Ken Henry — An Economic Odyssey (#145)

129 min read
Ken Henry — An Economic Odyssey (#145)

Dr Ken Henry is an Australian economist who served as Secretary of the Australian Department of Treasury from 2001 to 2011. He was instrumental in helping Australia avoid recession during the 2008 Global Financial Crisis — Australia was the only major advanced economy to do so.


JOSEPH WALKER: Ken Henry, welcome to the podcast.

KEN HENRY: Good to be with you.

WALKER: Ken, I have questions about treasury as an institution and the process of making policy. I’ve got philosophical questions and I have questions about specific policies. But first I want to start with some history.

HENRY: Okay.

[04:09] WALKER: You joined Treasury’s Tax Policy Division in 1984 and then you moved across to Paul Keating’s office in 1986 while he was Treasurer, to be one of his senior economic advisors. And you were there until 1991. What was it like to be in the engine room of Australia’s golden era of economic reform?

HENRY: Well, it was an absolute blast. For some years before that, I had been a junior academic, having just completed a PhD. And I went into the Treasury in, I think it was August of 1984, and I was naive but curious. I went in because of what I could see happening within government, that there was a hell of a lot going on. The Hawke–Keating reform era that had commenced, I guess really, well, pretty much after they were elected in March 1983. I mean, they got straight into it, but by early 1984, it was clear that this was going to be a reformist government. I thought, well, I wouldn’t mind finding out what this is like stepping out of academia, but I thought, I can’t step out of academia for very long. And all my colleagues said to me, you’re nuts.

If you step out of academia, you’ll never get back in or you get back in, but you take one year out, it’s like going to sleep for five years as far as your academic career is concerned. And I thought, oh well, okay, I’ll put a limit of two years on it. I reckon after six months of being in the treasury in that reform period, I knew that I was never going back to academia and that policy was going to, the policy work was going to dominate my life. I knew that after six months.

And of course, I was working as part of the team through the first half of 1985 that put together that Draft White Paper on tax reform. That Keating without Cabinet authority, by the way, that he took to the national tax summit in June of 1985, without any support from within, from amongst his colleagues on the back on the basis of work that had been produced by a very small team of treasury people – maybe you’d need two hands to count the number – maybe who had produced a reform package that had the support of nobody outside of the treasury. Nobody! Like not in academia, not amongst other government departments and certainly not in the media. And yet, Keating had the courage to take that all the way to the National Tax Summit, knowing beforehand that it was almost certain that he was going to lose the argument. And I just thought, God, it can’t get any better than this, right?

And so, when in the middle of 1986, he asked me to join his office as a senior advisor and get even closer to the action – which, actually, from my perspective, really meant get closer to him – well, it was irresistible. It was an irresistible invitation and, as you say, I stayed there for five years, but I would say that whole five years was just a blast, just one continuous, amazing experience. I don’t think the adrenaline ever stopped flowing, not for a second.

[08:03] WALKER: Do you have any Keating anecdotes that you can share?

HENRY: No. I’ve got Keating anecdotes. I’m not sure that I’ve got ones that I would share. Maybe one, which is maybe to give you a bit of a flavour for the sort of person he is. And I won’t mention… No, I’ll give you two. I won’t mention names, but I don’t think these stories have ever been told publicly and there’s no reason why they should be. And I was the only witness to these two.

On one occasion, it was shortly after I joined Keating’s office, so we were still in the old Parliament House, one of his senior colleagues, very senior minister, came in to see Paul and I happened to be sitting in Paul’s office across the desk from him. I’d been briefing him on some policy issue and the senior minister came in and said, ‘Look, Paul, I really need to talk to you before Question Time’. And I got up to leave and the fellow said, ‘No, look, honestly, it’s all right, you stay, doesn’t matter’. And Paul said, ‘What is it, mate?’ And he said, ‘Well, you know, I’m taking all these decisions and I find myself waking up at 2 o’clock or 3 o’clock in the morning just worrying about whether I was taking, whether I’d been taking the right decisions or not, questioning my own judgement on the decisions that I’d taken the previous day and days before.’ And he said, ‘I’m just in turmoil over it.’ And, I think, these are the precise words Paul said. He said, ‘Well, mate, it’s time to go.’


HENRY: Yeah, like, wow. And I thought, God, ’cause I don’t know anybody else, and I’m sure I’ve never met anybody else in my life who would have responded in that way. And, I mean, it wasn’t as if Paul was unfeeling at all, it was just, in fact, probably quite the opposite, because they then went on to discuss why Paul had said what Paul had said. And shortly after the minister did, he stepped down. It can come across as almost brutal, but there was more to it than that. I mean, Paul wasn’t being unkind at all, he understood the situation absolutely perfectly, but his assessment was the right one. And I’m sure that minister came to the, well, he obviously came to the same view that, 'Yes, this is the right assessment, you’re absolutely right.'

WALKER: So, the implication being that the reality of power is that you have to be able to sit with these decisions and make them confidently?

HENRY: Yeah, exactly. And if you find yourself questioning your own judgement, then this is not the place that you should be. You should not be putting yourself in this position, find a more peaceful existence, doing something else, helping out in some other way. This particular minister had a long career as an advisor and official in various capacities and a highly successful career, and was much loved by all of his colleagues, including Keating. Right. So, this was not a person without talent, far from it. Far from it. But had found himself in a position in which he was uncomfortable and in a position of power. And the power was, or the exercise of the power was, I guess, killing him – slowly, but killing him. Right.

Anyway, the second anecdote I’ll tell, this is now in the new Parliament House, but two very senior businesspeople came in to talk Keating as Treasurer – and he was probably also Deputy Prime Minister by this time, I’m not sure, but anyway, he’s certainly Treasurer, obviously – to inform him of a decision that they had reached to merge their two national institutions, both large corporate entities. And this was the first Paul had heard of it. But he was a bit curious as to why the two had sought a meeting with him and a meeting under, you know – there was a time constraint and ‘We have to see you today’. And they didn’t say why, at least in the meeting request, but ‘We have to see you today. It’s very important, critical.’

And so, when they arrived, he asked me to step in to really just be a witness to the meeting. I was blown away. Since I’ve been in very senior positions in the corporate world myself, but as a young policy advisor, what I saw was these two people who were absolutely certain that what they were doing was in the national interest. Like it couldn’t be questioned, it must have been, and they were merely, as a matter of courtesy, informing the Treasurer that they are going to do this. I don’t know if they knew that the Treasurer under various bits of legislation, one in particular, had the power to prevent them from doing what they’d already decided they were going to do. I don’t know if they knew that, but when he said to them, ‘You’re going to do what?’ I saw them sit back, colour drain from their faces and they went on and explained it again. He said, ‘You think you’re going to do that?’ ‘Well, yes.’ And he said, ‘Like hell you are. You’re not going to do that. No way are you going to do that.’

They’re absolutely shocked, and Paul had had no briefing on this issue. He didn’t know what was coming but he had this look, it’s more than instinct by then. He had such a robust policy framework in his head that he himself was capable of bringing some pretty sophisticated analysis to the issue that had been presented to him. And knowing, perhaps it was instinctive, I don’t know, but knowing anyway that this can’t possibly be in the national interest for this to happen, and he blocked it and that was that.

And they were both furious and devastated, these two, the two CEOs, when they left the room. And I thought well – I thought a lot of things. I learned a lot from that. But it was another, it’s another anecdote in the exercise of power that I’m sure has never been recorded anywhere – well, not publicly – which tells you a bit about the sort of person that Keating was. When he took a decision, he would be absolutely comfortable with the decision that he took, and he had that ability.

He didn’t always get it right, but I would say over the years that I spent with him and working closely with him, and of course even after I left his office, because he, six months later, became Prime Minister, I continued to work with him in a different capacity, obviously, but I rarely saw him take a poor decision. Now, he did take some, but it was rare. People tend to focus on those that were poor, and that’s understandable, but amongst the plethora of huge decisions that he found himself having to take on the basis of necessarily limited or incomplete advice, he was… Well, in my view, he stands well above any other Treasurer that I’ve ever come into contact with.

[18:00] WALKER: Wow. Raises a couple of questions. One is – so he obviously left high school at the age of 14, and that was sort of the end of his formal education. Didn’t have any economics education, learned it all on the job.


WALKER: And obviously, as you’ve described, had an incredible intuitive grasp of the economy. How far can intuition take you in economic policy making? Is it necessary and sufficient?

HENRY: Oh, it’s certainly not sufficient. Is it necessary? Is it even necessary? Helpful. Certainly helpful. Good intuitive instinct is certainly helpful, but then relying upon it to the exclusion of analysis and the exclusion of engagement with advisors would be very dangerous. There’s a lot of things that make good intuitive sense that I’ve seen in my career that are just nuts. Just nuts. So, you wouldn’t want to rely on it.

WALKER: So, is Keating the exception to that?

HENRY: I’ve seen others who have pretty strong intuitive grasp, so I wouldn’t say that he was the exception, but I would say an absolute standout. Yeah, an absolute standout. But people’s minds work differently. Right. Some are extraordinary intuitive thinkers. I had a – and I won’t mention a name, either – but I had in the department as an advisor somebody who these days is a very very wealthy, highly successful person in the private sector – very. And has quite a profile. He was working in the Treasury and he was deeply… most days he was upset. I mean, deeply upset, like, often in tears. And I spent quite a bit of time with him, because he was clearly brilliant, and discovered eventually that the reason for him being upset was a frustration. He saw it as a frustration – the capacity of people he was talking to understand why he was right. Fair enough. And I saw it… I think it would have been more honest of him to admit that his source of frustration was that he couldn’t explain to others why he was right.

We’re talking about really complex stuff, right. Without going into the subject matter, it was really complex stuff, and he could see the answer just like that – bang – that’s it. That’s what you’ve got to do. But he couldn’t explain why. And so, he was forever finding himself in heated arguments with other people who also had first-class honours degrees in several disciplines, if not PhDs, who had always been top of their class right through school and university and blah, blah, and who couldn’t see what he could see and who would not accept that he had it right, and particularly because he couldn’t explain why he had it right. It got to the point where, I had a hunch that his – I don’t know whether it’s inductive reasoning powers, I’m not sure that’s what I was seeing, but anyway – I had a hunch that he was unbalanced in the sense that his intuition was really really strong. But I had a suspicion that the linear analytical abilities were not so strong. Because, after all, if they were, how come he wasn’t able to explain it to other people? His minds work in that linear, sequential sort of fashion.

And so, I took one of the debates that he was engaged in, and I produced the algebra and the calculus that, to me, constructed the formal argument that analysed the thing, and I came to the conclusion that he was 95% right, which blew me away, actually. Because I thought that’s highly improbable. Like, I thought he might be 50% right, but he was 95% right. And I gave it to him and I said, ‘Look, could you just check this?’ And weeks went by and eventually he came back to me and again he was in tears and I said, ‘I just don’t understand what’s wrong.’ And he said, ‘I can’t understand your mathematics.’ And I said, ‘Well, I just do not understand how the hell how on earth could you be capable of analysing this complex problem without being able to understand this?’ Which to me was a relatively routine bit of analysis. And he said, ‘Well, that’s first… I just can’t.’

So can you rely on intuition? He can. He’s a fabulously wealthy person, done incredibly well. He can rely on intuition. Yeah. Would I want him to rely on intuition and run the country? I’d be a bit worried.

WALKER: Okay. By the way, I think I know who this person is. We can talk about it afterwards.

HENRY: Okay. Right.

WALKER: Another reaction to your second anecdote about Keating, your description almost reminds me of someone like an expert cellist or painter or a basketball player in flow state who’s completely confident, has almost a grace in what they’re doing…

HENRY: Grace is a really good word.

WALKER: It was almost like he’d made an art out of the use of power.

HENRY: Oh, that is so insightful, and I reckon that’s dead right. And it did look graceful to me. Even the brutality. Even the brutality. There was grace in it. Even, yeah, the way that he would wield that sword and the damage that he would do with it. There was artistry in it, and theatre. And grace. And it’s, you know, that comes through most of the things that he got involved in. Because he wasn’t involved exclusively in economic policy, right. I mean, he was a great appreciator of art and architecture, of history. His command of those disciplines, too, was well, anyway… He relied to a very large extent upon instinct and intuition. And if he were here, he would say, ‘It’s all the same, mate.’ He would, it’s, you know, being able to see the big picture, he would say, ‘It’s all the same.’

He would find that the sort of… the way that academics approach issues, where they find themselves getting narrower and narrower, and they say, ‘Well, of course we need to in order to be able to dig sufficiently deep to make real progress,’ I doubt that he’d find that. I doubt that he’d even understand what they were talking about. For him, it’s all about finding the patterns. And the truth is in the patterns.

[27:28] WALKER: Did interacting with Australian political leaders in Canberra make you more or less inclined to believe in the great man or woman view of history? I guess you’ve got this dialect between, it’s the people who influence history or it’s the forces that share history…

HENRY: So, both. And we’ve had leading politicians who have said things like, ‘The times suit me,’ and I think that’s quite revealing. And generally, I think when they have said it, it’s been true. Like, they haven’t said it just to inflate their own egos. I think it’s probably been true generally that the times have suited them. But of course, the other way of putting that is that other times probably wouldn’t have suited them. They might have been absolute disasters at other times. And yet there are also leaders that we’ve had who were able to change the times to suit them. Right. And I think Keating was in both camps.

I think he was capable of taking really maximising maybe not maximising, maybe that’s too strong, but exploiting as much as anyone could possibly imagine, exploiting the opportunity presented by the times as they were. But then he was also capable of shifting the narrative, changing the narrative. He created the debt and deficits narrative. Right. He created that. That wasn’t there. He created those times, and then he used what he had created to enormous effect to build support for extraordinary economic transformation or a set of policies that were going to produce and did produce an extraordinary economic transformation. Right.

Now, of course, it is likely that had he not cast the challenge in the terms he did, the banana republic and so on, had he not done that, at some stage we would have found… Australia would have found itself in a crisis and having to make those big changes anyway. And so maybe you could argue that, ‘Well, he was only ten years ahead of his time.’ Well, God, if only we had leaders who were ten years ahead of their time right now.

[30:10] WALKER: The debt and deficits narrative was a sub-narrative of a broader narrative which you term the Australian mercantilism narrative. And Keating kind of unleashed both of them.


WALKER: They were effective in his time, but they’ve obviously plagued the Australian political discourse in decades since…

HENRY: Yeah.

WALKER: Can you just talk about the origins of those narratives, why he constructed them?

HENRY: Yeah. Okay, so the debt and deficits one, his concern was that having taken big steps to open the economy up and, really, the steps that had been taken at that stage were to float the currency and to abolish capital control, so to allow capital to flow into the economy and, of course, to flow out of the economy. And so we had a bumpy ride. Right? I mean, the economic outcomes, the macroeconomic outcomes were quite volatile in those years following those two things, floating the currency and abolishing, removing capital controls. And there was no, at least by 1986, which is when he made the Banana Republic statement, there wasn’t a lot to show for it in terms of improved economic performance.

Sure, we’d come out of the recession, but were going to come out of the recession. The drought had ended in early 1980s, right. But things had not improved so much that the budget was showing any signs of getting back or getting anywhere towards balance. So, we still had a big budget deficit. The currency was under continual downward pressure. We had what appeared to be a widening current account deficit. Should that have worried him? Look, I don’t know, but it did. I mean, he did worry about these things, right?

It wasn’t part of a narrative that he could… wasn’t part of a nice positive narrative that he could construct. It was something that really worried him. And there was this concern. I don’t think he was the person who first articulated the concern about Australia’s increasing reliance upon short-term capital inflows from offshore, particularly debt flows. But he was deeply uncomfortable with it that Australia had, because it was continually running current account deficits, it was therefore relying upon the rest of the world to finance those current account deficits. And a lot of the funding was coming in the form of short-term debt financing, and if it wasn’t coming in the form of short-term debt financing it was foreigners wanting to buy up property and oh, God, that’s also not very comfortable.

The way that he chose to frame it, or frame the narrative, was that at some point, if we didn’t get on top of this, at some point, Australia would lose flexibility and maybe even sovereignty in respect of its economic policy settings. And so that it was better that we take matters into our own hands, take the decisions ourselves about how we were going to respond to being a small, open economy in a world of very large flows of global capital, and how we could insulate ourselves against the risks associated with that. And his answer – and look, he wasn’t the only person who came up with this answer. There were a lot of academics too who said, ‘What you’re talking about is,’ and this is true, ‘it’s just a tautology – you’re talking about a gap between national saving and national investment. That’s right. So, it’s just a simple piece of arithmetic that the current account deficit is simply equal to the excess of national investment over national saving. So maybe Australia’s got a chronic saving problem, right. And that’s in two parts, there’s a public saving problem.’

Well, that was clear from the budget papers, right. Succession of budget deficits getting worse and worse and worse. And we’ve also got a private saving problem. And it was true that household saving on international standards were pretty low. Of course, the irony is that in addressing his efforts to lifting public saving, i.e. reducing the budget deficit, and also to some extent lifting private saving – although that really came later with superannuation, private superannuation – but certainly that first bit in fixing or appearing to fix the structural budget position, what do you know? Capital flows into Australia increased. The capital flows were financing a spectacular investment boom because the rest of the world said, all of a sudden, ‘Australia is a great place to put your money, to invest in productive in an enhancement of productive capacity.’ Right? And so, there were all these new investment opportunities that opened up in Australia.

And that’s his true legacy, in my view, on the economic front, is that we had this enormous investment inflow and then, even though there was a recession in the early 1990s, as we came out of the recession it just kept powering on. Right. And it powered on because of the way in which he had educated the world or re-educated the world about the sort of place that Australia is and how they should think about Australia. Australia is actually a great place to invest and the current account deficit just widened and widened, right. Even though the budget deficit had closed. So, deeply ironic but nevertheless, the narrative in and of itself is flawed. Right? I mean the debt and deficits thing, well, it’s incomplete, but it’s seriously incomplete. I mean it’s so incomplete that in the wrong hands it’s deeply flawed, let me put it that way.

But, nevertheless, it did lie behind the extreme measures that were taken in the late 1980s or early 1990s that actually did tip the economy into recession. And there’s no resiling from that. I don’t think there’s any resiling from that. Yet it is also true that it supported an extraordinary investment boom that actually rebuilt the economy, restructured the economy and allowed the economy to produce rates of productivity growth that hardly, through the 1990s, that hardly any other economy in the world had ever produced at any time, including us.

