Speech - A Year Since Lehman: Where To From Here?




"A Year Since Lehman: Where To From Here?"




It is a great pleasure to be here with you all today.

In the world of independent think tanks there are few, if any, that rival the prestige and history of this institution.

Standing here one cannot help thinking of the discussions that have taken place both within these walls and beyond, under the 'rule' to which this building (and institution) has given its name.

In challenging times, the ability to invoke the 'Chatham House Rule' to facilitate free and frank discussion has, I have no doubt, helped shape the course of history.

But today I want to talk about the future.

The challenges we face as we adapt to the changing global economy. The opportunities this will bring, in particular for my country which finds itself ever closer to the epicentre of global growth as we go through the century ahead.

I'll also talk about what Australia and the G20 are doing to deal with the challenges, but also what we are doing to grasp the opportunities that will come with recovery.

Before I do so, I'd just like to briefly recap where we find ourselves and let you know a little bit about how my own country is faring.

The Current State of Play

G20 Finance Ministers met in Washington on the evening of 11 October last year, less than a month after the collapse of Lehman Brothers.

As we looked across the table into the eyes of our colleagues, perhaps for the first time we collectively saw the gravity of the challenges we faced.

Because we could see that what had begun as a financial crisis in the United States was turning into a global recession, the likes of which had not been seen since the Great Depression.

A global recession that has thrown millions out of work and pushed millions more back below the global poverty line.

By year's end up to 60 million more people are expected to have joined the ranks of the global unemployed, compared to 2007. Two-thirds of these will be in developing countries.

But while the global recession has had a major impact on every country, we can confidently say that it would have been that much worse if not for the unprecedented response from G20 governments of all political persuasions.

The magnitude of this global policy response is helping to stabilise the global economy.

Indicators of financial market stress have fallen to their lowest levels in more than two years.

The rate of economic contraction in the US, UK and euro area slowed significantly in the second quarter, although this does follow the biggest annual contraction in both the US and UK since quarterly records began more than 50 years ago.

In my region, Japan has seen a modest return to growth in the second quarter, following a very large contraction in the preceding 12 months.

Elsewhere in Asia, the story has been better, in recent months at least.

The Chinese economy, supported by massive fiscal stimulus and expansionary credit policies, registered growth of 7.9 per cent in the year to June.

This is remarkable given the Chinese economy almost stopped growing at the end of last year.

And South- East Asian economies are recovering in the second quarter, although this follows some severe contractions in the preceding period.

The Australian story is different . It is more encouraging than the story of the rest of the advanced world.

While most other advanced economies have experienced deep contractions in output and employment over the past year – the Australian economy has continued to grow.

Our latest GDP figures released two days ago show that Australia has the strongest growth of any of the world's 33 advanced economies.

Australia is the only advanced economy to have recorded positive growth over the past year.

And while every major advanced economy has experienced recession, Australia has not.

As a trade focused commodity exporting nation, we cannot claim this is because we are immune.

We have seen unemployment rise and government revenues have been hit hard by the global recession.

But Australia has been well served by the rapid policy response we put in place and the underlying strengths of our economy.

Among our inherent strengths is our location in the Asian region.

Reforms implemented over the past 25 years have helped to make our economy more flexible – more resilient.

Our banking sector is among the strongest and best regulated in the world. Indicative of this, of the world's 100 largest banks, 4 of the 9 highest-rated are Australian.

The state of our housing market has been another source of comparative strength. Unlike the US and parts of Europe, Australia does not have a large overhang of excess housing stock and as a result we have not seen the collapse in housing prices experienced elsewhere.

And in conjunction with monetary policy easing, the Australian Government injected three waves of timely, targeted and temporary economic stimulus to offset the worst that the world could throw at us.

Without the Government's economic stimulus, GDP would have fallen by 0.3 per cent in the June quarter, and the Australian economy would have contracted by 1.3 per cent over the past year. But instead it went forward.

Importantly, this stimulus is being pursued without running up excessive debt and without moving outside of our medium-term fiscal framework.

Australia's net debt is expected to peak as a share of GDP at 13.8 per cent in 2013-14, before falling in subsequent years.

In contrast, by 2014, net government debt is expected to rise to 75 per cent of GDP in the euro area, 83 per cent in both the UK and the US, and 136 per cent in Japan.

These actions have left Australia with stronger growth, lower deficits and lower debt than any of the major advanced economies.

But while we are weathering the global recession relatively well we are cognisant of the fact that the global economy remains fragile.

And though focused on meeting the challenges that lie ahead we are also eager to grasp the opportunities.

Challenging Times Ahead

Despite the extraordinary actions of Governments right around the world and the unprecedented collective actions taken through the G20, the world economy still faces difficult times.

