this. Why? How does that come to be the accepted position among others? It struck me as something interesting to study: how did this come to be so totally taken for granted?

At that time there were, of course, some theoretical critiques of this kind of neo-liberal position, but they were mostly materialist in orientation and seemed thin, unconvincing and deterministic.

What about all the messy, fuzzy stuff in between?

Is it all just reducible to material interest or

is there something else to be said. My neocon colleagues said, ‘You really should read Hayek because he can explain to you why we believe this.’

I read Hayek and thought, ‘He is really smart; it’s a very interesting, sophisticated text about the problems with state regulation.’

For those of us who thought of Hayek’s philosophy as an orthodoxy that had to be explained, there was a real need to respond to Hayek’s argument that regulation is always one step behind the market. Ultimately, I spent 10 years studying financial markets. I didn’t go looking for law – I was interested in the ideology of free markets and the problems with state regulation. I started out wanting to study traders, finance people and finance professors, and took a long time to get access. But over time the real surprise for me was the discovery of how much law and how many different kinds of lawyers work in this finance world.

So my book is really about what is unique about legal knowledge, expertise and reasoning. What is its role in markets and what are the dangers with it? What are the promises we might associate with it? How does our sense of the rule of law in markets shape our theories of questions like, ‘What is a market’? My answer, simply put, is that what is unique about law is this assemblage of things that get glossed over by lawyers as ‘technical stuff’.

If you asked a lawyer why you had to stick with that contract with AIG, they’d say there’s a bunch of technical stuff. What do they mean by that?

That’s the main subject of my book.

Anthropology and ‘technical stuff’ in financial markets In anthropology, unlike survey research, the focus is on deep and wide net analyses over long periods of time rather than on narrow and thin takes.

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It employs very open-ended questions; it’s qualitative, interpretive and not so quantitative. It’s very much informed by social and critical theory.

Obviously, this differs from the way markets are usually studied. Initially, it was hard to convince people that markets could be studied in this way because when I started this wasn’t really done.

Now the anthropology and sociology of finance is a vibrant field.

The book is based on a series of case studies that I did over a 10-year period of different technologies and different projects that were animating the passions of people in the financial markets in Japan. I’m only going to talk about the first of these – collateral – but there were many others, including the reform of the secure transactions laws, and questions about the legality of ‘netting’.

Returning to collateral, what would an anthropologist who goes into a trading room looking for collateral observe? Normally, you

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see traders at their desks, trading. Then, in the corners, at the fringes, you see some other desks piled high with paper documents. The most common document is the International Swaps and Derivatives Association master agreement – a contract that must be signed before a trade can be completed in the market. It’s a totally standardised form, meant to be something that a legal technician can complete. All the terms are defined. The traders themselves – type A personalities, testosterone-driven – are yelling on the phone. Intermittently, they throw something into a basket at the edge of their desks. About every 15 minutes someone comes around with a little cart, gathering the pieces of paper from the baskets and taking them to his desk. That’s the lawyer or legal technician. His job is to ‘paper the trades’ – to make legal the agreements the traders have made by phone.

Who are these people? In different countries there are different kinds of actors. In Japan they are law-

school graduates who have either failed the bar exam because only 2 per cent of the population can pass the exam, or never bothered to take it because they didn’t think they’d stand a chance. So they get a job inside one of these trading rooms as a second-best option. It’s a funny career, offering no chance of advancement to management because they don’t really understand the math or finance, only the forms.

These people are quite separated from the people they work with in terms of what they know and the circles they move in. They’re the back-office staff who contrast with their glamorous frontoffice colleagues in every respect, including salaries. But they’re a very important part of legal expertise in the markets; and they engage in the kind of governance that I want to talk about.

But the problem is that you’ve got people that are just like me and everyone else that I know in the academy and elsewhere. People with mixed motivations. So if a transaction doesn’t get processed correctly, it’s not because experts in finance are bad people, but because of the time difference between Dubai and Tokyo; or because it’s a national holiday in one of those places and people didn’t know that; or because something happened with the computer system and it got unplugged in the Bahamas and the next thing you know their numbers were screwed up in Taipei.

Glitches. Just everyday stuff. Just so many glitches that have nothing to do with good or bad morality but with the disconnects – technical, moral, professional – in the system at various points.

They often felt that what made them experts in law was precisely that they were not experts in finance and didn’t understand it. They were constantly feeling that they didn’t understand the computer systems but had to relate to the computer staff; they didn’t understand the sales people but had to relate to them; they didn’t understand finance but had to somehow paper these trades. I got very interested in their amateurism, not just their professionalism. So this is not just about what they know but also how they play in domains they are not totally confident in.