WALKER: Is the debt and deficits narrative not long for this world given that as of 2019 we’ve been in a current account surplus?

HENRY: Well, no… So why are we in a current account surplus? And the reason we’re in a current account surplus is because investment has collapsed. That’s the reason. And that’s the problem. I mean the problem… we shouldn’t see this as a good thing. And would Keating see it as a good thing? Would he say, ‘Ah, this is a triumphal moment for me, we’ve actually converted a current account deficit to a current account surplus?’ I think if he were to – and I haven’t had this conversation with him – but I’m pretty sure if he were to look at Australia’s rate of business investment, he would be absolutely appalled.

And he would understand that with the sort of business investment rates that we’ve got in Australia now, the sort of investment rates that, I mean, investment as a proportion of gross domestic product is so low. The only other times in our history that we’ve seen rates of investment this low is in the depths of recessions and yet we’ve been here for years now with these investment rates. He would be appalled and he would understand that’s a principal reason for declining productivity growth in Australia, the undermining of living standards, the lack of growth of real wages. He would get all that and he would be appalled by that. So, he wouldn’t regard it as a success story at all. He would want to see that investment rate lifted.

Now, by the early 2000s, I think I had managed to convince myself that the debt and deficits thing was no longer useful and that it was time to move on. I guess the view that I guess I had at the time – and I think all of my colleagues in official circles would have had a similar view – was that, look, provided you’ve got high-quality domestic policy, we took it for granted, right? I mean, this is ridiculous, but we did. We did until the beginning of this century, we just took it for granted that we were always going to have high-quality domestic policy settings, right, and an absolute commitment to first-rate transparency with respect to policy setting and so on.

We’ve got an independent central bank and all this kind of stuff, provided you’ve got that, you don’t need to worry about the rest of the world financing your current account deficit, even if it is going to increase to significant proportions of GDP from time to time. Who cares? They will do it because you’re such a good target, you’re such a good place to invest, right? Because you got those wonderful policy settings. And that’s what I thought. And I thought that I was thinking that right through to 2006, as part of a program of work that really began after the Asian financial crisis in 1997/98, which really didn’t affect Australia at all. And that kind of confirmed the view that, well, our policy settings are so good – look, we didn’t even suffer contagion in the Asian financial crisis.

And actually, our economic performance during that period was so good that North American commentators, including very senior ones, started calling, dubbing, Australia the miracle economy. But in 2006, as part of a financial sector assessment program run by the International Monetary Fund that came out of the interminable meetings that followed the Asian financial crisis, we in Australia received a visit from a very smart team of IMF officials. I remember I was a member of the Council of Financial Regulators at the time because I was Treasury Secretary. It’s a four-person council that’s chaired by the Reserve Bank governor. Treasury Secretary sits on it, the chairman of APRA and the chairman of ASIC sit on this four-person council. And we had a preliminary meeting.

It was like day one of this group being in Australia, and the mission leader said, ‘Look,’ – and we’d supplied them with boxes and boxes of documents before they arrived in Australia, so they were incredibly well briefed – and he said, ‘Thank you for all the material you’ve provided, and I’m pretty sure, like, I can’t prejudge this, but I’m pretty sure that in six months’ time, when we come back and talk to you, we’re going to say the Australian financial system is very robust. You’re doing everything right. But there’s one thing that worries me.’ ‘Oh, what’s that?’ He said, ‘The one thing that worries me is your reliance upon short-term debt flows to finance what’s going on in this place, and it’s all intermediated, or largely intermediated by your domestic banking system.’ And he said, ‘I don’t actually quite know what to make of it, but it has me a bit worried.’ And I’m thinking, ‘Oh, he’s a debt and deficits guy,’ right? That’s what he is.

Anyway, we politely wished him well and off he went. And six months later he came back with his team and he said, ‘Well, you know, this has turned out very much as I thought it would. Australian financial system is in really good health, you’ve got very well-regulated institutions, your regulators are world class, you’ve adopted all these relevant international standards,’ blah, blah, blah. ‘But there’s one thing that worries me,’ and he said, ‘after six months, it worries me even more, and that’s your reliance upon short-term debt flows.’ So, then we had a conversation about, and I remember saying to him, ‘Let’s think that through.’

‘So, in what circumstances,’ so this is 2006, ‘in what circumstances should we be really worried about that? We’ve done everything we possibly can in terms of policy settings and institutional settings, and so on. So, in what circumstances would we have to worry about the fact that we are reliant upon this flow of capital from offshore short-term debt? Even if it is short-term debt, why should we be worried about it?’ And we had a bit of a discussion about it and I remember saying to him, ‘I think what you’re saying is that this is something we really should worry about if the global financial system collapses.’ And he just smiled, right? And we just smiled at one another and had a bit of a chuckle and that was that.

But anyway, they printed the report in 2006, and you can go back and you can dig it out, and it has that concern in it. It is in it. It’s sitting in there saying that they’re a bit worried about it. That’s 2006. And two years later Lehman’s collapses and bang. And what do you know? That was our Achilles’ heel. That was the thing that was problem number one for us. And a huge problem was this reliance upon short-term capital inflows. It was the debt and deficits issue recast, but nevertheless, there it was, it was our Achilles’ heel.

[46:16] WALKER: I have three specific questions about that FSAP report.

HENRY: Yeah.

WALKER: And then I’ll come back to the narrative’s question. So, the first question is, does [offshore wholesale borrowing] really matter if the debt isn’t denominated in a foreign currency?

HENRY: Okay. So, we did see this as a big advantage for us that we were able to sell debt in Australian dollar. Australian-dollar debt, right? The issue, though, is that if the debt is denominated in your currency, then the interest, at some point the interest rate should pay again to reflect expectations of bilateral currency movements, right? So, if the people lending you the money think, ‘Oh, there is a risk, a substantial risk,’ the Australian dollar is going to depreciate, right? Then they will demand a higher interest rate to cover the currency loss in the value of the asset that they hold, you know, debt for us, asset for them. So, it can be reflected interest rates. Of course, and the reason for your question is that, there’s no question about your ability to repay the debt in Australian dollar terms because you can always print money, right?

WALKER: Yeah, exactly, the Reserve Bank can be a lender of last resort.

HENRY: Correct. But it can only look, if you were borrowing in US dollars, to some extent, the Reserve Bank could also be a lender of last resort, right, provided it’s got sufficient reserves. But pretty soon it’s going to run out of those reserves, right, of US dollars. And you want to avoid that, so it makes sense, obviously, to be able to issue debt in your own currency. You are then in control of the question of whether you can ever repay that. And creditors, those lending you money, they can drive some comfort from the fact that they will get their money back, but they’re going to get it back in Australian dollars. And what are those Australian dollars going to be worth? And they may be worthless, relative to the dollars that matter to them, which is generally US dollars. In order to protect their own interest rate, they are going to be demanding higher and higher interest rates. And so that’s how the cost is reflected. So, yeah, it matters.

[48:46] WALKER: My second question about the FSAP report is, to what extent is offshore wholesale borrowing still the key vulnerability of our financial system?

HENRY: Yeah, and that’s why I said in response to your earlier question, that even though we’re in a current account surplus position, I don’t think we should be sanguine about the debt and deficits narrative. I mean, we’ve got to be careful about the way in which we interpret it. But one day, hopefully, our investment rate will bounce back. And when our investment rate bounces back, our reliance upon offshore capital, including short-term debt, is going to increase.

Now look, that doesn’t necessarily imply that we’re going to have the sort of extreme volatility ever again that we had in the global financial crisis, and it may very well be that. And there were people, including in the Reserve Bank, and very senior people in the Reserve Bank, who even in the middle of the global financial crisis, said, ‘Well, it makes sense for the government to guarantee these debt lines as a form of insurance. But really, are the capital markets going to remain closed for an extended period or is this just going to be a short-term thing until people sort out who they can trust and who they can’t trust?’ And as soon as they get around figuring out who they can trust, they’re going to look at Australia and say, ‘Well, we can certainly trust them, right, because they never miss a payment. And look at their track record.’

But the general view taken at the time was that it was worth taking out quite a lot of insurance, even if the insurance was going to be expensive. Turns out it wasn’t expensive for the budget at all – we actually made money out of it. But would I be courageous enough to say that we should never expect to see a repeat of anything like the global financial crisis, which at its core, was all about counterparty risk or really about people’s views on whether they could, the extent to which they could rely upon undertakings that were being given by their counterparties in the financial system. And they just lost confidence, lost trust. Lost trust. And it’s trust that holds the whole thing together, really. I mean, contracts, of course, but really, in the moment, it’s trust when you’re picking up the phone and doing a deal. Can you trust the person on the other end of the line?

And that’s what fell apart, really, in the global financial crisis. Turns out the activities of governments were sufficiently swift and large as to be able to rebuild a sufficient level of trust in quite a short period of time. Will that always be the case? I don’t know and I just think that… Well, I don’t think we should assume that will always be the case. And there is therefore, I think, a risk that’s inherent in… Well, what I was going to say is that there’s a risk that’s inherent in a world of mobile capital flows. But even if you cut yourself off from the rest of the world, this risk of one part of the system losing confidence in another player, in maybe the same part of the system or even a different part of the system upon which they rely, that’s still a fundamental question. Right. It’s really at base, how confident can you be that the claims being made by your counterparties and the undertakings that they’re giving you that they can be relied upon.

For the most part it’s been good, but I mean more than good, right. I think actually the ability of the global financial system and national financial systems to be able to intermediate flows of capital that go into building productive capacity and allowing people to buy houses and everything really is an extraordinary success story for economics, really. But there is that fragility, or is it a fragility? Anyway, there’s a risk that’s inherent in it and you can do a lot, of course, to manage that risk, but there will always be residual risk – always – sitting out there in the tail somewhere, right, that most times you can ignore. Turns out you can safely ignore what’s sitting out in that tail, but every now and again that tail is going to whip you.

[54:45] WALKER: My third FSAP question is, by the time the financial crisis struck, only three of the 183 IMF member states hadn’t completed their FSAP and one of them was the United States.

HENRY: Yeah.

WALKER: How much would it have helped the US if they had that FSAP report, or was the pain already baked in?

HENRY: They wouldn’t have taken any notice of it.

WALKER: Because of the politics?

HENRY: Well, I don’t know, it’s certainly not Big P politics.

WALKER: Right.

HENRY: It is that the IMF, I think generally the IMF is incapable of criticising the United States in any meaningful fashion.

Well, at least it was. I don’t know if that is still the case. So that’s the first point. Second point is, were the IMF to do so, I don’t think the United States would have taken any notice. And why? Well, look, I just think the domestic scene, and you can call it politics, the domestic political scene, then, in the United States is impervious to international criticism. And that’s what this would have been seen. It would have been seen as an international organisation taking a potshot at us. And I think that’s generally true of international organisations. It’s just a general… I’m no expert on the psyche of the United States as an entity, if it’s legitimate to talk about such a thing, but I think they’re pretty impervious to international criticism.

Maybe this is part of the when people talk about US exceptionalism, maybe it’s part of what they’re talking about is that the United States sees itself as standing apart. And there’s… I mean, I delivered a speech at the ANU in 2004, which was was a Bretton Woods’ sort of function. And I reflected in this speech that on the history of the Bretton Woods institutions and what I saw as their declining effectiveness. In part it was a consequence of their own success, which is that, remember, when they were established, they were established in a world of fixed exchange rates. And the IMF and its principal lending programs were actually designed to forestall or deal with a balance payments crisis in a country that’s got fixed exchange rates. Right? Where, as were talking about before, it experiences capital outflow and a central bank for some time can actually meet the outflow from its reserves, but then the reserves are drained very quickly. This is what we saw in the Asian financial crisis. Bank of Thailand – I don’t know how many days of reserves they had, but it disappeared pretty quickly. Right. And then the Thai baht just tanked.

And when you move to a world of flexible exchange rates, it’s just much less likely that anybody’s going to need to rely on the International Monetary Fund for support, for financial support, because how do you have a balance of payments crisis in a world of flexible exchange rates? Right? I guess it’s possible, but it’s just very unlikely. It’s probably not the problem you’re going to be dealing with. And so, did countries, really, in this world of flexible exchange rates, did they really have to pay that much attention to what the IMF was saying?

One of the good things about Australia is – was – that in that period, certainly up to the global financial crisis, we were as a community broadly defined, highly sensitive to international criticism. Whether it was the OECD, the International Monetary Fund, The World Bank to some extent. Not the United Nations, somewhat deplorably, but anyway – they could criticise us all they like about the treatment of asylum seekers and so on, and nobody seems to give us stuff. But if you’re talking about financial matters, then Australia has historically been quite sensitive to that sort of criticism. You don’t see it in a lot of other countries, but you most certainly don’t see it in the United States. So, yeah, you’re right. The United States was one of only three.

Anyway, in that 2004 speech, I said that, you know, I pointed out that there’s no reason for the United States to take any notice of the IMF. And I said that – and this was true at the time – that the United States was had become the biggest debtor nation in the world, right? And it was borrowing from the rest of the world to fund its current account deficit. And, of course, it was actually borrowing most, certainly more than half and, in some months, all of its borrowings are being funded by the People’s Bank of China, right. So it was selling US treasuries to the People’s Bank of China, which was just rapidly building up huge stores of US treasuries. And I just said, and I thought it was kind of obvious, that the biggest risk to the global financial system right now has to be the United States and the quality of its domestic financial system. That was in 2004. And the IMF had drawn attention to this earlier in 2004. This was not a novel proposition, it’s just that nobody took any bloody notice of it. And certainly in the United States they didn’t. But when I said it in Australia, a lot of commentators got stuck into me, said, ‘What the hell are you talking about?’ Blah, blah, blah. ‘Unnecessarily alarmist. And anyway, it’s not true,’ and blah, blah.

The United States should have been acting on its financial systems’ fragilities through those early years of the 21st century. After the collapse of Bear Stearns, I found myself accompanying Treasurer Swan on meetings in Washington and New York. So this was early 2008, it was before Lehman’s collapsed. And I had – we had – he was actually the Treasurer, of course, who was the principal interlocutor in the meetings, obviously, and I was there supporting. But I was absolutely amazed at the things I learned about the poor quality of US financial system regulation. I mean, absolutely gobsmacked. And I remember we were walking down the steps of the Federal Reserve and I said to Wayne Swan, because we were reflecting on the rescue that the Federal Reserve had been instrumental in or had organised the rescue for Bear Stearns. And I said to Treasurer Swan, I said, ‘God, heaven help the next US investment bank that gets into trouble.’ And he turned to me and he said, ‘Why do you say that?’ And I said, ‘They’re going to let it go. They’re going to let it go.’ And so, when Lehmans got into trouble and they let it go, I was not at all surprised.

WALKER: You knew that because they’d been so defensive in the meeting.

HENRY: Hugely defensive. Like, I couldn’t believe how defensive and I’m not going to name names of who were talking to, but I could not believe how defensive they were. Anyway, I formed the view that they had been so beaten up over what they’d done by, I don’t know by whom, I have no idea. But anyway, so they were so shell shocked they wouldn’t do it again today. Of course, today, they would do it again. Right. I mean, I think they’re different now. It’s a different institution. But in those days… Can you remember in the UK as well, I mean, it was Northern Rock? That was earlier – if my memory serves me correct.

And before Northern Rock collapsed, you had Mervyn King as Governor of the Bank of England talking about the evils of moral hazard. Right. And he was trying to get out I think he was actually trying to get out ahead of all this. He saw that there was a possibility of financial institutions collapsing and he wanted to lecture the policymakers in the United Kingdom. And I understand they took umbrage at this small wonder, but he wanted to give them a lecture about the evils of moral hazard. And there were people in the United States who had a very similar perspective, were also convinced that moral hazard was such an evil that you had to be prepared to allow even systemically significant institutions to fall over, even if people’s lives were ruined.

As a consequence, people had to learn, even if learning the hard way about the risks that are involved in the economic system that we have was gobsmacking.

[1:05:37] WALKER: To go back to the mid 80s, when Keating was constructing the Australian mercantilism narrative and the debt and deficits narrative, at the time did you have any sense that these narratives would eventually metastasise?

HENRY: No, I didn’t. No. Oh, God. Now you make me feel really uncomfortable. Because I’m now asking myself the question, suppose I did, what would I have done about it? And I was so impressed by what Keating was doing. If I’m to be honest with myself, I don’t think I would have dissuaded him or sought – not that it would have been effective – but I don’t think I would have sought to dissuade him from using it, even had I seen how it was going to be brutalised, really, by the Australian political system subsequently. I’ve never reflected on that question before, so thank you for asking it. And I feel a bit uncomfortable answering it, but I think that is the truth.

I’m not generally in the ends-justify-the-means camp. Not generally, because I think that so many of the things we regard as means are significantly important ends in their own right. Yeah. But I think I would have forgiven him this one. And I forgive him, in retrospect. I don’t think one should blame him for having constructed that narrative just because others have used it for base political purposes.

[1:07:36] WALKER: What gives a politician a talent for crafting compelling narratives? Because presumably smarts or intelligence isn’t sufficient. Plenty of very smart politicians who failed miserably at this. What gives one the ability to be good at crafting political narratives?

HENRY: Again, I feel like I almost have to answer this question the way I imagine Paul Keating answering it, and I think he would say, you’ve got to be a storyteller. You got to be comfortable with telling stories. I mean, more than comfortable, you have to like telling stories. And it’s more than being a raconteur. It has to be stories that expose people’s minds to things that… either things they would never have thought about or to thinking about things in a completely different way, in a way that they’d never thought about them before. And he had the capacity to do that, right. To just completely wrong-foot you, then, to get you to think about an issue in a completely different way and then to make you feel comfortable and safe again. And that’s, I think it’s quite an extraordinary ability. But if you’re not drawn to the storytelling business, then it’s probably not a game for you.

Actually, my younger brother said to me, somewhat unkindly the other day, and he’s a mathematician, theoretical physicist, and he said to me, somewhat unkindly, and yet it’s true, he said, ‘Is economics really anything more than storytelling?’ Well, it’s probably not really.