Don't forget the IMF still expects 2009 to be the largest contraction in the world economy since World War II.

The world economy's growth in 2010 is forecast to be just half what it was prior to the global recession.

And much of the global growth we are seeing now is largely being supported by the public sector, and progressively, a restocking of inventories.

How we sustain growth beyond these temporary supports is yet to be seen.

In many respects the world changed forever following the collapse of Lehman Brothers.

No longer will the world be able to rely so heavily on the American consumer as the primary driver of global demand.

US households have already begun to save more and consume less.

Even if US households were only to maintain these new savings rates, rather than increasing further, the IMF has estimated this could leave a hole of around 3 per cent in aggregate demand in the US economy.

This is around US$425 billion annually in aggregate demand that would no longer be there, or nearly three quarters of a per cent of the global economy.

This is demand that will need to be generated elsewhere in the US economy, or more likely, elsewhere in the world economy.

To sustain the kind of growth rates they're accustomed to, emerging economies will have to rely more on internally-generated sources of demand.

In addition, the post-crisis global financial system will have to operate with higher capital and liquidity buffers than before the crisis.

While the nature of global growth is changing, it is also shifting.

These global changes that I have talked about also bring with them opportunities – in particular for those of us in the Asian region.

The Asian Century

Increasingly Asia is becoming the centre of global growth and in many ways we are now entering the Asian century.

In 2010, almost 90 percent of world growth is expected to come from emerging economies and the growing importance of Asia to the world economy will obviously bring many opportunities to Australia.

And by 2014, with the recovery well and truly in train, the IMF projects developing Asia on its own to contribute half of world GDP growth (2.3 percentage points of the projected 4.8 per cent growth).

For Australia there is much promise in the years ahead.

Of course, there will be increased demand for our commodities. But there will also be increased demand for Australia's other products and services.

Taking advantage of these opportunities is not something that will happen automatically; it will require significant adjustment on the part of businesses, and substantial Government investment in productivity growth.

We know that the opportunities of the Asian century will only be ours if we are bold enough to grasp them.

That's why the Rudd Government is embarking on the biggest modernisation of the Australian economy in 60 years.

We are delivering the most critical and long overdue infrastructure investment this country has seen in decades – building vital hard infrastructure like roads, rail and ports as well as investing in clean energy infrastructure.

70 percent of our stimulus packages is devoted to nation building infrastructure.

These investments are supporting jobs during this period of weakness – when it is most needed – but will also enhance the productive capacity of the economy for the long-term.

We are bringing our economy into this century through the National Broadband Network and the Education Revolution that will help our kids attain rewarding and higher paying jobs.

We are ensuring our economy is positioned as among the first movers as the world tackles climate change through the introduction of the Carbon Pollution Reduction Scheme and driving energy efficiency in our economy.

We are removing red tape and impediments to work in our economy through the biggest tax and welfare review in 50 years, through competition and regulation reforms, and the reform of Commonwealth-State relations.

And we are doing this while delivering on our promise to return to surplus and pay down debt.

These reforms will provide the opportunity for Australia to take advantage of the Asian century, but we also know that many of the challenges we face need to be tackled beyond our shores.

Role of the G20

Australia understood from the beginning that the global recession could not be dealt with by the actions of national governments working alone.

Nor can the challenges that are emerging as a result of this crisis.

That's why Prime Minister Rudd and I saw a critical role for the G20 in bringing together the world's 20 most systemically important economies to address what is truly a global crisis.

We have both worked closely with our G20 colleagues to ensure a decisive initial response to the crisis through the Washington and London Summits. We greatly appreciate the leadership role played by Prime Minister Brown and Chancellor Darling.

The G20 – with its unique membership of systemically important countries representing 85 per cent of global GDP – has been the international body most able to provide the political authority to ensure a truly global response to the global recession.

Supporting Jobs and Growth Now

Let me use the remaining few minutes to talk about Australia's priorities for the G20 meetings in London and Pittsburgh.

As Finance Ministers prepare for our meeting in London this weekend, we are all acutely aware that the global economy remains fragile.

For this reason, we must ensure that G20 members are fully implementing the commitments we agreed at the London Summit.

We must fully implement our stimulus measures to support jobs and growth.

We must reaffirm our commitment to address 'toxic assets' and recapitalise banks so they can supply the credit necessary to support global recovery.

We must push forward with the major reform blueprint agreed by the Leaders in London in April. The regulatory shortfalls exposed by the global financial crisis must be fully and comprehensively remedied.

International standard setting bodies have been working hard to develop stronger and better regulatory frameworks.

But we are not there yet.