That’s my vision of the market, an assemblage of glitches. But you also have a way of dealing with these glitches. This is what I’m going to call techniques. Netting, for example, is an amazing little epistemological trick that lawyers use where they might say, ‘It will be deemed that at moment T-1 we have done something that needed to be done but we will deem that at T0 so that at T+1 something else can come to be’. In other words, you can imagine that in the future I would have already done what I needed to do from the point of view of that future. It’s really whacky.

Who else but lawyers time-travel like that? It’s a totally common lawyerly trick. If you ask people what you mean by ‘it will be deemed’, they’ll say, ‘Well of course we know that we don’t move in time that way but we just act as if we do’. Hans Vaihinger’s The Philosophy of ‘As If ’ provides a great explanation of how these people imagine what they’re doing. So this simple little humdrum technique, ‘it will be deemed’, is in fact a quite phenomenal epistemological trick. That’s what I mean by a technique.

This is important because what I often hear among my US friends on the left is demonising rhetoric about people in financial markets: they’re bad apples, bad people who have no morality. If we could just find the bad ones and put them in jail, then we could clean up the market and then it would all be better!

What are the characteristics of these techniques taken as a whole? First, they’re boring and hidden in plain view because nobody pays any attention to the little guy in the corner with his documents.

When I talk about this stuff with law professors their reaction is total condescension – it’s trivial, unimportant.

In the anthropology of finance we talk about markets as cultures or assemblages of expertise – places where different kinds of expertise interact: financial, mathematical, sales or whatever.

We normally think of expertise as something possessed, like gold in your pocket. It gives you a special relationship to other people. But for my back-office informants, expertise was as much a lack as it was something that they had.

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The other characteristic is that they’re utilising craftlike practices that are learned through repetition and observation. There’s not much theoretical content to them, it’s more like pure form or mere tools. They have extremely compartmentalised and routinised ways of thinking.

When I first landed in these financial markets, I was struck by the strange fact that no-one has any idea who these other people are. They never see them or socialise with them. The guy on the other end of the phone in Dubai is totally disconnected from the guy in the next building in Tokyo. At first, I didn’t believe it. Then I started to trace their social patterns and social relations, and realised that it was pretty true.

So how can it be that a world functions not only without society, but also without the social?

What these people often effectively said was, ‘I’m connected to people in Beijing in a way that I may not be politically or emotionally. If we sat together we’d probably disagree about all kinds of things.’ Arguably, this whole world of routinised, compartmentalised ways of thinking is a kind of customary law, a set of tools for regulating the market.

Now what else can we say about the back-office stuff? It’s designed to travel. When it was ‘built’ by the International Swaps and Derivatives Association, it was designed to be transnational. So it has got globalisation as an ambition built into it; it’s supposed to work in Dubai as well as Beijing.

All these techniques add up to what we might call the private law modality of regulation. It’s a tool, a means to an end, a way of doing things. If you ask lawyers why they do what they do, they’ll say that they do it to help the bank’s bottom line. Then they’ll want to talk about the really cool device they invented to do it. Yes, they understand it’s going to help the bottom line, but what they’re really interested in is the means, the tools.

Then, of course, these techniques claim to be on the sidelines, something outside of law. I contrast this modality of governance with public law reform, what I call the technocratic reform, which 58

The role of collateral in global finance

is the way that most financial law works, which is actually much more straightforward and flatfooted epistemologically speaking. It says this is legal and that’s not. It also sees itself as a means to an end but in a much more straightforward way. If you ask lawyers inside government, ‘Why did you do what you needed to do?’ they’ll say they did it to fix a financial problem. So they focus on the ends, not the means.

Conclusion My ultimate answer to Hayek is that what he’s critiquing, for good reason, is the technocratic.

But he’s wrong to say there’s a mystique to the private so therefore we should leave things to the market. What he’s really talking about is the power of technique, which is the power of private law, and there’s nothing inherently private about private law. People inside the state can use it as much as people outside the state. It’s just a different modality of doing law.

So why doesn’t any of this matter? Because the world of Lawrence Summers has not passed.

Collateral is still the name of the game. If you look at what everyone is saying today it’s all about collateral, better collateral, more collateral rules, more collateralisation. This is the private law solution. You would think this would make people on the left nervous but no, they too are saying more collateral.