WALKER: Storytelling through models.

HENRY: Yeah, storytelling through models. Well, it’s the models that give you some confidence that there’s an inherent logic in the argument. Okay. Even though you have to accept that the model itself is going to be flawed. I mean, it’s going to be flawed necessarily in respect of scope, because a model can’t possibly incorporate everything that you see out there, and it’d be of no use if you tried to construct such a model. But it’s also going to be flawed in respect of the assumptions upon which it has to rely. Right. And so, it’s necessarily going to be flawed in those respects. But even accepting all of that, it’s the model that’s going to give you some confidence in the intellectual rigour of the argument. But then you have to convert that formalised model into something which is a really compelling story, a story that grabs people’s attention.

And more than that, and it’s not just a story. There’s something quite unusual about these stories that we’ve been talking about, which is that you want the listener to become a part of the story as it unfolds. You’re not telling an historical story. You’re not telling a story in history. You’re actually talking about a story of, yes, the present and to some extent, the past. Yes, but more importantly about the future. And you want these listeners to be a part of that story, players in that story, participants in that story, and feeling good about the development of that story as they go along. It’s quite an unusual storytelling quality, really, that is needed of our leaders. But it’s always been true. I mean, I think it’s always been true.

And you go and read Shakespeare’s words on the great leaders, you know, on which he spent a lot of time. All flawed characters, of course, but nevertheless, their stories were largely about encouraging others to be part of a different future from the one that was actually confronting them, whether in the near term or the distant term.

WALKER: Yeah, that’s really interesting. I mean, yeah, you’re right. That’s what separates political narratives from history. Political narratives connect past, present and future.

[1:12:29] I want to ask you some questions about Treasury and the public service, but let me segue way to that from narratives by asking this question. So traditionally, there’s been this distinction between the sort of work that a government agency like treasury would do, which is almost like the object-level policy analysis, and then the storytelling aspect or the crafting of the narratives is left to the politicians, to the government. In recent years, economists like Bob Shiller have started talking about the importance of narratives in economics as something that should actually belong in the object-level economic analysis. Bob has a book called Narrative Economics. Should Treasury actually be prepared to provide advice to the government on economic narratives and which economic narratives will work?

HENRY: Yes. And my answer to that’s unequivocal.

WALKER: Did that happen when you were in Treasury?

HENRY: Yes, it did. Yeah, it did. I mean, that’s actually what motivated a lot of the work that we did on well-being. That was about us... I mean, weren’t asked to do that. Nobody said to us, ‘Oh, we’d like you to think about a well-being framework to guide the way that we, the government, think about economic, social and environmental policy.’ No, we constructed this well-being framework ourselves to be able to recast narratives that we presented to government in the expectation that the government would then change its own narrative or broaden its own narrative to deal with some really, really difficult issues. Think of entrenched Indigenous disadvantage, for example, where… And that’s not a success story, right. But the narrative did change. The narrative did change.

Look, I think without the change in the narrative, it would have been really highly improbable that the Closing the Gap narrative would have been constructed. I just don’t think it would have. And the notion of – which has not been well respected, but nevertheless is understood within government and has been for a long time – the notion of involving Indigenous people at the grassroots level in discussion, sorry, policy design, the design of policies, that will improve their circumstances. That notion, I think the well-being framework did make a contribution to that as well. Not that it’s a novel notion. I mean, it certainly wasn’t a novel notion at the time. Many Indigenous leaders had been banging on about it for decades, right. It was just that there was a tin ear in Canberra, really, I think, until we started having those discussions about a broader framework for thinking about progress – economic, social and environmental progress, but particularly economic and social.

And so, yes, I do think that should be a core competency of an economic policy agency. And that was my view at the time. I remember – here’s an interesting thing – when I had shortly become what’s called a band 2 SES officer in most government departments in Canberra – these days that position is referred to as a first assistant secretary; in the military, it’s a two-star general, right, so that’s the level we’re talking about; I mean, in the army, it’s a two-star general, major general – and I attended a residential leadership course. I think it was in Bowral, if my memory serves me correctly. It was five days and one afternoon we had a fellow come in full of enthusiasm with literature that had been that had come out of the Harvard Business School, and it was all about strategic alignment. And he had this, and I don’t know whether he was relying on any literature or whether this was just his own bright idea, but the proposition that he was putting to these relatively senior public servants was that we should think about strategic alignment in the same way that businesses think about strategic alignment. And of course, what he was talking about was businesses identifying their customer base and then understanding everything about their customers. What is it that makes some tick? If you want to be successful as a business, you really got to understand your customers, right? These days it’s called customer centricity.

I mean, who would have thought, right. This is a really amazing idea. But then he was saying, and what that means is that in the private sector, that means you should think about even your organisational structure in terms of how you can best match the personality. You can see where this is going, I suspect, but anyway, match the personality of your customers, right. And then he said, ‘And that’s how you should be thinking about your own departments.’ And he went into it, you know, ‘You really got to understand what makes the minister tick. Everything about the minister.’ And I was getting increasingly uncomfortable, right. There were 22 or 23 of us sitting around the table. At some point, I put up my hand and I said, ‘Excuse me, what if your minister is an idiot?’ And he was uncomfortable. I think everybody in the room was uncomfortable, right. But seriously, what if your minister is an idiot?

And then, actually, he dealt with the question. I thought I was surprised at how well he dealt with the question, but then I said, ‘So are you saying…’ I said, ‘Sorry, let’s take this up one other level. Another level, right. So what then about the minister? How should the minister be constructing his or her own persona? I mean, who is their customer, right? Or is it even valid to think about a minister as having a customer or a set of customers for whom they are seeking to deliver high-quality product? And maybe it’s the case that ministers are just responding, in the main, just responding to events.’

And this was, I know, quite a radical thing to say, but I said, ‘Is it never appropriate for a public servant, even a senior public servant, to go out into the public arena and construct such an event, the narrative for such an event, anyway, right. Because maybe that is, in certain circumstances, the way to have maximum impact. In certain circumstances, maybe you should be seeking to influence the truly external environment, the one in which both you and the minister are operating, right, and not just rely on a conversation between you and the minister as to what should be happening.’ And I think I mean, I got some support for that view subsequently. Not in that room, not at that time. I think everybody said… not everybody. There was a rear admiral who thought it was quite a reasonable proposition, although he didn’t disclose that at the time. He disclosed it to me the following morning at breakfast when he said, ‘I didn’t realise how similar treasury and defence are until you made that comment.’ And I said to him, ‘Well, you shouldn’t assume that this is treasury speaking, this was just me.’

But subsequently, I think, at least for a period, there was an acceptance of senior public servants having voice in the public square, provided they were not embarrassing the government nor embarrassing the opposition, not embarrassing the political players, but nevertheless talking about the challenges confronting the country and, in general terms, about the sort of policy directions that would probably have to be followed if we were to avoid the risks, the traps associated with those challenges, or make the most of the opportunities that those developments present for the nation. There was some level of comfort with that. I would say that during the ten years of the former government there was no comfort with that, excluding in the national security and defence space, which is quite extraordinary. But I did think that’s the case and I think we lost a hell of a lot because of that.

You see, one of the things one of the deep flaws… Is it a flaw? Well, let me talk it through, see if it’s a flaw. I think one of the deep flaws in our system of government is that we rely upon adversarial instruments for almost everything, right? Well, our political system is adversarial, our legal system is adversarial. Actually, the capitalist model is adversarial in its construction, right? That you got businesses out there doing nothing other than seeking to maximise profit. It’s up to the rest of us – actually, that was the phrase that Milton Friedman used – the rest of us to use our agency as citizens in a democracy. He didn’t quite use that phraseology, but that’s what he was talking about. To force these to elect politicians who would frame rules and regulations and would resource regulatory agencies and the judicial system such that it would force profit maximising businesses to operate in a competitive manner without fraud or deception being inflicted upon the public, that in its construction is adversarial. It sets the corporation up against the rest of us, right. And the rest of us having to get in there and muscle it. So much of it is adversarial and one of the consequences of that is that the sort of institutions of civil society that you necessarily have to rely upon to keep the political actors honest, or at least to call out the bullshit, is that they get seduced into reporting the contest rather than what is at contest, right. So they become no more than enthusiastic commentators of a gladiatorial spectacle, right.

You even think about, as I have done and had to, the way that the Financial Services or Banking and Financial Services Royal Commission was constructed. It became, and I think quite deliberately, a reality TV show. And what was reported overwhelmingly wasn’t the substance of what was being discussed, but rather the arguments that were being put on either side and who performed better. So, who won the gladiatorial contest? And you can understand why, but you need to have a voice of the experts that’s external from all of that and which precedes all of that, that is calling out the bullshit when the bullshit is being espoused by the politicians or whoever they are, really the redneck commentators or whoever, right. And I think we’ve lost a lot of that.

And maybe… There’s a lot of people who point to social media here and say, ‘Oh, well, it’s a all social media. It’s just kind of oxygenated the place so much that considered analysis from respectable commentators and even considered reporting of what’s going on by responsible journalists, it’s just all too hard. And, you know, that’s probably true, but only to some extent. I remember even before I entered the public service, when I was still a junior academic, I was a junior academic in New Zealand in the last years of the Muldoon government, right, there was no social media. There was media. There were two publicly owned television stations, TV One and TV Two. And when parliament was sitting, every afternoon when parliament was sitting, Sir Robert Muldoon would call a press conference. There were two TV cameras in the room and TV camera operators, and maybe one or two or three journalists, and he would say something outrageous and it would lead the evening news, both channels. So, when New Zealanders were sitting down, tucking into their dinner, watching the evening news, they saw Sir Robert Muldoon saying something really outrageous, but quite entertaining, usually highly divisive, disparaging his opponents, and quite often disparaging Australians, by the way, because it worked really well in New Zealand.

WALKER: Punching up.

HENRY: Yeah, punching up, exactly. And at the time, I thought, this is just populist crap. How can these journalists allow… Why do they even show it? Right now I know they showed it because he yielded the purse strings, right? But actually, I think there’s always been a temptation on the part of even good journalists to report on the punches being thrown more than the reason for the punches being thrown, right. So, it’s a real trap. And I think that in Australia, over many years now, we’ve lost something that I think we once had. Maybe I’m just looking back with rose-tinted glasses, probably am, but… I think there was a time when we had media that were less inclined to be seduced by that kind of stuff and more interested in the substance of the issues. But we also had academics who were in the public place, experts, I mean, genuine experts, right, who were in the public space, seeking to educate the public about these things.

Now, we haven’t lost that entirely, and publications like The Conversation have gone a long way. And I think I mean, what you do, right, what you do through your blogs in getting to the heart of the issues and not just the personalities, right, that kind of stuff, I think, is really important, and we need more of it, right, to hold this show together, because there are dangers inherent in the adversarial contest that really could blow the whole place up. This is what Trump was doing in the United States. Sure, he was being advantaged by social media. I would wake up, as you would every morning in Australia, but in the probably 12 months or 18 months up in the run up to the last presidential election, you’d have awoken up every morning to the lead story on the news being something amazingly ridiculous that Donald Trump had tweeted overnight, right. The whole world was…

WALKER: I miss those days. [Laughs]

HENRY: Yeah, right. See, I think a lot of people do, right. They didn’t miss it because of the entertainment in it. But here’s the thing… So, the Robert Muldoon thing tells me that even without social media you would have been waking up to that stuff. He would have found a way of getting it on the TV cameras and we would have got it if it’s sufficiently outrageous, we would have got it, right, because people are just so drawn to the drama and theatre. And as much as they say, ‘Oh, I hate politicians’, they love the entertainment content in the political argument.

And then the last thing I’ll say on this point well, I should never say it’s the last thing I’ll say, but you know what, I have had very senior ministers open up to me and tell me things as troubling as, 'You know what? I’ve never had any interest in policy. The only reason I came into parliament was because I was a good barrister, and I enjoy the argument.’ Because if you’re going to have that sort of adversarial system where what’s valued is the perceived quality of those engaged in the combat, those are the people who are going to be drawn to it, right. Think also of the dumbing down of debate that you get when interviewers, unlike what you do, because you’ve let me rabbit on and on and on. But when interviewers say, ‘Look, we’re about to go to a break,’ – by which they mean we’re about to earn some money from advertisers – ‘we’ve only got a few seconds. I’m going to ask you a really complicated question and I want you to give me a three-word answer,’ right. And what are you going to get? Well, you’re going to get a three-word slogan and small wonder that eventually Australia ends up with a politician like Tony Abbott. What do you expect?

So, there are real risks in this and we’ve got to be alive to those risks and we got to make sure that the other institutions of society are capable of, and really do contribute to a better informed public. And I do think that leaders of public institutions, including institutions like the treasury, do have a role to play here.

WALKER: That comment that minister made to you is disturbing. For me, it’s also indicative of this kind of culture of individualism that emerged in the west beginning around the 1970s, where now you have this whole class of politicians for whom a seat in Parliament is a prize rather than a responsibility.

HENRY: Sure. That’s the goal.

And hanging onto it at all costs is the goal, no matter how many deals you have to do with the devil.

WALKER: Yeah. And regardless of what policy you actually get done.

HENRY: Yeah.

[1:33:41] WALKER: A few more questions about the public service. So, when I was preparing for this conversation, I read a Canberra Times article about you from 2006 that mentions you putting in 100 hours weeks at the treasury in the 80s and 90s, and it also mentioned this anecdote about how in the mid 80s you would slip a tax draft under your division head, David Morgan’s door at like 3 a.m. By 8 a.m., he’s up and he’s read it and responded to it.

HENRY: Yeah.

WALKER: 100 hours weeks is a lot. Was that A) something unique to treasury because it’s got things like budget week it has to deal with; B) something unique to the reform era and the sort of esprit de corps of the 80s and 90s; C) something unique to senior officials; or D) something unique to Ken Henry?

HENRY: B and A, and probably in that order, because I was not unique. Certainly was not unique. There are a team of us who are working those sorts of hours. And look, not all the time, obviously. I mean, you can’t work those sorts of hours all the time and survive for very much time. But there were several times in my treasury career going for several months at a time when, yes, I did work those sorts of ridiculous hours. And the only reason I know it’s 100 hours is that during the 1985 process, you know, I referred to this earlier, where there was just maybe a bit more than one handful of policy officers who were working on the content of what became called the Draft White Paper on Tax Reform.

And, at some point, Paul Keating, observing the sort of hours that were working, said to somebody more senior than me in the department, ‘Are these people getting paid any overtime?’ And actually, I don’t know if you know this, but once you reach a certain level in the public service, you don’t qualify for overtime, right. Anyway, were all at that level. No, there was one person in our group who was below that level, but all the others were at that level or above. So, we didn’t qualify for any overtime at all. The answer was,’Oh, well, actually, no, I don’t think any of them are being paid overtime.’ And he wasn’t aware of how many hours we were working, but he knew that it was ridiculous.

And somebody senior in the department said, ‘Well, I think you better keep timesheets for the next three months. Keep timesheets, right, and we’ll see if we can do something. We’re not compelled to do anything. You don’t deserve overtime pay, but we’ll see if there’s something that we can do.’ And so I did and then I totted it all up and over the three-month period, it averaged 100 hours a week. And, ironically, I should have been smarter, I should have figured this one out. But of course, when you calculate how much overtime I would have been entitled to for that three-month period, it was larger than my annual salary, right. So it was so big that I didn’t get a cent. I should have been smarter. I should have said 70 hours, it was 60 hours, even 45 hours, I would have got something. But at 100 hours, I got nothing, right.

But during budget week, more than budget week, during the run-up to the preparation of the annual budget, there are people who do work those hours in treasury. Yes, there are. And then, at particular times, like that 1995 tax summit yeah, it does happen. And it’s, of course, it’s not appropriate, right. And yet there is something in it that speaks volumes about the sort of organisation that that place is, at least was, and I’m sure still is, and there isn’t a esprit de corps in it. And look, some politicians are working those sorts of hours, too, right. I mean, people don’t, most people have no idea of the hours that politicians work. And maybe it’s not all work either. Maybe it’s not all what you and I would regard as being worthwhile work, but it is part of their job, or they won’t survive in their job if they don’t do it.

That kind of stuff does happen. But it’s also true. The D is also true, because I could have opted out, you know, obviously, and I could have said, this game’s not for me. And of course, there were times when I had that feeling, of course. But you go on. And it’s for the reason that I mentioned in answer to your very first question. Those periods are just a blast, an absolute blast. You are full of adrenaline and you just go on and on. And it’s probably both a good thing and a bad thing that humans are capable of that sort of thing. You see it all over the place, not just in policy development, right. And sometimes it’s for the good and sometimes it’s actually for the bad.

[1:39:09] WALKER: So, Ken, you can correct this if it’s wrong, but I heard a story that you famously wrote Prismod in 1991 on about 20 odd sheets of paper one night. And those sheets of paper may have even been a translation from, like, the back of a coaster or a napkin hastily written on late one night in a Canberra restaurant. Is that anecdote correct? And how much of policy happens like that? Like a brilliant public servant just kind of whipping something up versus a slower, more formal process?

HENRY: I don’t know the answer to that question. Oh, sorry. The first part of the question that’s broadly correct, at least the architecture of Prismod of course. Prismod is a huge model and ended up being the, I think the OECD certainly described it as the most detailed economic model that had ever been constructed. It probably was, but there’s a reason for that which we can go into if you want to, but it doesn’t really matter for this question. But so, it’s broadly correct, the architecture. How much of… how much of what happens in policy circles happens like that? Yeah, I really don’t know. But I’ve seen enough instances of people having brainwaves and those brainwaves subsequently translating into big things that… I can say it happens a bit. Probably doesn’t happen enough.

It’s easy to say that the public service is structured in such a way that it has insufficient flexibility and gives people insufficient authority to be able to behave in that manner. That’s probably true, but it certainly wasn’t true of the treasury, not from the day I first joined it. One of the strengths of that institution was that you could be a graduate recruit and you could have an idea that challenged orthodoxy and you could expect people to take notice of it. I mean, they might tell you, ‘It’s complete crap and go away and grow up,’ but that’s also part of what, well, was… a strength of the department was that whether you’re going to be listened to or not, whether notice it’s going to be taken of your idea or not, dependent upon rank? Not at all. I mean, just not at all.