My message to my G20 colleagues is that recent improvements in financial markets are no reason for moving with any less urgency on fundamental reform to the very financial systems that were at the heart of the global recession.

We must also deliver on our reforms to the international financial institutions.

While the G20 is making good progress on resourcing issues, this must be matched by real progress in the months ahead on governance reform.

This includes measures to rebalance power within these institutions to reflect the emergence of the dynamic economies in the Asian region.

This is vital to boosting the legitimacy and effectiveness of these organisations and ensuring they can make the most effective possible contribution to global development.

When I address my G20 colleagues tonight I will be imploring them to maintain this momentum if we are to ensure a role for the IMF in the twenty- first century, rather than just patching up the system of the twentieth century.

New Growth Model

But we must also move beyond just implementing our commitments in London five months ago.

The global economic adjustments I have been talking about today will also need to be facilitated by sound global policies that deal with the aftermath of the global recession and ensure the world economy is placed on a more stable path.

That is why coordinated global action will be an important part of our strategy to prepare for the future.

Over recent months there has been much discussion on the need for policymakers to develop credible 'exit strategies'.

This recognises that policy coordination will be as important in exiting the financial crisis as it was in responding to it.

But we should not get ahead of ourselves. We are, after all, only just seeing the early signs of stabilisation following the worst rupture in financial markets since the 1930s.

There is still much to be done before we can say confidently that a sustainable recovery has taken hold.

I think that exit strategies should be placed in the context of a three phase strategy to sustain growth. These three phases are as follows.

The first phase is to focus on ensuring policies to restore growth are fully implemented, including fiscal stimulus as well as measures to restore the health of banking systems and ensure credit markets are fully operational.

In the second phase, the emphasis is on consolidating the transition from stimulus-driven growth. If stimulatory and market stabilising policies are withdrawn prematurely this could jeopardise the recovery.

The third phase is the commitment to withdraw extraordinary policy measures as growth returns to a more stable path. Our own fiscal stimulus has been deliberately designed to begin unwinding towards the end of this year, while continuing to provide support for activity and jobs in the period ahead.

Part of this third phase involves taking measures to rebalance growth and to lift countries' growth potential.

This is why you'll hear a lot from world leaders about a "New Growth Model".

Rebalancing growth will require greater reliance on domestic demand as a source of growth in emerging markets and sustained balance sheet rebuilding in advanced economies – the issues I touched on earlier.

Boosting potential growth rates will require commitments from both advanced and emerging economies to pursue structural reforms.

The necessary rebalancing of growth in key emerging economies, for example, can be catalysed by progressive capital account liberalisation.

And by enhancements to social security and health systems that reduce the need for the very high precautionary savings in many countries and free these funds to support a higher level of domestic consumption.

Such structural reforms can also help build more diversified economies that do not rely so heavily on exports to the west, but increasingly become more domestically focused.

Climate Change Financing

Climate change and related financing mechanisms will be another key issue impacting on both advanced and emerging markets in coming years.

And any consideration of setting the global economy on a sustainable path has to take into account the challenges presented by climate change.

We believe the G20 has an important role to play in this area.

While the UN has the clear mandate to negotiate climate change financing, discussions by Finance Ministers over the next few days, and then by Leaders in Pittsburgh, can provide political momentum ahead of the Copenhagen negotiations in December.

These UN negotiations have an important financial dimension and the G20 can provide for direct engagement on these issues by Finance Ministers.

In this way, the G20 can help build common ground between key developed and developing countries – just as it has since the weeks following the collapse of Lehman Brothers.

Concluding remarks

That collapse of Lehman Brothers changed many things.

It would be easy to say that the world took a significant turn for the worse on that fateful day in September 2008.

However, the degree to which the unprecedented range of fiscal, monetary and financial sector interventions was coordinated globally — via the commitments made at the G20 Leaders level — has been impressive.

The world has shown it has learnt from the lessons of the Great Depression.

The Lehman collapse and the global recession that followed have presented some significant challenges and imposed great costs.

But they have also provided us with an unparalleled opportunity to address global problems that had previously been put in the 'too hard' basket.

It has provided us with an opportunity to put the global economy on a more sustainable growth path, one that is less prone to financial system-induced cycles of boom and bust.

It has provided us with an opportunity to ensure that our international financial institutions are adequately equipped for the 21st Century.

It has provided us with the opportunity to establish and stress test a Leaders‑level global governance framework that more appropriately recognises the importance of emerging markets in the global economy, and more broadly, that balances efficiency with legitimacy.

It is incumbent upon us all to capitalise on the impetus for change generated by the historic events of the last two years.

Thank you again for hosting me today and I look forward to your questions and to the application of the Rule!