The latest US Treasury Department white paper sees collateral as the answer. In fact, you now have states playing collateral games. If you’ve been following what the European Central Bank is doing with collateral you’ll find that the states themselves are doing some of the wackiest stuff when it comes to collateral. So there is a merger of public and private at this point. On the one hand, Summers is still out there and collateral is still the name of the game. On the other, you have this post-2008 fantasy that we can just go back and finally do left-wing, state-run regulation the way we always wanted to do it. In other words, Hayek was wrong: let’s have the new, new deal. Let’s just go and regulate the hell out of these banks.

In terms of the 2008 global financial crisis, we’re by no means out of the woods in the US in terms of the economic welfare of the population and people’s sense of hope. We academics mostly seem to present two options to the world: either go back to the old way of doing it or go back to the really old way of doing it. But is there anything else on the table? We could look anew at how markets are governed, at what kind of hegemonies exist in them and how we could recreate them.

We could begin to recognise that financial governance is not just about laws, statements by politicians, or administrative agencies; but that it’s about a whole bunch of stuff that doesn’t even look like law from the standpoint of people who think about market regulations. Stuff like the epistemology of ‘as if’ transactions, incredibly powerful and yet totally ignored because it doesn’t sound like law. The materiality of things like documents. The kind of virtual sociality that’s created between someone in Dubai and someone in Beijing through compartmentalised knowledge and much, much more.

References Riles, A 2011, Collateral Knowledge: Legal Reasoning in the Global Financial Markets, University of Chicago Press, Chicago.

Antonio, G 1971, Selections from the Prison Notebooks, Lawrence and Wishart, London.

Hayek, FA 1976, Law, Legislation, and Liberty, University of Chicago Press, Chicago.

The Bank of Japan was really clever about figuring out how to find back-office staff and give them prestigious positions as research fellows for two months, during which time they could find a life purpose as a source for government and connection to people in government, and to be reminded that they were lawyers and not just paper pushers. They could feel a connection with classmates now inside the central bank and share information with them.

So what I’m really interested in – as I think about how we might change our regulation of the global economy at this moment of reform – is whether we might learn from private legal experts and take back some of the tools of the chess game and use it for other purposes.

Annelise Riles is Jack G. Clarke Professor of Law in Far East Legal Studies and Professor of Anthropology at Cornell University.

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occasional address

be prepared for change Focus from the outset on what you can contribute rather than what you can take, and you will gain a lot of personal satisfaction and really make a difference. by anthony di pietro

An edited version of his Occasional Address given at Wilson Hall, the University of Melbourne, on 2 August 2013.

It is a pleasure for me to come back here and address you on your graduation day, some 22 years after I was sitting where you are today. My Commerce years seem like yesterday and hold some of the happiest memories of my life. Today is the culmination of several years of your hard work.

It is a day to celebrate with those close to you – family, friends, and possibly even tutors, lecturers and professors.

With all the excitement of today it is easy to forget what people say to you on such an occasion.

I must confess that I cannot remember who it was that delivered my Occasional Address. In fact, I can’t even remember what the key messages were from him or her. Therefore, I want to lay down a challenge to you. I don’t expect you to remember me in 22 years’ time, but I want you to try and retain a few of the messages that I will now share with you about my business and life.

Premier Fruits Group Perhaps like some of you, I was the first in my family to pursue an academic career. As you know from my background as the CEO of Premier Fruits 60

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Group, the company began as a family business and it was assumed that at some point I would move from education into the business. But, like you, I had my own thoughts and aspirations, and I chose a banking career. I was accepted as a graduate trainee at the State Bank of Victoria (SBV), where my much longed for banking career lasted literally five minutes. I walked into the SBV building in Melbourne and I don’t know what came over me, but I knew this wasn’t going to be for me.

Given the dire economic circumstances of the time, when I was privileged to be one of four graduates accepted into the program over scores of applicants, one can imagine the wrath of the HR Officer when I delivered the news! In hindsight, the decision not to join the State Bank was right, because within months, under the weight of failed investment loans, the SBV folded. That period is not dissimilar to today where we are facing tough economic conditions.

So, what made me change my mind? It wasn’t a sixth sense. During the holidays I worked in the family business and it struck me that there was a chance to transform its operations. I started to

wonder if I could apply some of the theory that I had learnt during my course to the business. Most of my friends thought I was crazy – I was about to commence the journey along a golden path, but decided to take the dusty road. And what a winding track it turned out to be, particularly in those early years.

what you are doing and not expect things to be handed to you. You will then earn the respect of those around you. Before you turn your back on anything, ensure you have thoroughly analysed the situation and made an informed decision; not an emotional or defeatist one. Finally, never compromise your integrity.