I hope that’s still true. But it was true. And yeah, I saw enough of those people having a brainwave and things happening as a consequence to know that it is quite a feature of, or has been quite a feature of public policy.

WALKER: So took you and about five other people about five months to build Prismod. How long would such a project take nowadays? And what was the main constraint back in 1991? Was it software? Hardware?

HENRY: Oh, actually, I think it would take longer now.

WALKER: Really?

HENRY: Yeah, because I don’t think people would work those hours. But also, even when that project was launched, those launching it knew and everybody involved in it knew, all five of us knew that this was just quite unreasonable. Right. You wouldn’t have been able to…

WALKER: John Kerin gave you about four months.

HENRY: Yeah, yeah. And that was in a, you know, a written document. I mean, it was a letter to the secretary to say, this is what I want and I wanted to have this capability, blah, blah, blah. Now, look, in truth, we could have done a slimmed-down version and we could have achieved, well, I guess, an acceptable outcome in a less stressful way. But several of us, the total was five, a couple of us had been involved in a similar sort of exercise back in 1985. And we were aware, we carried scars from the I’ve used this word a lot today, but brutality of the battles that were fought around the modelling that we had done back in 1985, and having survived that experience, we were determined that what we produced in 1991 would be technically unassailable. That nobody would be able to say, ‘This is shonky. You’ve cut corners, you’ve ignored, blah, blah, blah.’ The data demands were absolutely immense. A lot of data, what you would call data, had to be constructed from scratch.

Think about this, right – maybe this is one way of describing the challenge. So, imagine a matrix that’s got 109 different industries identified. So that’s your columns, 109. And then it’s got 1400 rows and those rows identify commodities that are purchased by those 109 industries. So, 1400 commodities purchased by 109 industries, right. That’s got some scale that’s big. And then you say to somebody, and this is in the days before the GST, so we had, I think at the time, it was the world’s most complex indirect tax system – multiple rate wholesale sales tax excises – and these things were not just levied at final point of sale, right. I mean, wholesale sales tax, obviously not. So, they applied to industry purchases of commodities, of product. And we had to know with some level of precision how the wholesale sales tax revenue was distributed across all those cells, right. Well, nobody’d ever done that before, and why the hell would they. It took months for a couple of people, and it was only a couple of people because we couldn’t afford any more in terms of resources. It took them months to get their head around that question.

And it’s just a I mean, you could say, well, it’s just a statistical exercise, but they had to do it with a high level of precision. That had to be unassailable. And of course, what they discovered, I mean, they discovered all sorts of things like, we should be collecting more wholesale sales tax revenue. If the base is really that big, then how come we’re not collecting enough whole sales tax revenue. And then in other cases we’re getting more whole sales tax revenue than that. That suggests that the ABS’s input–output data are wrong. And so we had this toing and froing with the ABS and they did amend the input–output data on several occasions because of this exchange. It just doesn’t make sense. We can’t make sense of this. So, we ended up creating data sets that had never previously existed and we ended up helping the ABS revise, I’m not saying a complete transformation, don’t get me wrong, but nevertheless revise in important ways data sets that have been around for quite a while now.

It probably helped us that one of the members of the team, and indeed a fellow who is very close colleague of mine, unfortunately now deceased, but who went through the 1985 exercise, we sat shoulder to shoulder working those hundred-hour weeks through the 1985 exercise. And he was also a member, key team member of this exercise. And at an earlier time in his career, he had spent ten years as head of the input–output section in the Australian Bureau of Statistics and he actually compiled Australia’s first ever input–output tables. And that is, I mean, there is just this chance, right, just extraordinary…

Actually, to clock back a bit, because this is, I think, actually part of the answer to your question, or maybe your earlier question, but in the 1985 exercise we needed to answer questions like this. Well, suppose you replace the wholesale sales tax with a broad-based consumption tax that applies in the following way, at the following rate with input taxing of certain transactions in these places, these places. Zero rating or exemption in these places, these places, right. Adjustments to excises in blah, blah, blah. Now tell me what happens to the CPI? Well, nobody’d ever done anything like that before. And the task was handed to one person because we were a small team, right. And this guy, he was given the task because he had previously worked in the Australian Bureau of Statistics at some stage in the national accounts area. I think he then went on to become quite a good journalist years later. And he spent weeks nutting his hair through this and he produced a piece of paper that was more than 50 pages in length. It was probably 55 – from memory anyway. And I saw this, and I thought, oh, my God. Well, firstly, poor bugger. And then secondly, so now we’re going to be asked, well, hang on, what if I tweak this right here and tweak that there and tweak… then what happens? Are we’re going to have to wait another three weeks while this poor bugger goes through all of this again and produces his workings manually.

And I went to this colleague who I knew had worked in the input–output section in the ABS and I said, ‘You know, what we need here is what in economics is referred to as a price input–output model. I’ve never seen one except in the textbooks. I don’t know if one even exists anywhere in the world, but that’s what we need, and that’s what we need to construct.’ And he just beamed at me, right, and he said, ‘Oh, well, I suppose I do know more about the input out Australia’s input–output system than anybody else, so maybe we could give this a go.’ That was back in 1985. But, see, had he not been there and had I not had what you could call an insight. But, I mean, it was not that big an insight. But do I then ask the question and then get the engagement from him, which was like, you know, was enthusiastic, like, ‘Let’s give this a go,’ right. Then I think maybe that poor bugger would say, ‘Well, this is going to take weeks, and destroy my life for several weeks and, actually, it wouldn’t have worked. It just wouldn’t have worked.’ So, there is something of chance in these endeavours, I think. You can’t plan for it. No, you can’t plan for it because you don’t know what bit of kit, what bit of technology you’re going to need to answer the policy question in a way that will provide the politicians with what they need to be able to run the argument, construct the narrative, convince the parliament, all of that kind of stuff. You just don’t know.

WALKER: It’s a fascinating glimpse into how policy gets made. It’s also interesting that there are these decisions that affect the wealth of nations, and they’re based on the policy and the advice that the public service provides. And ultimately, you can trace that back to one guy kind of hunched over his desk, working 100-hour weeks, and it all kind of hinges on the quality of his work.

HENRY: Yeah. Or her work.

WALKER: Or her work.

HENRY: Right. But that is true. Yeah, it is true.

[1:53:29] WALKER: I learned a fact about you when I was preparing for this conversation, and that is that you’re colourblind. And I wondered whether that ever caused any issues when you were reading charts as Treasury Secretary?

HENRY: Oh, come on. You are too well briefed. You are too well briefed. Yeah. And I know this became something of a running joke, particularly during the Global Financial Crisis...

WALKER: ...when there’s like, a red and a green line or something…

HENRY: Magenta.

WALKER: Magenta, okay.

HENRY: Magenta was the colour that I settled on to highlight. I wasn’t even aware that such a colour existed, because being colourblind, well, why would I? But in having charts prepared for me to look at and then think about presenting to Kevin Rudd, in particular, and Wayne Swan, that group in the global financial crisis, people got to learn that there were particular colours that they had to use. So, there was a colour… I know they developed a colour palette for me. Bizarre.

But anyway, it worked for me. I could see these colours. The most outstanding of which was this... it looked iridescent, that magenta colour. And I know Kevin Rudd, at some point, he said, ‘Why, why, why this colour?’ And we had a bit of a joke about it for years afterwards. He’d ribbed me about the magenta line on the chart. The magenta line was always the one that I wanted to emphasise, so the one that I wanted anybody in the audience to take most notice of. I have no idea whether it stood out for them the same way it stood out for me.

[1:55:27] WALKER: Two more questions about public service and then I want to ask about recession and financial crises. Yeah, so when Terry Moran was appointed Secretary of the Department of Prime Minister and Cabinet in 2008, he said, and I’ll quote him here, ‘I’ve had a fortunate career, having often been in jobs where I have been able to make a difference. It’s not been about boring administration, but about improving things — the Benthamite concept that the role of government is to achieve the greatest good for the greatest number.’ And it got me wondering, I’m not sure whether you have thought about this, but does the Australian public service have a uniquely utilitarian atmosphere or are all public services in Anglosphere countries naturally quite utilitarian?

HENRY: So, I think most are, even those that don’t think about it. But no, the public service doesn’t have that as a philosophical framework, even though great chunks of it do. And look, most people in the treasury would certainly start with a utilitarian, indeed, even welfarism perspective. Just a sum ranking of outcomes to assess the relative merits of different policies or different policy options, and also to assess things like the big question: Is human progress improving or is it not improving? And I have a lot of time for utilitarians and I’ve got a lot of time for that perspective, but it’s not my perspective. For example, I think that there is a case for in exceptional circumstances, maybe – but these exceptional circumstances are always present – of improving the circumstances of the most disadvantaged in society. Even if you cannot demonstrate that lifts the sum total of utility across society.

There are a lot of utilitarians, I’m sure, who would be jumping up and down listening to this, saying, ‘Well, that’s just ridiculous because you can’t even conceive if such an intervention, namely something that would improve the lot of the most disadvantaged, would not also result in an increase in aggregate utility.’ But I’m not sure that that is the case and I wouldn’t want to constrain my thinking to possible policy interventions that had to satisfy that test.

WALKER: The reason I ask is, some people think that Australia has like a uniquely utilitarian or Benthamite political ideology, sort of embedded in our political DNA from the days of Chartism and the Harvester Judgement

HENRY: Yeah, it really is powerful in Australia and may be more powerful in Australia than in other places. And, by the way, one of the other – and this is not by the way actually one of the really attractive features of that – is that people don’t get so hung up on concepts of procedural fairness like rights and liberties and things like that, and storm the barricades if their individual personal liberties have been infringed in some arguable way. That’s a real attraction of the utilitarian discipline, is that you’re focused on the outcomes rather than, say you’re focused on the ends rather than means, if you like to go back to something I was talking about earlier. And you are not going to be distracted by or you’re not going to allow concepts of procedural fairness to interfere.

But then, on the other hand, you’re on a slippery slope, I think, or at least in my view. I don’t want to insist on this, but and I don’t think I’ve ever insisted on it, but my own view is that there are some aspects of a rights-based approach that are just in some circumstances so foundational, so fundamental, that if they were not delivered by a system that was just focused on some ranking and the aggregate sum of individual utilities, then the society might well be brooding the seeds of its own destruction. And I mean, the most obvious thing to say there is that you’ve got to be worried about distributional consequences and not just aggregate. And you can’t draw comfort from the fact that… Well, you can draw some comfort from the fact that the aggregate condition is improving and that the majority of people are getting better off. You can draw some comfort from that, but you got to allow yourself to be embarrassed by or bugged by the fact that some people really are missing out and maybe missing out for generations, maybe. And that it is incumbent upon people with policy responsibilities to pay particular attention to those cases. I think so, but yeah, but there is a strength… Look, I don’t want to be too critical of those who are firmly wedded to utilitarianism because I think it has enormous strengths.

WALKER: I think in many ways governments have to, be people almost expect their government to be, utilitarian.

HENRY: I think they do. Yeah. I think they do. I think they do. And that’s… Look, it’s got to be a hell of a good starting point, right? More than anything else that I can imagine. It’s just that I want them to be particularly focused in particular areas and not allow themselves to get relaxed by what’s happening to the average or the majority or whatever.

[2:02:56] WALKER: So, many biographies have been written of political figures in Australia. Is there anyone in the public service, living or dead, who would befitting of a 700-page Recollections of a Bleeding Heart-style biography? Are there any public servants who we need to know about?

HENRY: I don’t know. One of the issues here, and it is actually quite problematic, is that… When I left the treasury, of course well, not of course, but I did have a number of publishers contact me and say, ‘Would you like to write a memoir?’ And I know other senior public servants been asked the same question, and for that, I assume, the same reason. And I assume that what would sell such a memoir is a lot of stuff that would titillate people. Well, maybe I’m being unfair, but things that are more about theatre or the contest than the substance, but also, even when it’s dealing with the substance of issues, what would interest people and understandably is: ‘Well, what did you advise and how was that advice treated,’ you know, ‘What was the response of the responsible minister?’

And I said to the treasurers that I worked for that understanding the difficult position that this could place them in down the track, I said to them, ‘I will never write a record of this. I’ll never write a memoir of this exchange. You know, you don’t have to worry about my ghost coming back to haunt you at any time.’ Because I felt that there has to be a very high level of comfort in the confidentiality of the exchange. Now, I’ve told you a couple of anecdotes, but not anecdotes I think that would, and I certainly hope would not, embarrass any particular minister, and I just wouldn’t do that. I mean, anecdotes come out of those sorts of private exchanges that are had in absolute confidence. And I feel very strongly about that.

So, I think that aspect of the engagement between, or the nature of the engagement between advisors and those charged with taking decisions, I just don’t think that should be exposed in books. So, then the question that’s left is, ‘Well, what is there left to write about?’ And of course, there’s personal stuff, but how important is that? I mean, I think even for politicians, it’s taken on an exaggerated level of importance. Certainly, the public has a right to know, I think, something about the personal lives of politicians, but there’s a level beyond which it gets embarrassing for all concerned, I think, and certainly distracting. It may be diverting, but it gets distracting.

[2:07:11] WALKER: So, speaking of Recollections of a Bleeding Heart, in that book there’s this passage where Don Watson quotes Don Russell saying that, from the Treasurer’s office, he had heard the economy 'snap like a neck' in 1990. The recession we had to have finished before I was born. What are your personal memories of the beginning of that recession?

HENRY: Wow. There were not many people in Paul’s office at the time. It’s not like those political officers – well, sorry, political is the wrong description; that’s the wrong adjective to use. Those Parliament House officers are not staffed sorry, were not staffed in the way they are now. So, there weren’t many people who have a lived experience of that. And Don is certainly, he was much closer to it than anybody else in the office. He and Paul were, I mean, the weight was very much on their shoulders in respect of how to deal with that piece of news. It had been even before that particular national accounts figure came out to confirm that – ywo negative quarters, of course – well, once we got the first negative quarter, there was a high risk of a successor.

But in the quarters leading up to that first negative quarter, I mean we knew there was a significant risk that the economy would go into a recession. The policy action that had been taken was pretty extraordinary. On top of the fiscal tightening, which was being done for structural reasons, not for macroeconomic reasons – we weren’t tightening the budget in order to, well, not principally in order to dampen domestic demand. That wasn’t the principal purpose of it, except in a structural sense. We did want to rebalance private and public net savings balances, but that was a structural thing. That goes back to the conversation we’re having earlier about the current account and the contributors to that current account, of which, and the response to it featured very heavily in the twin deficits proposition that was part of that debt and deficits narrative. But the monetary policy response was just huge.

And, it’s well documented that Paul played a key role – he said himself that he played a key role – in the determination of the interest rate increases that occurred during that period in the lead up to the recession. And Don would have been very much, was very much a part of those conversations with Paul. So, they knew that this was an increasing risk. I’ve certainly heard that expression that they ‘heard it snap like a’… did you say, ‘a neck’? I thought it was a stick. But anyway, that doesn’t matter. Maybe it does matter. There’s quite a distinction between those two.

Oh, hell. That’s a bit gruesome, really.

Yeah, so, sitting where I was in the office with primary responsibility for micro and structural stuff rather than macroeconomic stuff, I mean – not that I was excluded from the macroeconomic discussions – it’s just that I was not as intimately involved as Don was – Don Russell. I didn’t have that sense, although I certainly had a sense that the place was at risk of slowing very sharply. And we did have discussions in the office before the event about the macroeconomic policy structure and the risks that we were taking. And those were open enough conversations. Several advisors with Paul, like: ‘Paul, this is getting close. Like, this could happen. Is it wise to keep tightening? Should we back off a bit?’ You know, and it’s a matter for, of course, it’s a matter for judgement.

But also when Paul said in that first press conference that, ‘This is the recession Australia had to have’, of course he was pilloried for it. And of course, people thought he was being completely insensitive. But if you recall that anecdote that I told you right at the start when he told one of his cabinet colleagues in 1984 who was sweating on decisions that he had taken, ‘Mate, maybe this is not the place for you. Maybe it’s time for you to go,’ there is something in the assessments that Paul makes and the way he communicates them in the moment that can come across as quite brutal and uncaring. But, in respect of both of those, I would argue that one should look a lot deeper into what lies behind those comments.

And, in the years following, quite a few people came to the view that Australia would not have achieved the economic restructuring that it achieved in the absence of a truly deep recession, as ugly as it was. And I’m not saying that excuses it, but it nevertheless may well be an accurate analysis that the high productivity growth that Australia enjoyed through the 1990s and the big structural, the big change or restructuring of the economy that occurred as we came out of the recession of the 1990s might not otherwise have happened. I think, actually, where most economists would sit is they’d say – it’s probably a bit of a cop out, right – but which is that, ‘Well, hang on a second, you should find other ways of achieving that massive economic restructuring. You shouldn’t have to rely on a recession.’ But I think they would also admit that in the absence of that recession, at that time, we would not have achieved such a rapid restructuring of the economy.

[2:14:48] WALKER: I remember reading that you were haunted by one particular statistic that emerged from that recession, and that was that more than something like 50% of men above the age of 45 who lost their jobs just never worked again, which is crazy. I mean, not to put too fine a point on it, but that book I mentioned to you I’d been reading before we started recording – Wellbeing: Science and Policy that Daniel Kahneman recommended to me at the end of the podcast I did with him – in the introduction, they mentioned the importance of employment, and they note that workers who lose their jobs suffer in life satisfaction on a scale comparable with the death of a spouse.

HENRY: Yeah, it’s brutal. It is brutal. And yeah, that’s haunted me for a very long time and it was certainly playing on my mind during 2008. You know, actually, my father is now deceased, and actually died 18 years ago, but in that period, in the late 1980s, as we were having these discussions in the office, I did say to him, ‘Look, this economy is just going nuts’. And it was I mean, were just having this extraordinary boom in the late 1980s. Inflation was one consequence of it, but it was only one consequence of it. The place was going absolutely nuts. And I said, ‘Maybe it is the case that the only thing that’s going to stop this is a recession. Maybe that’s unavoidable.’ And he said to me, and it stuck with me, particularly in the months that followed, he said, ‘Nothing excuses a recession. You can’t allow yourself to think like that.’

My father was not an educated person. I mean, he left school at 13 and was a timber worker almost all his life. But he had that sense and had obviously seen it of colleagues of his who had lost their jobs and it just destroyed their lives. Destroyed it. That was it. They lost the capacity, not just the opportunity to find another job, but they lost the functional capacity to go and look for another job. They’d just been so devastated by the experience. I mean, I don’t know if it’s like many of those who went to war and were not functional when they returned from war, but it’s something like that. I think, the trauma that people suffer and there are just so many elements of loss, aren’t there? Loss of respect or self-respect and certainly loss of pride in what they’re doing for their families and so on, you know, truly devastating.

It’s actually why – and it’s no wonder that Julia Gillard made a point of it subsequently – but I do remember on – when was it? – it was the second weekend, second Saturday in October 2008, when those four ministers met with the first serious discussion about response to the collapse of Lehman Brothers. And Wayne Swan was in Washington, so he joined by phone, but the other three, Julie Gillard, Lindsay Tanner and Kevin Rudd, were in the Cabinet Room and she went straight to that point. She said, ‘We cannot allow this to happen.’

And for that reason, and it hit me like a punch in the guts, because it had not been, up to that point, part of my advice to Kevin Rudd and the other ministers. And it just hit me with a huge force. And I just thought, ‘Of course, this is the lesson that I learned all those years ago. It is exactly this and that’s all we need to know.’ Of course, there’s a lot of other things we can know, but all we need to know is that.

[2:19:56] WALKER: In a senior strategy meeting of the Treasury in 2004, Martin Parkinson, who was sitting beside you, leant over and remarked to you that you and he were the only two in the room with lived experience of the 1991 recession. And I think you interrupted the meeting to say that we need to run some war games.

HENRY: Yeah, I did. We were having discussion about – I can’t remember, it was, I don’t think it was just a macroeconomic policy discussion – and there were about 20 people, 15 to 20 people in the room, anyway the most senior level of the department and we were talking. We used these discussions to discuss policy issues that were really so significant that they affected a large part of the department. And in part it was to deal with the risk of silos that you get in any organisation. But it was more than that. It was part of building and maintaining that… A treasury identity. And it was in that conversation and it had been going on for – I don’t know, I can’t remember how long, but anyway – it had been going on for a long period of time, let’s say an hour. And it was at that point that Martin lent across to me and made that comment.

Again, that struck me with such force that I – and it obviously been something that had been worrying me, I assume subconsciously – because I just immediately stopped the meeting” ‘Stop, stop, stop. We’ve got to have a different sort of discussion about these issues.’ And I said, ‘I think we need to war-game some scenarios. That’s what we need to do. We just need to do that.’ And I said, ‘Martin has just mentioned to me, just made the observation about the depth of experience in the department in dealing with recessions and let’s hope we never have another one. But we of all people should ensure that we’re the people the government tends to for advice if and when we find ourselves in that sort of position.’

The reason I put it that way is that one of the other memories that I carried with me from the recession of the early 1990s is that when the recession was confirmed – I mean, the fact that were in one – the advice that came from treasury was: ‘There’s no case for a large fiscal stimulus and that instead, of course, monetary policy should be eased,’ of course, ‘and that should happen immediately. But as far as the budget is concerned, you should rely upon the operation of the automatic fiscal stabilisers, which just’… Actually, reflecting on it and having gone through that recession and then the response to the global financial crisis and then having left the department, of course, and observed from some distance the government’s response to the pandemic, I actually find that automatic stabiliser narrative quite stupid. Quite stupid.

For the reason that the way the automatic stabilisers work – and what people mean by that is that when the economy goes into recession, the budget goes into deficit – well, like duh! The reason it goes into deficit is because people lose their jobs and tax revenue plummets. And because people lose their jobs, there are more people on the unemployment benefit, so spending goes up and revenue plummets. That’s a consequence of a recession. That doesn’t bring the economy out of recession, it’s just a consequence of recession. So, you’ve now got unemployed people. How does that provide any sort of fiscal stimulus to get people back into work? So, it doesn’t. It’s just stupid. And so, the whole proposition… And look, I’m probably doing a deep injustice to the – because I was in Keating’s office at the time – I’m probably doing a deep injustice to those who were involved in framing the advice within treasury at the time on what the government should do to respond to that recession of the early 1990s. And at the time I didn’t think it was stupid. I just think it’s stupid now, having had the opportunity to think more about it.

So anyway, Treasury more or less said sit on your hands except in the monetary policy area. Well, of course government can’t sit on its hands through a recession, nor should it. And so, what happened was the government and now Keating is now Prime Minister, of course, rather than Treasurer, the government finds alternative sources of advice and those are in other government departments, largely. And then the treasury finds itself sidelined in the process that’s developing a policy response to a recession. Well, that’s completely absurd. Completely absurd. It’s perverse.

I said to the group, ‘We have to make absolutely sure that if the country ever finds itself in those circumstances again, that it’s the treasury sitting across on the other side of the table from the prime minister, not some other agency that doesn’t have our responsibility, doesn’t have our training, doesn’t have our understanding, can’t possibly have prepared as well as we should have prepared for this sort of eventuality. And more to the point, what use are we if we’re not at that table?’ So that’s why we started wargaming.

WALKER: What does a war-game actually look like in the treasury context? Like what’s the output? Is it a model?

HENRY: It’s model driven, yeah.

So you run, you have various macroeconomic models and you run various scenarios through those macroeconomic models that allow you to look at well, firstly, to develop a benchmark scenario. So just imagine that a component of aggregate demand would fall by this much. How many people would lose their jobs? Tell us a bit about where those people are, what sort of people are they? What would happen? What would the monetary policy response be or likely to be? So, what would happen to interest rates? What would happen to the exchange rate? Because that’s also a possible stabiliser that can be helpful, right, in ameliorating the impact of that exogenous loss of aggregate demand in some place. And then, consider various policy responses.

So, what sort of fiscal response would be required to address that sort of demand shock? To compensate for it, if you like. And you can do that all model based, so that’s just model based. And you can run various simulations and scenarios through that discussion, and then you get to the really meaty part of it, which is, well now let’s think about the timeliness of the intervention. By the time I was an undergraduate student of economics, I learned that one of the problems with using fiscal policy as a macroeconomic instrument is that there are all sorts of lags involved in its use. I mean, there’s obviously the recognition lag, but that bedevils monetary policy as well.

So, we didn’t know that the economy was in recession until well after the event, because of the lag in the collection of national accounts. And you can look at indicators, but you don’t really know until that national accounts figure comes out. So, you’ve inevitably got the recognition lag, and then you’ve got the lag involved in developing a policy response, and then you got the lag involved in implementation, like rolling that response out in some way. And that led us to having conversations about the fastest track means of contributing to aggregate demand. And all of our war games, all of our war-gaming told us that you got to get cash in the hands of households, and there are ways that allow you to do that quite quickly. And we had explored a number of those ways in that war game, in that war-gaming exercise, which is why when it happened, in 2008, our focus was on very much on getting cash into the hands of households.

[2:30:35] WALKER: War-gaming has to be done in secrecy…

HENRY: Indeed, you could say that – yeah. [Laughs]

WALKER: [Laughs] I’m taking this to an interesting conclusion, and indeed, a lot of an economic policy department’s thinking has to be done secretly, because obviously you don’t want to unnecessarily negatively influence the public’s perception of the economy. Does that imply that it is impossible for the public to ever fully appreciate counterfactuals?

HENRY: Well, no. Well, I think there’s a time dimension to that question. I think that’s, well, maybe you don’t want to go there, but maybe this is me seeking to squeeze out of a tricky spot. You know, once the decision’s been taken, of course it falls to the political leaders to communicate that to the public and the reasons for it and to, as part of the narrative, construct the counterfactual. But even then, this is really, really tricky stuff. When we decided… On our advice, the Rudd government decided on that first fiscal stimulus package in October of 2008, which was delivered before, or most of it was delivered before Christmas of 2008, there were any number of critics who were lining up accusing the government of firstly being spooked and not knowing what they were doing, which was just a cheap political shot.

Secondly, of unnecessarily alarming people about the circumstances we’re in. After all, the ABS had not said, ‘Guess what, we’ve had a recession.’ So that action was all about forestalling a recession, dealing with that risk in advance. And so, there was no counterfactual there that anybody else had constructed. The government had to construct it. And the problem is, if it constructs the counterfactual, it falls into the trap that you’ve referred to, where it can stand accused of having made things worse. And it was certainly accused of that by the opposition, a political opposition, and by a number of newspapers. So that is really difficult. But how else does a government explain the seriousness of the issue and why it has to take such exceptionally, well, such exceptional steps? There is no way… I just can’t see any way of avoiding it.

And so, you need a really, really powerful narrative to be able to carry that one. It would be the same, though, in a national security context. It’s why presumably, although I know… I was about to say I wasn’t part of these discussions, but actually I was because I used to sit on the Secretary’s Committee on National Security, among other things. But you know that fridge magnet that said be alert but not alarmed? Well, that’s exactly the point. It’s trying to walk that very fine line that you’re getting to… That you’re getting at, and it’s exactly the same in trying to forestall an economic crisis.

WALKER: Has the public gotten better at thinking about nonlinearities and exponential growth as a result of events like the financial crisis and COVID?

HENRY: Okay, so I’m not sure. I think they have got more understanding of the need for governments to do exceptional things in exceptional circumstances. I would say that.

WALKER: To act pre-emptively.

HENRY: And to act pre-emptively, yeah, absolutely. That much, yes. But that’s when you’re talking about a real crisis. What about if you’re talking about a slower moving undermining of national capacity or national capability, for example?

WALKER: That is an interesting question.

HENRY: I don’t think so. It used to be said that, and I think it was probably the OECD that described Australia in these circumstances way back in the… it could even have been in the 1970s, maybe it was the 1980s, that Australia is — and these are not the exact words, of course – but ‘Australia has demonstrated a great capacity to deal with crises in the moment and after the moment, but has not demonstrated the same ability to deal with things before they become a crisis,’ that kind of slow-moving build-up of imbalances or whatever the hell. And so there are quite a number of those that you can see playing out in Australia or have been playing out in Australia for some decades. So, for example, the impact of climate change.

I mean, at some stage… Well, I guess in respect of some of the consequences of climate change, like the increasing incidents and severity of bushfires and floods and droughts, I think people are getting it. But in the early 1990s, when some politicians were trying to have this or run this narrative and engage the public, they were getting no traction at all. So that, I think there is still some way to go.

WALKER: To connect this back to leadership, I would go so far as to say that the real heroic virtues are actually best demonstrated by solving those slow-moving train wrecks

HENRY: I agree with that.

WALKER: … not by working on the kind of sudden crisis.

HENRY: It’s true. Yeah. And of course, as others in conversation with you have talked about, I’m sure would have noted, this extraordinary ability of humans to discount probable future events because they’re future, well, they’re in the long… they’re out there.

WALKER: Hyperbolic discounting.

HENRY: Hyperbolic discounting, exactly right. Yeah. It’s a nice way of putting it. That’s exactly it. And that makes the task of such leaders damn near impossible. Yeah.

[2:38:26] WALKER: Let me ask one question about Kevin Rudd and then I want to move on to this topic of reform and leadership. So, on the morning of the 29 February 2008, must have been a leap year, you get a call to tell you that the PM is expecting you to be on an aircraft at Gladstone for a chat in the air. And on the flight, Kevin asked you what happens to the Australian current account…

HENRY: It’s not how he framed the question. No. It took me a while to figure out what the hell he was talking about. No, the way he framed the question was this look, the plane had just taken off, we’d levelled out. In fact, I think we’d been served a cup of tea and Wayne Swan was on the plane as well. There was one other – it’s my fault, I just can’t remember who it was. It wasn’t a minister, it was an advisor. And I was sitting opposite Kevin and he leans across the table and he literally said, ‘What is the worst thing that can happen?’ Those are his exact words. ‘What is the worst thing that can happen?’ There was no introduction. There was no context. Right. For a brief moment, I thought, ‘Well, I guess we could fall out of the sky.’ I just had no context at all.

And it wasn’t until a long time later that he told me what the context of it was, which was that he’d not been able to sleep the night previous. He hadn’t got any sleep at all. And he was, the question he was asking himself was, with what’s going on in the global financial system, how might this play out in Australia? And we’ve been sending him briefing of the sort that you’re going to see, given the earlier past this conversation, you’re going to see how absurd this is, but we had been sending briefing of the sort that said, ‘Well, Australia has got one of the best regulated financial systems in the world. Bank balance sheets are extraordinary. We just don’t see a high risk to the assets sitting on bank balance sheets. There are no strong connections between Australian banks and foreign institutions that might run into trouble. As far as we can tell, the banks have not been big investors in these collateralised debt instruments and so on, which have been a feature of other jurisdictions. Exposure to the housing market, well, of course it’s there, but we don’t think the circumstances exist in Australia to produce a housing price crash and the banks have been stress tested by APRA on multiple occasions’ and blah, blah, blah. And we're not briefing the government on the exposure that the banks had on the liability side of their balance sheet, which is what we were talking about earlier, their dependence upon these international capital markets for funding.

And I don’t know if that was what was in the Prime Minister’s mind, Kevin’s mind, at the time either, but he was deeply troubled that there must be some exposure that we have to the global financial system that we’re overlooking. There must be. But that’s not how he asked the question. He asked the question, what’s the worst thing that could possibly happen? He obviously just assumed that the same question was sitting in my head and he wanted to know the worst thing and then we were going to come back from that: ‘Okay, that’s the worst thing that can happen. How would we respond to that? Let’s backtrack from that to something that’s more likely to happen and how respond to that.’ And then, ‘What should we be putting in place now to help us deal with that in the event that we find ourselves in that position?’

But once I realised that he was talking about Australia’s exposure to the international financial system, I said to him, ‘The worst thing that can happen, well, among the worst things that can happen is that the rest of the world stops funding our current account.’ That’s what I said. And more than that, the really worst thing that can happen beyond that is that they stopped buying Australian government debt. That’s about as bad as it would get, I think. And when went through possible responses to that, just what you might have to do. And he and I have agreed that I’ll never talk publicly about some of the things that we discussed on that plane. So I won’t do it. Won’t do it here.

Then we step back from the absolute worst thing that could happen. So that’s a place where you do actually have willing purchases of Australian government securities. So, people out there all over the world who are lining up to buy treasury bonds. And so, then we had a discussion about what the government might have to do in those circumstances. And we did discuss things like possibly having to guarantee bank liabilities. I don’t recall what sort of discussion we had about a fiscal injection, you know, government actualy spending more money. But that must have been in the conversation somewhere, given what happened subsequently. Must have been, yeah.

WALKER: My question is, why was he… I mean, he didn’t really have a specialised economics background…

HENRY: No, no, he used to tell me all the time, he used to say, ‘I don’t know anything about economics, I’m a student of Chinese poetry.’

WALKER: So why was he so far along in his thinking? Was he just getting really good briefings from some other agency like DPMC?

HENRY: No. No.

WALKER: What was it like a temperamental edge?

HENRY: Is that the right word? I think you were on the right word there. But it’s just he was… You know, he was out in front of any other leader of any country, anywhere in the world in asking that question. I’m sure he was. So, it was the way that he was interpreting the briefings that he was getting about what was going on international meetings and so on. And of course, he had attended a couple where these things, fragilities in the international financial architecture, were being discussed. I mean, pretty abstract stuff, really. But his interpretation of it was, ‘Hell, this could get really, really ugly.’ It’s in the nature of him that he is so keen on detail and ensuring that every base is covered, that that’s what he wanted to do. He wanted to get on top of it, on top of every contingency.

But of course it’s impossible, but that’s what he wanted to do. And he certainly and understandably, wanted some level of confidence that there were people in the public service who had some understanding of these contingencies and would be in a position to be able to provide him with advice on what he should do at the moment. And in the moment. An uncharitable way of describing his personality is that he’s a control freak. But you know what, in a crisis, that’s probably exactly what you need. He’s a control freak. And maybe that is exactly the behaviours that he was demonstrating through 2008, well before the collapse of Lehman Brothers. Maybe it is. Well, good on him. It’s a good thing for Australia that he did. That’s my view.

[2:47:42] WALKER: So, moving to the bigger picture and reform…

HENRY: Huh! There’s a bigger picture.

WALKER: There’s an even bigger picture. I’m struck by the irony that you seem to have had a better experience of reform under a conservative government than a progressive government.

HENRY: I was struck by that too.

WALKER: So, to make this clear, [John] Howard put you in charge of the GST task force in 1997, you spend about a year working on that, the government goes to an election to get a mandate, then there’s a couple of years to implement it. The government even nearly gets rolled at that election in 1998.

HENRY: Yes, lost the popular vote.

WALKER: Lost the popular vote, and just got re-elected on the basis of the distribution of votes in some marginal seats. And then the negotiation of the bill through the parliament is fraught. Brian Harradine famously rejects it in the Senate in May 1999 with those words: ‘I cannot…

HENRY: In good conscience, was it?

WALKER: Yeah, ‘in good conscience, support this tax’, or something like that. And then Howard negotiates with the Australian Democrats. He invites Meg Lees into the cabinet room in Melbourne. And so, this really difficult, complicated, potentially unpopular tax reform gets up under a conservative government and you’re working closely with them, helping to design and implement that. On the other hand, fast forward to the Henry Tax review and you come up with a whole bunch of things that are actually intuitively popular, like the Resource Super Profits Tax, which, I mean, it’s difficult to recall a poll that was against what was colloquially called the ‘mining tax’ and that just crashed and burned. And on top of that, the vast bulk of the 138 recommendations weren’t adopted by the Rudd Government. So, I want to get your reflection, looking back on those two experiences. What, has changed in the Australian polity to make reform more difficult? Or was the example of mismanaged reform under Labor more just an example of mistakes and bad management?

HENRY: So, it could be those two things, and there’s a third. I’ll come back to those two things. The third, though, is that, and it’s very important, is that the GST package was the implementation, commencing 1 July 2000, of the core recommendation of a tax review that was published in 1975.

WALKER: The Asprey Review.

HENRY: Yeah. And had been commissioned a few years before, and there had been a number of attempts to implement that core recommendation. So, Keating’s 1985 Tax Summit package, that was a notable attempt to try to implement that core recommendation of the Asprey Review. Option C.