Situations and business and career conditions are forever changing. Therefore, my first point to you is: be prepared for change and do not be afraid to change, particularly if you are not happy.

This faculty has given you the tools; now you just need the confidence and courage. You come into a business or career with a dream. You came to this university with a dream. Now you have to make that dream a reality. However, it is how you go about it that makes the difference – and that is how I have approached my business career.

Melbourne Victory

My dream was to make an impact in the fresh-produce industry. Whether farming or distribution, the industry was labour-intensive and predominantly small businesses with little vision or opportunity for career development.

I wanted our company to grow into a new environment of long-term sustainability, one of a thriving workplace, delivering innovation and trust in our fresh products, as well as reliability in our services.

This dream has been realised. Premier Fruits Group – which was a Melbourne-based market wholesaler in the early 1990s with a staff of 10 – is now a nationwide operation, with a verticallyintegrated farming, marketing and distribution network guaranteeing work for employees, contractors, service providers and suppliers for well over 1000 people. To get there hasn’t been smooth going, and it didn’t happen overnight, so whatever your dreams be ready for the long haul.

My journey has highlighted to me a number of key elements that I struggled with after graduating – but eventually learnt. You have to be a considered thinker and you have to back yourself. Even when you back yourself don’t expect things to always fall your way. Remember to commit yourself to

These lessons have been important for me as the Chairman of Melbourne Victory. So how does a person with my background get to head one of the most successful sporting clubs in Australia?

I could say that chance had a lot to play in it, but I think a determination to be part of a sporting network with successful business people from a cross section of industry – who are all focused on building something special – was the key driver for me. I have always been interested in football and when Frank Lowy of the Football Federation of Australia decided that it was going to license a Melbourne team, I was keen to become involved.

As you know, football (soccer) is a sport that had been wracked with ethnic rivalries, poor financial management and poor player management.

When Melbourne Victory began, we had no home ground, no stadium, no TV rights, no centralised membership and the club needed about $6 million to get off the ground. This is a typical ‘walk away’ or ‘stick it out’ scenario.

However, there were key success ingredients from the outset – a group of people coming together with an aligned vision, a belief that Australians wanted to be part of the World Game at an elite level, a business plan and an objective which remains today, to be the leading sporting organisation in Australia. Over nine years we have won premierships and championships; competed in Asia; and built up world-class headquarters at AAMI Park.

We now have the highest membership, broadcast ratings and crowd numbers of all A-League teams and are financially sound. We have hosted international friendlies against clubs from the Insights Melbourne Business and Economics

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world’s most revered leagues, including the recent record-breaking 95,000-plus crowd to see Liverpool at the MCG. For me this has been heady stuff! But I strive to always remember that ‘no one is bigger than the club’.

At Victory, we have had people come and go; and mistakes have been made, such as the wrong coach, the wrong player, or people motivated by self-interest. Despite these mistakes, the club is still growing.

If you focus from the outset on what you can contribute rather than what you can take, you will go a long way. You will also gain a lot of personal satisfaction, and really make a difference.

Conclusion When the celebrations of this momentous occasion in your life settle, you will begin the next stage of your career journey. As you find your own way over the next few decades I hope you will think about my story from time to time, and reflect on some of the key messages I have shared today. If you do this, I think I will have achieved my goal with this speech and you yours with your future.

Take the tools you have worked hard to acquire, and the values you have learned from your family.

Through your career be proactive and prepared to change. Align yourself with people who are keen to be as accountable as you, humble enough to admit mistakes and strong enough to address them.

Today you have achieved a significant milestone in your life. I now look forward to crossing paths with a 2013 graduate in the future who is earning respect through business, sporting and social networks and engaging with the Commerce Alumni.

Anthony Di Pietro is CEO of Premier Fruits Group and Chairman of Melbourne Victory Football Club.

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Mailing Address: The Faculty of Business and Economics The University of Melbourne Victoria 3010 Australia Telephone: +61 3 8344 0006 Email: droller@unimelb.edu.au Internet: http://insights.unimelb.edu.au Published by the Faculty of Business and Economics, November 2013 Š The University of Melbourne Disclaimer Insights is published by the University of Melbourne for the Faculty of Business and Economics. Opinions published are not necessarily those of the publisher, printers or editors. The University of Melbourne does not accept responsibility for the accuracy of information contained in this journal. No part of this journal may be reproduced without the permission of the editors.