And in fact, Option C – actually, I think we called it Approach C, but never mind, it’s remembered as Option C – Option C is pretty much Asprey, Asprey, Asprey. That’s pretty much what it is, with income tax-based broadening things, like fringe benefits tax, capital gains tax and so on. And then personal income tax cuts – overall reform the income tax system and a broad-based consumption tax, pretty much, which is pretty much what Asprey recommended. So, ten years later, that failed in spectacular fashion. Didn’t get the support of anybody, I mean, absolutely anybody apart from Keating and the treasury. And then you have John Hewson in 1993 with his Fight Back package developed in opposition, which, and by the way, a very high-quality document. Well argued. It was confronting, it was challenging, it was really, really ambitious. But, nevertheless, it was, and particularly for a document created in opposition, an outstanding piece of work.

And of course, on this occasion, I was in the department providing briefing for actually, John Kerin, who was Treasurer at the time that was launched, as I recall. I think I’ve got that right. It must have been in 1992 that… Yeah, of course it was 1992 that it was released. Was it? Must have been. Or maybe it was ’91. No, Karin was Treasurer…

WALKER: It must have been second half of ’91.

HENRY: It was released in 1991. And so, preparing that briefing for Treasurer Karin in a role that put me, well, people chose to put me or decided that I was then on the other side of the argument, which I certainly wasn’t, but I was nevertheless providing the briefing on the package as it was presented. And that Fight Back attempt failed. And that was probably a more surprising, well, that was certainly a more surprising failure than the one that Keating had suffered in 1985. Very surprising failure. And you would have thought, and everybody did think, well, that’s it, that’s the end of it. Never going to happen again. And that’s what Howard said in the 1996 election campaign, right: ‘There will never, ever be a GST.’ So, 25 years, I mean, I think that’s something, and I don’t think we should, in several failed attempts, so I don’t think we should ignore that. Having said that, I’m not going to say to you that…

WALKER: So the point there is that, well, reform has always been difficult and takes a long time.

HENRY: And takes a long time. Yeah.

But having said that, I’m not going to say to you that I’m very confident that in 15 years’ time we will have a resources profit tax in Australia. It takes more than that. So, there is something about the other, in the other two things that you mentioned. One of them, in fact, maybe both of them, go back to the ability of the proponents to construct a narrative that is sufficiently compelling to not just to build public support, because, as you said, the polls suggested that the Resources Profits Tax had public support. But it is to – I have thought about this a lot – it’s to give your… If you’re the treasurer or prime minister running the argument, it’s to give your parliamentary colleagues confidence that you’re going to win it, you’re going to win the argument. Also, to give them a narrative that they can use in their own electorates, too. And that’s, that is more than being able to point to public opinion polls which show that overall, the public is in favour.

I think the reform ambition of governments, it certainly relies on the leadership and the qualities of leadership that we’ve spoken about. But the fuel for it, on which it absolutely depends, is the more or less unquestioning support of the parliamentary colleagues of the leader. And that’s what wasn’t there in 1985, and that was a Labor Government and it wasn’t there again when the tax review was launched in 2010. There was just insufficient confidence in the parliamentary Labor Party that they were going to be able to get this done.

Now, people will debate for a long, long time whether that was a fair assessment being made by those people or not. But I’m sure that’s why the jockeying for... or the moves against Kevin Rudd as Prime Minister started.

[2:57:16] WALKER: Is the lack of confidence and the inability to craft a narrative endogenous to the good times? So, I guess here, you’ve kind of got, you know, those cyclical theories, like, ‘tough times create hard men and women; good times create soft men and women’. Is there something like that going on? Does good policy leadership require a wolf at the door to motivate it, or were we just unlucky with the political leaders we had during those periods?

HENRY: I think it’d be a bit unfair to say we were unlucky, I guess.

WALKER: With respect to those specific policies?

HENRY: With respect to those specific policies? Okay, so, I used to think about this a hell of a lot, particularly when I was speaking publicly on economic challenges confronting the nation. When you think about the Intergenerational Reports, it’s called, and the first of those was published in 2002. So, these are reports, and treasury publishes them, and these are reports that produce 40-year projections of government spending. And they used to just assume, and certainly in 2002, the report just assumed that tax revenue would remain constant as a proportion of gross domestic product. Just a technical assumption. Let’s not worry about the tax side of the budget and let’s focus on the spending side of the budget. I briefed the Howard Cabinet on that report well in advance of it being published, and drew out what I saw as being the central components of a policy reform narrative that could be built on those projections. And there was a lot of interest around the table. A lot of interest. And in the subsequent period, Peter Costello as Treasurer gave a lot of speeches, a lot that were based on that narrative, and I did, too. We both did. And it was kind of a double act. And he would address some audiences and I would address other audiences. And that’s exactly what we’re trying to do, was to build a platform or more an environment, actually, more an environment in which one could have a serious conversation about emerging reform needs and then motivate the reforms that would be required.

Because you’re not in a crisis period, and the narrative is based on 40-year projections, you can test things. And, because as a politician, your political window is three years at most, right, you don’t actually have to implement anything in that time period, so you don’t actually have to expose yourself to the verdict of the electorate. So, with that, you can be a little more comfortable about the ideas that you’re expressing. The evidence is, though, that no matter how daunting those distant challenges are presented as being, because of what you referred to earlier as hyperbolic discounting, and maybe for other reasons, the narrative has no impact. It just doesn’t grab people. They just, ‘Oh, well, we don’t have to worry about that. We’re worried about tomorrow, thank you very much.’ And with good reason. Most people are, and with good reason. ‘Let’s not worry about that.’

And I used to finish almost every speech I gave on this, I would finish with the words, like, ‘We don’t have to…’ Like, ‘We’ve got to do a lot of things. We don’t have to do them immediately, but we will have to do them.’ Well, we still haven’t done any of them. And we’re 20 years in. That was 2002. We’re 20 years in. And by the way, the projections that we published in 2002, although they were 40-year projections, we had decadal projections. So, we had projections for the first decade, second decade, third and fourth. If you compare those projections for the first two decades against lived experience, against what’s actually happened, they’re pretty damn good; i.e. the disaster that we had outlined is occurring. It’s a slow-moving disaster.

And, surely people have been aware that the disaster is emerging. I mean, surely they’re aware of Australia’s atrocious performance in productivity growth, for example, atrocious performance in growth in gross domestic product per capita – all of those measures that matter to utilitarians. Surely they’re aware of all that stuff and they’re just allowing it to happen. And moreover, no politician, no political leader has pointed to those things and said, ‘Oh my God, this stuff that Costello was talking about 20 years ago, we’ve actually done nothing about it, and look where we are. It’s about time we did something.’ That’s kind of deeply troubling. Right? So, I think it is possible to develop the narrative, but I’m not at all confident that you can get traction sufficient to motivate action.

WALKER: And is this a problem that’s unique to this period? Is this something that…

HENRY: No, I don’t think it is.

WALKER: It’s not? Interesting.

HENRY: And I think that’s exactly the frustration that Keating was venting, expressing anyway, in his 1986 Banana Republic-interesting statement. It’s exactly that. We’ve got this slow-moving disaster. It’s not going to hit us tomorrow, but if we don’t do something pretty dramatic, it is going to hit us in some years hence. And I don’t think he thought… Look, well, I have spoken to him about this. He was just expressing frustration. But of course, what he was doing was constructing a burning platform. Yeah, that’s what he was doing.

WALKER: And he was making the counterfactual vivid…

HENRY: Yeah. Making it real. And I’ve thought a lot about how one might construct narratives to motivate change. And when it comes to major policy change, at least economic policy change, and certainly tax policy change, nothing short of a burning platform will work. You’ve really got to convince people that we’re all going to hell or somewhere. Well, let’s assume there’s nowhere worse. We’re all going to hell unless we do something and do it pretty damn quickly.

WALKER: So, Ken, should I think of you as standing in contrast to thinkers like Mancur Olson, the Public Choice economist who wrote that book The Rise and Decline of Nations, or more parochially, like a Ross Garnaut who thinks that there are all these, almost like, secular factors that now make reform more difficult? Should I think of you in contrast to those kind of theorists?

HENRY: No, I don’t think so. I mean, I think those factors have made it more difficult. I think what I’m saying and where you’d be able to find accommodation between my views and theirs, is that I don’t think it was ever easy. And I don’t think were ever very good at it, honestly. I think there were circumstances that were largely, I mean, the circumstances were bad, but it took somebody like a Keating to construct the burning platform to motivate action. That’s with respect to the big things, some of the big things that were done. With respect to things like floating the currency, removing capital controls and so on, those things that were taken, in those decisions that were taken in December 1983, there was a burning platform there as well.

And it had to do with concerns about pressure on the currency, which officials and governments had been wrestling with for a very long time before those decisions were taken in 1983. But of course, the other thing is that other countries from all around the world, most actually, I think, I could be wrong in this, but my sense is that most, certainly leading IMF members, would have floated their currencies before Australia did. So, it was kind of a, ‘Why are we not doing this?’ That doesn’t tell you very much about Australia’s preparedness for economic reform. I don’t think I’m doing that an injustice. It’s really in motivating public appetite for the difficult things, like bringing the budget deficit back under control, that you’ve got to construct that burning platform. And that’s what Keating did.

And the only other times we’ve had it, is when it couldn’t be ignored, when were actually in the middle, have been in the middle of a crisis, whether it’s a global financial crisis or the pandemic or whatever.

[3:07:49] WALKER: If there’s a problem with democracy, that implies a bigger problem for capitalism, right?

HENRY: Yeah, absolutely. Two sides of a coin.

WALKER: Yeah. Because Milton Friedman’s argument that the only social responsibility of a business is to maximise profit for shareholders was predicated in part on the idea that governments could internalise externalities.

HENRY: Absolutely. I mean, more than in part. More than in part.

WALKER: Well I guess the other part I’m contemplating is that individuals can internalise externalities as well.

HENRY: Yeah, well, let’s talk about that. So, Friedman’s perspective, as I read Capitalism and Freedom, is that… I mean, it’s funny. So, when I read Capitalism and Freedom, what I get from it is a perspective that says without functional democracy and governments playing their role and the public, i.e. the citizens who elect them, ensuring that governments play the appropriate role, with respect to – and Friedman points to free and open competition, an absence of fraud or deception, right – in those things in particular, he would say, and he does say in Capitalism and Freedom that, well, it’s not going to work. But in saying that, he sets up an adversarial system, where the rest of us – and that’s the expression he uses ‘the rest of us’ – as citizens in a democracy, we necessarily find ourselves in an adversarial position with respect to business. And he says, ‘but that’s fine’, because provided businesses seek to maximise profit and government does its bit to ensure that, as consumers and workers and so on, we’re not dudded by their profit-maximising activities. What do you know? That’s fine.

Formally, in neoclassical economics, the expression is that the outcome is Pareto-optimal. Now, there are in the sense that nobody can be made better off without somebody else being made worse off, right? And it satisfies all the utilitarians. But there are other issues, and he canvases these other issues in Capitalism and Freedom, where he refers to the possibility of neighbourhood effects, which today we call externalities. And I mean, everybody’s aware of the really big one, which is climate change, which is clearly a negative externality of the operation of markets and businesses seeking to maximise profits and being allowed to do so without taking account of the damage that they’re doing to the climate and to the environment and now to people’s lives as a consequence of those commercial activities.

But there are many other negative externalities that are a consequence of profit maximisation. And he admits that – more than admits – he sets out the way that one should think about the role of government in dealing with those externalities. And he refers to essentially a balance sheet approach, or maybe a profit and loss approach. Anyway, what we these days have termed something like a cost–benefit analysis of government intervention. Because one should recognise that if governments seek to intervene to address a negative externality, and they’re successful, they do some good, but they could also be doing some harm as well associated with the regulatory imposition. Blah, blah, blah, you know that.

And he also talks about the other case for government, the other big case for government involvement, which is in the provision of public goods. But from memory, and it’s a while since I’ve read it, but from memory, aside from defence, he’s pretty reluctant to endorse a case for governments getting very much involved in the delivery of public goods. I remember being absolutely shocked when I read that he could see no case for governments funding national parks. The reason I find that one shocking is that I understand the argument that the beneficiaries, those who derive benefit from national parks are those who visit them. So rather than national parks being funded by the general body of taxpayers, they should be funded by those who get to enjoy the national parks, i.e. those who visit them. The problem is that many of those, and even if you are utilitarian on this, many of those that you would hope get to visit national parks are not even born yet, far less of a voting age, and they’re not capable of expressing the value that they attach to a national park by paying park entrance fees. And so, there’s a complete ignorance in his writings of the important role that government has in preserving things for the enjoyment of future generations. And that, I think, is a significant weakness.

But the other thing that’s ironic is that it’s not until – I think it’s in the foreword of the 40th edition, because he kept revising that book. I think I read an interview with him at some stage where he said it’s the most difficult thing he ever wrote, which I think is why he continued to revise it. But I think he says in the foreword of the 40th edition that he, on reflection, wishes that he had paid more attention to the way that governments might discharge their responsibilities. I think he was thinking more of the contest between authoritarianism and democracy.

But I think, and I don’t know if he had this in mind, but my perspective on it would be that he should have spent more time thinking about how capitalism operates when government is incapable, for whatever reason, of discharging its side of, its responsibilities. So, what happens when government is dysfunctional, for whatever reason, is incapable of ensuring that business does operate in a way such that profit maximisation does actually lead to a utilitarian utopia.

[3:15:04] WALKER: Two questions. If government is dysfunctional for secular reasons, does that imply that companies and other organisations are actually the real vehicles for social change? So, all else being equal, today should ambitious young people think less about the political arena and the public service and more about the start-up world?

HENRY: So this is a good question. All your questions have been good. So, I don’t know about the start-up world. I wouldn’t focus on that particularly, but I found myself having to – I didn’t have to, but I chose to – talk about these issues in an address I gave recently to a bunch of graduating students at the ANU. And I made the point that this somewhat dystopian perspective that I have that government has essentially become dysfunctional opens up enormous opportunity for people who understand how the system operates and understand what it might take to achieve better social outcomes, including environmental outcomes. And the point I made was that, at an instrumental level, the point I made was that there is a role for smart people in achieving things that governments, for whatever reason, have demonstrated an incapacity to achieve.

And what’s at play here is that even if the vast majority of people don’t understand the reasons for the bad things that they observe going on around them, they know that there’s something wrong and they are inclined to the view that business is at the heart of it. And why not? After all it’s businesses that actually take the decisions that affect most people’s lives, right? Businesses, one form or another, who decide what gets produced at what price, who gets a job, where the job is located, how much they get paid, what inputs are used in the production of whatever it is that they’re producing, whether it’s a good or a service where those things are sourced from what environmental damage is tolerated in the production of those things, what social harm is done by people consuming the products that they produce, all of that kind of stuff. It’s actually businesses doing them. Right? And I think people understand that and I think they see businesses being therefore the source of the problem. So as a policy-trained economist I see government failure there. I think most people see business failure well in that there is enormous opportunity right?

So, there is more interest now in people understanding the consequences of business activity. And so there’s a lot of support now for enhanced disclosure regimes. So, take for instance the Task Force on Climate Related Financial Disclosure that is voluntary. Although it’s voluntary, I know the new Environment Minister has signalled, or maybe it was Chris Bowen has signalled, that one day these disclosures are going to be mandated for large public-listed companies, but nevertheless they’re voluntary. But most large public-listed companies are making these disclosures now. They’re only making scope one and possibly scope two disclosures, not full scope – three disclosures of carbon emissions associated with their activities – but they’re nevertheless moving in that direction.

And why? The reason they’re moving in that direction is because they understand that increasingly the expectation that investors have, so shareholders have, is that they will take some responsibility or some accountability, it’s probably a better word, some accountability for what they’re doing and seek to avoid those negative impacts. Workers don’t want to work for such companies. So, if you’re in the market for labour, as you are, as every business is – and that’s an increasingly difficult market, you’re going to find it increasingly difficult to attract people who want to work for you – you’re going to find banks increasingly reluctant to lend to you because of the reputational risk but also the credit risk associated with those lending decisions. And you’re going to find customers saying, "I don’t want to buy your product, bugger off. I’ll source product, I’ll satisfy my wants and my needs from other businesses that I just like the look of. I don’t like the look of you."

So the way to think about that in Economics 101 terms is that it’s actually those economic agents — investors, credit providers, lenders, workers and consumers — who are effectively imposing an externality tax on that business, on business generally. You can avoid this externality tax by changing your behaviour. You don’t change your behaviour, you’re going to have to pay higher wages to attract people, you won’t be able to charge such high prices to attract consumers, you’re going to pay higher interest rates and you’re going to have to be capable of paying higher dividends to attract investor support. And that’s probably going to dwindle and dry up anyway.

So it’s effectively disenchantment on the part of the public, or members of the public generally, and attributing the source of the problems to the activities of business (and understandably so) that is, I think, leading to an implicit externality tax being imposed on businesses. That is going to change behaviour. And what I was saying to this group of graduates at the ANU is there’s enormous opportunity there. You think about everything that’s going to be required to put that system in place. The information requirements, the data requirements, for a start. People who are capable of sitting inside businesses and guiding them on how they should respond to this implicit externality tax in its various forms and what they need to do. Massive change coming, I reckon, and it’s going to go well beyond climate.

So the next cab off the rank is the Task Force on Nature-Related Financial Disclosure. That too will be voluntary, at least initially and maybe for a very long time, but I nevertheless expect to see Australian businesses responding to that and responding quickly and maybe even seeking to be at the forefront globally in responses. Anyway I certainly hope that’s the case. And you’ve also got other governments in other parts of the world that are not as timid as ours, that are taking decisions — maybe they’re protectionist — but of the sort: "Well, we’re not going to allow our consumers to source product from countries like Australia that have such a poor record of with respect to carbon emissions or have such a poor record with respect to species extinction." And so on. And that is driving change behaviour as well. And I think it’s going to be an increasingly potent force.

[3:23:45] WALKER: Were you working on anything around the social responsibility of companies before you left NAB?

HENRY: Yeah. Yeah, sure. We were having a lot of conversations internally about this topic and in fact we had (turned out to be quite an expensive) an exercise on the whole question of social purpose. And we developed through a long process involving a lot of people in the organisation, certainly all of the board and all of the senior management, but it went well down into the organisation of developing a purpose statement for NAB. We had a lot of conversations about it, and that included the stance that NAB should take with respect to its regulatory obligations. And it’s kind of ironic that I would say that NAB was more advanced on these discussions than any of the other banks — in fact, I’m sure that’s true — and had made substantial progress.

But of course, NAB had the wealth business, the MLC business, which it had acquired in 2000, and it had recently restructured or changed the business model of, and in advance of everybody else, in moving from a trailing commission model to a fee for service model. And it was still in the process of being bedded down. And I would have to say with huge problems. I mean, massive problems. And we were aware of those problems and were engaging with the regulators on those problems. But that was just at the time that the legitimate angst in the public was escalating and we found ourselves in a Royal Commission. Interestingly, that Royal Commission had the opportunity, because it was certainly within its terms of reference, to consider these issues.

In round seven, I think it was, I was called as a... it’s funny how you get these invitations, because the invitation is to appear before the Royal Commission as an expert witness, and mine was as an expert witness to talk about the big topics of corporate accountability, governance and culture — exactly what we’ve just been talking about in this interview. So they’re big policy questions. And I didn’t get any questioning on these topics at all. And that’s because I think it’s just the structure, the way that the Royal Commission had been established and the way it was doing its work — and I’m not being critical in saying this — but it was operating more as a criminal court, the way a criminal court operates. And it was good theatre.

And I’m not in any way wanting to diminish the seriousness of the issues that were under consideration because they were certainly serious, no question about that. But what it failed to do is it failed to grapple with any of the policy issues. And that’s a problem. In fact, the big policy issues, the core policy issues that were at issue in respect of the financial advice part of NAB, the MLC part, which is what I got all the questioning about, they’re still unresolved. And in fact, the newspapers even this week have been full of commentary about whether the Labor government will act on a subsequent review of those parts of the law that the Hayne Royal Commission had failed to address. It’s still ongoing. Who knows when these issues will ever be resolved, right?

But, yeah, it’s a bit of a shame. We were certainly working on these issues in NAB in the time that I was there and I don’t know what’s happened to that work since.

[3:28:51] WALKER: When you left Treasury in 2011, some Coalition MPs had been openly attacking you since about 2008. And you’ll remember in the 2010 election, as part of the negotiations with the crossbench, Oakeshott and Windsor extracted the Red Book and the Blue Book, and then the Treasury advice about Abbott’s policy programme had been quite scathing. And that leaked. And Abbott was filthy and was no doubt prepared to be vindictive, as he eventually was when he took government.

HENRY: That was years later, though.

WALKER: Years later, yeah. I guess I’m curious what part of your motivation in leaving in 2011 was to protect the broader institution of the Treasury from political attacks?

HENRY: Well, it was certainly playing on my mind. I thought a lot about this. Well, I thought a lot about it in the moment. Look, in the 2010 election... This is probably not known, I’m sure nobody has written this, but I don’t think there’s any reason why I shouldn’t disclose it; I don’t think I was in any confidential discussion. But in that period following the election when the discussions were going on with the crossbenches and both potential governments were involved in those discussions, I was sitting in my office. I got an invitation to go across the Parliament House and meet with the Liberal leader and the Deputy Liberal leader, which I willingly agreed to do, of course, even though they’d been bagging me for years. Or at least the party had.

And so I met with Tony Abbott and Julie Bishop. The only other person in the room was Peta Credlin. And the purpose of the meeting was simply for them to ask me whether, in the event that they were able to get the support of the crossbenchers and form government, I would give them an undertaking to stay on as Treasury Secretary. And I said I’d be very pleased to do so. And I would have stayed on. As a matter of fact, Tony Abbott said he would be honoured if I did so. Anyway, I would have stayed on, and I would have expected to have had another term as Treasury Secretary had I done so. My term was up in April 2011. I think had I stayed on, I probably would have had another term. But the thing is that politics is fickle, right?

And it’s largely about personalities, of course, because that’s the way the game is played. But politicians on both sides can be absolutely brutal with people and with institutions when the circumstances suit them. And I had absolutely no confidence that were I to stay on that was going to improve the quality of the relationship between the Treasury and the Coalition government. And so I didn’t think it was in the Treasury’s interest that I stay on. But mind you, I certainly didn’t think it was in my interest that I stay on either. I’d had a gut full. And anyway, I’d been doing the job for ten years and I thought it was the right time to hand over, and certainly to hand over to Martin, it was the right time.

I was only 53 when I left, and a lot of people have asked me whether I’ve ever had any regrets about leaving when I did. And maybe occasionally, but not very often. Not very often. Which isn’t to say that I don’t miss it, I miss it enormously, like, every day, I miss it. I miss the work, I miss the colleagues. I still think about the issues. Like every day I think about the issues. But not in the way that I was once able to think about the issues.

I mean, what an extraordinary privilege it is for a person interested in policy that if they wake up in the middle of the night with an idea or a thought or even a burning question, within a few hours, they can have a team of very, very smart people working that issue to death, and then before the day is out, be engaging in a robust debate with those same people about the various issues, right? I mean, that’s extraordinary. Who gets that opportunity? And I lived that for years and years and years. It was just wonderful.

[3:34:54] WALKER: I guess it’s just a shame for the country that you were cognisant of the scapegoating dynamic in leaving treasury but not in walking into the Banking Royal Commission.

HENRY: Yeah, well, no, that’s right.

WALKER: Possibly I'm drawing a false equivalence.

HENRY: No, you’re not. No, I don’t think it is a false equivalence. Well, it’s false in the sense that I don’t think it’s such a loss for the country that I left NAB when I left NAB. Because, honestly, whilst I felt that I was having an impact on NAB, and I know I was, and by the way, I think it has from everything I read, the institution has continued to improve in the years since I left, which is not all that long ago. In those roles, no matter how much you do, you can’t achieve the sort of change that you can achieve and have the sort of impact that you can have when you’re working in the Treasury. You just can’t.

Those roles, those very senior policy advising roles, they’re just in a completely different space from what people have been able to achieve in the corporate world, or in all of those (many of them) extraordinarily worthwhile NGOs that we have, which are vital parts of the civil society that underpins Australia. And they’re certainly in a very different space from what academics, even the world’s best academics, are able to achieve with their work. Of course, they’re highly influential, or should be, on those senior policy people, but they don’t have the same proximity to the action, they don’t have the ear of the policy decision makers and cannot in quite the same way. And of course, they wouldn’t even seek to right. It would impact their independence.

So there is something very special about it. So there is no equivalence in that sense. Nevertheless, there is something in the... what is it? I don’t even know what it is. There’s obviously a bit of a sense of personal loss, although certainly nothing as profound as losing one of those senior policy roles. I mean, the people who, like Martin years later, who was unceremoniously sacked by Tony Abbott, only to be brought back by Malcolm Turnbull. I mean, you just can’t get your head around this stuff. Even though I understand how all that happened. I think I do. I mean, that’s really bloody devastating, right? Losing that sort of role for absolutely no reason.

At least when I walked away from NAB, there was a reason for doing it. It was very much in the interest of the NAB reputation, that I considered that somebody in my job, i.e. the Chairman of the Company, stand up and say, "Well, you know what?..." — and it took me a while to get to this point, and I know that’s my own failing — "...but you know what? As chairman of this outfit, I just have to take accountability for this." And by the way, there used to be a parallel in public service. It was called ministerial accountability.

And it was motivated by much the same idea that, of course, if you are the minister with responsibility for an agency and the agency misbehaves in some way, in some big way, even if you couldn’t possibly personally have had anything to do with that, you are nevertheless accountable and you must resign. And that’s the doctrine of ministerial responsibility, which we don’t have any longer in Australia. We had it up until some way through the Howard government. You may recall that in the, I think the first twelve months, of the Howard government, I think there were six ministers that lost their jobs, not all of them on the doctrine of ministerial responsibility, but some, yes. And it’s a peculiar feature of the Westminster system, and it’s a really oddball thing.

But the reason for it is that, whether it’s fair or not, somebody has to be seen publicly to take accountability for failings. And where is the buck going to stop if not on the desk of the minister or on the desk of the chairman of the company? So I think it actually should be seen as a strength of our system, not a weakness of our system.

[3:40:55] WALKER: To finish the conversation, I thought it would be fun to ask you a few questions about specific policies.

HENRY: Oh, yeah.

WALKER: And these will be high-variance questions. Either the questions will be kind of daft, or they could actually provoke really interesting responses. So we’ll see how we go. What would it take for Australia to build a major new city, and where would you put it?

HENRY: Yeah, okay, so that is a question I’ve thought about.

WALKER: Oh, wow, great. Did Treasury ever look into this?

HENRY: Yeah. Oh, yeah. So when was this? Oh, goodness me.

I was Treasury Secretary, certainly at the time, and I remember having a conversation with Kevin Rudd only a few days after the November 2007 election. In fact, it was the first conversation I had with him after he became Prime Minister. And we were just talking about a whole range of issues, and I think he said something like, 'Oh, and by the way, what do you think the maximum sustainable population for Australia is?' And I said, 'Probably 15 million thereabouts.' And he thought I said 50, and he leant forward and he said, '50 million? Ah right, good.' I said, 'No, no, I said 15.'

'How can you say that — the population is already much more than 15.' And I said, 'I don’t think you can argue that human activity on this continent is sustainable, not in any way I think about it. And so I think we’d have to cut our population quite a bit if that’s all we're going to do in order to achieve a sustainable population.' And he was obviously shocked and obviously disappointed. He may even have been appalled, I don’t know. And then I said to him, 'But although that’s my view, it’s also my view that it would be possible to construct a set of policies that would sustain a population of 50 million. 5 0. That’s possible, but it would mean that we’d have to do a lot of things very differently.'

And in that conversation, I said, for example, we might have to build a whole brand new city for 10 million people, one that doesn’t presently exist. So then we subsequently in the department — and it wasn’t just in the department, there were other people involved in this as well — started exploring where you might build, not a whole brand new city of 10 million, but, say, a number of cities of 1 million, where you’d put them throughout Australia. I’m not trying to avoid the question, but here’s the thing. The reason we don’t have a very fast train in Australia from Melbourne to Brisbane is obvious, and everybody knows it. It’s because we don’t have the population that would support it. But that doesn’t mean we don’t have sufficient population in total. It’s the distribution of the population that makes it ridiculous.

But if the population were distributed differently, like along a corridor that a train line might run through with maybe five stops, something like that, maybe a few more (because not every train has to be an express), then it is possible to think about those things. And so, in specific answer to your question, I think there’s a lot of spots along a potential rail corridor where you could build such cities. Of course, there are environmental issues associated with every one of those spots. So those are factors that have to be taken into account. But we don’t avoid those issues by allowing the continuing suburban sprawl in Melbourne and Sydney and Perth. Brisbane, too. All those cities that are going to become mega cities.

Maybe Brisbane won’t ever be called a megacity, but it’s going to be a big one. And Perth is going to be a big one. And Sydney and Melbourne will be called megacities globally if we don’t do something smarter. So transport infrastructure, I think, is quite a big part of it. And of course, there are other things that would have to be attended to, but I would start looking at that corridor.

[3:46:43] WALKER: That’s so interesting. Have you heard of the Bradfield scheme?

HENRY: Oh, yeah. To turn the rivers back?

WALKER: Yeah. So as you know, it was this really ambitious project back in 1938, I think it was first suggested, basically to create an inland sea in Australia by filling up Lake Eyre and diverting rivers to it. And the idea was that this would basically drought-proof much of Queensland and South Australia.

HENRY: Except that it would be salt water, right?

WALKER: Presumably, yeah.

HENRY: Well, it would.

WALKER: I’m not actually familiar with the details of how they were going to get around that particular problem.

HENRY: Well, I don’t think they were. I don’t think they thought about it.

WALKER: Right, well, that probably explains why it doesn’t exist.

HENRY: No, I don’t think that’s why it doesn’t exist.

WALKER: Might be other reasons as well. [Laughs]

HENRY: Yeah, I think there might be other reasons. [Laughs]

WALKER: Okay, fair enough. But regardless of the merits of that particular scheme, I guess just thinking on that level of kind of like crazy ambitious nation-building projects, what incredibly ambitious project are we not building currently that we should be. Outside of "new cities".

HENRY: Outside of new cities. See, I actually would start with new cities. That’s why I was so well prepared for that question.

WALKER: Oh cool. I’m glad I asked.

HENRY: Yeah, I would start with new cities, but others oh, look, the renewable energy space offers huge challenge and huge opportunity. Look, this is a gross generalisation, so it’s not it’s nowhere near close to being accurate, but to date, we’ve applied much the same thinking and policy analysis to the accommodation of renewable energy projects as we have anything else, even though we know we’ve got a pretty good sense of the size of the transformation that’s going to be required.

And of course, whenever anybody talks about it they say, "Oh, my god, we got to do what we’ve already done, we got to do it ten times over, and we got to do it within ten years," or something, things to that effect. And I know some people are thinking about an entirely new approach to this: just turn the way we think about these issues on their heads and let’s just say, okay, let’s aim to achieve that outcome, right? What are we going to have to do in order to achieve that outcome? It does bring you back to locational issues like where you’re going to locate the cities. It forces you to think about transmission infrastructure, of course, in a way that we haven’t to date thought about it.

It forces you to think about things like local electricity networks, using battery storage or whole variety of different possible pumped hydro storage or whatever. Every one of those projects would be multibillion dollar projects. They’re huge. And as a country, aside from Snowy Hydro — and not even Snowy Hydro 2.0 — it’s not of the scale that’s going to be required of some of these other projects. It’s not even big enough. It’s not. I mean, some of these projects that we are going to have to invest in will be much bigger than Snowy 2.0. What sort of policy thinking do you have to bring to projects of that order of magnitude? And it’s kind of pressing. Because it’s not as if we can avoid these challenges. So that’s another one.

Here’s another one. When I was working for the Gillard government, leading the development of the white paper on 'Australia in the Asian Century', this idea popped into my head. I was in Darwin and I thought, "Why doesn’t Darwin look like Singapore?" So that’s a good one to think about. What would it take?

WALKER: I like that.

HENRY: What would it take? What could you do? And I know what’s happened since to the port of Darwin makes some of these questions problematic. But if there’s enough money and enough will, you could build a second port of Darwin. Would it be possible to do a deal with the Singapore port authority, or whatever it’s called, with respect to entrepôt activity? You think of all those ships that sit for weeks and weeks off Singapore merely to drop their cargo, for that cargo to be sorted and then picked up by another ship to take it somewhere else. It was never heading for Singapore other than to allow for transference from one vessel to another vessel.

Darwin’s a few hours south of Singapore, of course. And if the ship would sail... I’m not sure how much additional time it would take. But I mean, if you’re going to be sitting for a couple of weeks off Singapore, why not divert to Darwin? It’ll cut your time massively. And get the activity undertaken there. Why not see the port of Darwin as an export port for some of the natural resources that are going out through the port of Gladstone? A lot of them are located in western Queensland. What would it take? You’re getting the vibe here, I can see by the expression on your face. What would it take to have that cargo sent west and then north out through the port of Darwin?

And then what are the other opportunities that would be available in essentially a tropical city in the north of Australia, very close to all of Southeast Asia? When I was consulting on this project, I visited the then Chief Minister of the Northern Territory and stood in his office and he’s got this — I’ll bet it’s still there; I’ll bet every Chief Minister of Northern Territory hangs onto this — it’s a wall map and, of course, Darwin is at the centre of it So that’s how the world is drawn. That’s how the world map’s drawn. It’s wonderful. And then there are these concentric circles identified by flight time, or maybe it’s kilometres. Anyway, it doesn’t really matter — there’s an easy translation. And it just shows how many Asian cities are closer to Darwin than is Melbourne or Perth or Sydney.

And it allows you to think about Darwin playing a completely different role as a significant Southeast Asian city with obvious connections to several very big cities in Australia, right? Yeah. There’s another idea for you.

[3:54:49] WALKER: This is great. My high-variance questions are going well so far. Okay, here’s another one. So we have a decentralised, privatised superannuation system. 2 trillion of disengaged money. And that’s a honeypot for fraud and misbehaviour. ASIC has to be the arbiter of that fraud. Has ASIC been set up for failure? Does it have enough resources to oversee a honeypot that large?

HENRY: Okay, so no, it doesn’t. I mean, clearly it doesn’t. It has to rely on reporting and information systems, data collection systems, that are... well, they’re getting better. I don’t want to sound alarmist, and I’m not really alarmed about it because actually things have gone pretty damn well. You’d have to say things have gone pretty damn well to date. But it’s going to become increasingly challenging, obviously, for ASIC to stay on top of that. And in part, that’s because it’s not just fraud, but there’s also the risk of internet-based activity, so-called cybercrime, for which I don’t think any regulatory agency in the world would regard themselves as exceptionally well-placed to deal with. It’s just an increasingly difficult set of issues for we humans, having invented the capability, to now deal with.

I sometimes wonder, and don’t you? I mean, I had to go into a bank branch yesterday to once again supply documents to prove that I am who I say I am. So that’s under KYC provisions, know your customer provisions. Very sensible. Understand it. Understand it completely. But I’m old enough to remember a time when you’d never have to do that. And of course you didn’t have to do it because the risks to which you’re exposed, or were exposed back then, are several orders of magnitude less than what they are now. The risk of identity fraud or identity theft, and then fraud that can be perpetrated once the identity theft has occurred, all the spam emails and so on that you get.

And I was in this extraordinary conversation with a very helpful person in the bank and I said, "Look, I’ve received this email from you. Well, it looks like it comes from you, but I can’t be sure. And the reason I’m worried about it is because I’ve heard your CEO say, 'Be wary of spam emails. We will never send you an email that asks you to click on a link to anything.'" I said, "Have a look at this email. It’s got twelve links in it." Turned out it was a genuine email from that bank. Like holy hell. Now is that just a case of the left hand not knowing what the right hand is doing? I don’t know, but it’s hugely complex and the exposures that we all have are of a diabolical order of magnitude.

And so, the simple answer to your question is that no, I don’t think ASIC could possibly have the resources that would be required to prevent fraud in all cases —and that’s probably not its objective. It’s probably looking to a more realistic objective, which is to provide a level of deterrence that minimises, to some level of comfort, the amount of fraud that’s going to be undertaken. And that’s not a comfortable place, but it’s a realistic place. And by the way, that issue raises its head because of the interconnection, because of the way in which our financial system is wired, including the superannuation system. That issue is there no matter whether the superannuation funds are privately owned as they are, or if we had one mega superannuation fund in public ownership. You’d still have the issue.

I mean, if the Commonwealth Bank was still in public ownership, it would still have the same issues that all the other banks have go on.

[4:00:17] WALKER: True. So, on my most recent podcast episode, I interviewed Palmer Lucky, who’s a US tech entrepreneur. He’s founded a couple of unicorn companies. The second is Anduril, which sells weapons tech to the US government, the Australian government, other Western governments.

HENRY: Oh wow.

WALKER: I think he’s designed a lot of the tech himself. But he was telling me about how the defence industry in the US is grossly inefficient. Contracts are awarded on a cost-plus basis, and the incentives are structured such that sometimes there’s almost a competition to see who can put in the most expensive bid, not the cheapest bid. Is this problem similar in Australia as well? And I guess as a corollary of that, could we view the nuclear subs decision through that lens?

HENRY: That’s not the lens that I would use in looking at the nuclear subs issue. The issue that has bedevilled defence procurement in Australia is in part to do with, let’s call them inefficiencies, or cost padding, or cost overruns on the part of vendors or contractors. That’s part of it. But there’s a part of me, because I’m an economist, I kind of accept that it’s a fact of life that people will get away with whatever they can get away with. And I know that’s harsh and actually, I hope it’s the case that most of the people I know are not actually like that. But look, it’s not a bad working assumption if you’re a policy economist.

And so I think more about then what you can do in respect of institutional arrangements and policy guidelines and whatever to protect yourself or to protect the system from that. We can lament that people are greedy and we can lament that greed encourages people to behave dishonestly, but isn’t there something that we can do to protect government, protect taxpayers, protect citizens against that? Now, the big issue in defence procurement, for as long as I had any visibility on it, was our determination — infatuation, actually — with bespoke assets, the development of bespoke assets: it cannot possibly be the case that a piece of military hardware used anywhere else in the world is suitable for Australian conditions, even if we have no intention of ever using it in Australia but could only ever deploy it to one of those to a foreign battlefield.

WALKER: What were the origins of that infatuation?

HENRY: Isn’t that a great question. And I don’t know the answer to that question, even though I saw it play out time and time and time again. So that’s all about: "It would be a mistake, Prime Minister, to build an off the shelf product. We have to build it here now, because there is no off the shelf product that suits us." Was that a bullshit argument that was really motivated by a desire to protect local industry jobs? Yeah, probably. I’m not sure, but quite probably. And when you look at the connections between the military and domestic suppliers, that’s plausible, right? And you look at, as in the US, that military people, on leaving military positions, tend to pop up in jobs in supply firms. Yeah, well, it’s plausible.

It’s plausible that what’s at play there is the protection of domestic industry jobs. But I remember having this conversation with somebody who used to run defence procurement, and his take on it was that, "Yes, well, that may be true, but then on the other hand, doesn’t it make sense for Australia to sustain a capability in the construction of military assets? Because you never know, right?" And the answer to that question has to be, "Well, yes. Okay. Of course it does." So the policy challenge here is actually quite tricky. In many cases, the policy conclusion would be: buy off the shelf. But then on the other hand, there is a policy argument for sustaining a local build capability, not of everything, but who knows of what — we just don’t know, right?

So that’s how I think the policy issue should be dealt with. And it should be dealt with in an open way. We really are trying to sustain this domestic industry capability. Yes, we are. And we’re not making any secret of that. We’re not trying to hide that. But that’s why we’re doing it. We’re not doing it because Australia is unique and needs heavily modified things, knowing that there’s a very high probability that the modifications are going to lead to extraordinary cost overruns and time overruns. And in some cases, and there are some cases I’m aware of where it’s rendered the asset completely inoperable and it’s had to be scrapped. And I’m talking about projects worth more than a billion dollars. But I’m not going to name them.

[4:07:19] WALKER: The economist Vernon Smith, had on my podcast a couple of years ago (as a factoid, he actually shared the Nobel Prize with Danny Kahneman), he wrote a book on the US housing bubble a few years after the Great Recession. And he argued that the bipartisan Taxpayer Relief Act of 1997, Clinton’s Act, which exempted home resales from capital gains taxes, is the prime suspect for the trigger that caused the US housing bubble. Because suddenly you have this exogenous shift where people start to view homes as a speculative asset.

HENRY: You mean they become more Australian?

WALKER: I think you can see where I’m going. Let me phrase it this way. To the extent that, at least in the 2000s, Australian house prices were overvalued or certain housing markets in Australia were frothy, could we tell a similar story? Could we say that the Howard government’s decision to halve the rate of the capital gains tax in 1999 was the trigger for — call it whatever you want — bubble, overvaluation, et cetera?

HENRY: I think we’d have to say it had a significant impact, yeah.

WALKER: Would that be the prime suspect?

HENRY: Prime suspect? I don't know. There’s a few things at play here. So in my view, definitely one of them. So prior to that, we had capital gains tax indexation. So the cost base of the acquired asset was indexed in line with the CPI, and you paid capital gains tax on the difference between the sale price and the indexed cost base. So you paid capital gains tax at full marginal rates on the real gain, the bit over inflation. Now in high inflationary times, that is where the CPI is rocketing and house prices are just kind of chugging along, that means you get a lot of protection from having to pay capital gains tax.

But of course if monetary policy is effective and the Reserve Bank is successful in keeping inflation within the range of 2 to 3%, then there are going to be many times, at least Australian history suggests, there are going to be many times in which it would be rational even to expect that house price growth is going to result in very substantial real gains. And of course the Howard government change did mean that those real gains would be taxed at a much lower rate, basically at half the rate. Most of the gain would be taxed at half the rate it would have been taxed at previously. That’s with respect to rental property.

And of course owner-occupier property has always been exempt, right back from 19 September 1985 — has always been exempt. And so you had, particularly through the years 2001, 2002, 2003... I mean we were dealing with accelerating house prices through those years. Yeah, you would have to say that the capital gains tax decision played a significant role in what was happening in the housing market, because what we saw was a lot of people jumping into investor housing. There was more debt being taken on by households for owner-occupier housing as well. But there was strong investor interest. And we’ve seen that strong investor interest in every house price run-up in the subsequent period. Every one of them.

Whenever the house prices take off, investors pile in. And those investors have got a blend of debt finance and increasingly pretty close to 100% equity acquisition because they’re baby boomers who have retired and are wondering where they’re going to put all of that cash that they didn’t manage to get into a tax preferred superannuation vehicle. Where are they going to put it? Put it in investor housing. You won’t have the interest deduction that you would have had you debt financed it. You know what? You’re going to make a capital gain and you’re going to walk away laughing because only half the capital gain will be included in your taxable income. Yeah, I think it’s a significant part of the story.

And also, in the way that you phrased the question, this idea that what’s motivating it is speculation is, I think, true. It’s true. What happens when these house prices accelerate is the people who jump into the market are jumping in for speculative reasons.

WALKER: It’s not too much of an oversimplification to say that everyone who’s negatively gearing is by definition speculating.

HENRY: No, probably not. Probably not. Because after all it’s an investor asset. If it’s negatively geared. So we’re not talking about owner occupiers.

WALKER: But also, you’re losing money on the carry. So presumably you think you’ll make it back on the price appreciation.

HENRY: You got it. I mean, otherwise it’s nuts. And I don’t believe that people who are doing this are mad. Quite the converse. But I remember having discussions about this around the Reserve Bank Board table from time to time and just saying, "Well, what, if anything, can the Reserve Bank do about this?" After all, it’s not its mandate to control house price inflation. Its mandate is to look at consumer price inflation and keep consumer price inflation between that target band of 2 to 3% — okay, on average over the cycle.

But with respect to speculative assets, including property, it has no particular mandate other than to wring its hands and be worried that if bubbles burst they could cause some instability in the financial system, which is a concern, and they could lead to broader macroeconomic impact — so affect the economy more generally — which would be a concern of the Reserve Bank. But the Reserve Bank does not, to date anyway, have instruments at its disposal that would allow to address asset price inflation as opposed to consumer price inflation. Now, we have in recent years, under the present Governor, seen some use of so called macro-prudential instruments. These are instruments that APRA holds, not the Reserve Bank.

If it is the case that the Reserve Bank — and we don’t know because we’ve never been told — but if it is the case that the Reserve Bank has been leaning on or instructing or in some way influencing APRA to make use of those macro-prudential instruments, then that’s a curious thing, right? And I presume that is what’s being happening, and I’m not being critical of it either, but it doesn’t sit well with the idea that the board of the Reserve Bank determines monetary policy in Australia and exercises monetary policy independently.

WALKER: Yeah. I kind of empathise with the difficulty of the Reserve Bank's situation in the sense that if, on the one hand, you say to them that it’s not their mandate to lean against the wind, then if they find themselves in a situation where they’re very concerned about a build up of household debt, presumably there’s got to be some other way of addressing that.

HENRY: Oh, no, don’t get me wrong. I’m not being critical of them.

WALKER: I’m not saying you were.

HENRY: I think the position is well, I guess it’s not diabolical, but it’s a very difficult position that they’re in. And I can understand why they would be, from time to time, very concerned about asset price inflation, particularly speculatively-driven asset price inflation. Of course, it makes perfectly good sense that they’d be concerned about that. But if their only instrument is the overnight cash rate, the target cash rate of interest, then they are simply not capable of dealing with that issue.

I mean, if house prices have been increasing at 15% per annum for, let’s say, three years — and there are several periods in Australia’s recent history where you can see that — it’s highly likely that people who are purchasing property as a speculative asset have got in mind that for some time, house prices are going to continue to increase in double digits. So to what level are you going to have to lift? Suppose they do have a mortgage. To what rate are you going to have to lift the overnight cash rate of interest to convince them that’s a dumb thing to do? And the answer, I think, on every occasion I’ve looked at it, is that you’d have to lift the cash rate of interest to a level that would generate a recession, because it would just kill the rest of the economy. So that’s the problem. You need additional instruments.

And that makes sense. You've got more than one target. You've got a target for consumer price inflation. You've got a target now for speculative asset price inflation. You’re probably going to need more than one instrument.

WALKER: The Tinbergen rule.

HENRY: Tinbergen. Yeah.

WALKER: One goal, one instrument. Not not to spend too much time on this, but I think it’s now quite clear that the Reserve Bank did consciously lean against the wind in the early 2000s. Was that the right decision in those circumstances? Whatever you think of...

HENRY: Well, I was on the board. How could I say otherwise? But I do think it was the right thing to do. But they actually did more than that. There was an exercise of what’s colloquially referred to as jawboning. So Governor Macfarlane was out there publicly talking about the risks: words to the effect that nobody should assume that house prices are going to increase at these rates forever, and those who are operating with that premise in mind are taking on an increasing risk. And during that period, of course, even people you’d talk to socially would say to you, "But house prices never fall." That’s how poorly informed markets can be, right? "House prices never fall. It’s a one way bet."

In more recent times, I think there’s a broader appreciation of the fact that there is a significant risk that house prices could fall and could fall by quite a lot. And you may find yourself in negative equity territory having to sell a house and recover less than what you owe the bank. And I think people find that really confronting. I mean, that’s not part of the Australian mindset. But then neither is it part of the Australian mindset that you should expect to lose money when you find yourself in front of a poker machine. But anyway.

[4:20:10] WALKER: Okay, last question. For me this is one of the more interesting questions, but let’s see what you think. Why hasn’t Australia taken a populist turn to the same extent as the US or UK?

HENRY: I think the jury is still out.

WALKER: Do you have any explanations as to why it hasn’t happened so far?

HENRY: I think there have been periods at which we have been at considerable risk of doing so. So, gee, how to answer this question without getting really personal about particular... Look, the risk is obviously on let’s call it the right-side of politics, pretty much, I think, because the issues that left-wing populists have been able to exploit in other countries are not as obvious here. So we do have income inequality. Of course we do. And we do have wealth inequality. Of course we do. And the wealth inequality is probably increasing. Yeah. But we avoided much of the Global Financial Crisis, right? Whereas in North America and Europe, that really brought these issues to everybody’s consciousness.

That’s when you had the Occupy Wall Street movement and so on, as a consequence of that. And it really gave voice to — I know they’re not all left wing, and actually some of them are right wing, but anyway — it gave voice to disaffected elements that are a bit more extreme than what you see in Australia. So I think that’s part of the story. And the challenge that I think the left-side of politics finds itself dealing with in Australia is more from the environmental movement. And that’s not an extreme or populist challenge at all. It’s actually a deeply conservative challenge, if you think about it, because it’s motivated by conservation, it’s motivated by a desire to protect what we have and what we have left. It’s a movement that we’d like to see government do more, not less.

So I think the risk for Australia is more on the right-side of the political spectrum than it is on the left. And there was a time in the 1990s when I think the major political parties on the right-side of politics were deeply concerned about what was happening there and how to deal with what was happening there. And what do you do? I mean, you either ignore it and there’s a good reason for ignoring it, which in economics — I don’t know what they call it in political science — but in economics, it’s referred to as Hotelling's law on spatial location.

Are you familiar with Hotelling's law? So the simple idea is your town is just a ribbon development, right? You just got one road running through the town. And you’ve got two stores. They don’t necessarily sell the same product, but actually, part of Hotelling's law is that they will sell the same product. But anyway, two general stores, right? And where do they locate? And let’s start with the proposition that one locates at the western end of the town and the other one locates at the eastern end of the town. That being the case, either one of them would have an incentive to move closer to the centre. So let’s suppose the one at the western end of the town moves closer to the centre, they will retain all of the customers to their west and they’ll get half of the customers to their east, right?

And so they end up side by side, right in the middle, and they end up selling exactly the same products and being located in exactly the same place. And this is why duopolies end up with identical behaviour, blah, blah, right? So that’s Hotelling's law. And in political science, I don’t think they call it that, but they’ve got the same proposition: that if you’ve got two major political parties, it makes sense for them to sit in the centre with virtually indistinguishable policies. And for many, many policies in Australia for many years now, that’s what you’ve seen. It’s exactly what you’ve seen.

So if you were in charge of running, had responsibility for, the right-wing of that political system, and you saw an extreme right movement out there, a valid response is to ignore it. Because, after all, it’s not as if those people are going to jump all the way and direct their preferences to the left-side of politics. That ain’t going to happen. So provided they remain a fringe group or a small group, you’re going to end up with their preference flow anyway. You don’t get that in the United States. There’s no such thing as a preference flow, right? And anyway, voting is optional.

But with exhaustive preferential voting and compulsory voting, such as we have in Australia, it’s a legitimate thing, a valid thing to do, maybe a smart thing to do, to just ignore what’s happening out there and just rely on getting their preferences eventually, at the end of the day. Trouble is, it relies on a lot of people being able to hold their nerve, right? And there’s something else. And look, I’m no expert on the Liberal Party, but remember, the Liberal Party is a... Well, if you go right back to the formation of the Liberal Party, I mean, for goodness sake, you had the free traders and the protectionists get together. They got together in order to produce a party that was in opposition to the Labor Party. That was the only reason they got together.

And you got free traders and protectionists in the same party. It’s not going to be happy on policy, will never be happy on policy. And so that was in the party that predated the Liberal Party, but it still is in the Liberal Party. You’ve got both free traders and you’ve got protectionists, and you’ve got so-called moderates and you’ve got right-wingers. I mean, it’s you’ve got everything there, right? Everything that’s non-Labor, which I think basically means "don’t like trade unions". I think that’s what it means. (Which seem to be a disappearing issue.) The question for the moment is really about the identity of the Liberal Party. I think it is.

And if you’d like to see the Liberal Party remain attractive to those who tend to be a bit right-wing in their thinking, you’re going to want to keep the stake in the ground right there. Because if you follow the alternative that I was describing earlier, that Hotelling's law would drive you to, when you see the emergence of a political party in the extreme right, that would push you further to the centre, further to the left. That’d be the smart thing to do, according to Hotelling's law. But if you’re ideologically really uncomfortable with that and you can only ever imagine yourself occupying the right, then you’re going to seek to do battle with the extremists on the right.

And I think that’s the real risk. The real risk in Australia, I think, is that in these terms — and I don’t want to overstate it, but I think it is nevertheless a risk — is that a major political party decides that it wants to occupy an extreme position over there on the right. And that’s what’s happened to the Republican Party in the United States. I don’t think we should rule it out as a risk, even though I think it’s a low probability outcome.

But then what is a higher probability outcome? A higher probability outcome is probably that the Liberal Party becomes a different party. Maybe it formally dissolves the coalition arrangement with the National Party. Obviously doesn’t mean it wouldn’t seek to rely upon the support of the National Party for supply in forming government following an election. That’s how coalitions operate around the world in many countries. But they don’t see themselves as being part of the same party and they just come together in a marriage of convenience.

WALKER: Coalitions are very unstable.

HENRY: Very unstable. And that’s a possible future for Australia.

WALKER: That’s all super interesting and makes complete sense. I also just want to offer one speculative explanation for why we’ve avoided the same levels of populism as those the US and the UK have experienced, and get your reaction to it. Because I think it’s an underrated explanation and maybe someone listening can do this as an honest thesis or something. But we’re a highly urbanised country. This is an exaggeration, but you could almost say that Australia’s population is distributed bimodally. You have a lot of people in rural centres and then most people in the massive conurbations, and we don’t have that middle category of the medium sized cities that you have in the US and the UK.

HENRY: Wow. You think they’re all redneck cities?

WALKER: [Laughs] No, but what I do think is when globalisation and automation hollowed out the manufacturing centres — so, say, in the UK, that’s like, Sheffield; in the US, Dayton, St Louis, Milwaukee — you have large swathes of the population disaffected, angry, suffering the indignity of unemployment.

HENRY: Yeah, this is really interesting.

WALKER: And that’s dry tinder waiting for a demagogue. We don’t have that. And to complicate this picture further, the Australian cities which would have legitimate claim to being our versions of Detroit and Sheffield, have actually maintained their progressive identities. Newcastle, Wollongong, Geelong, Adelaide. So it’s a puzzle, but I think it’s worth thinking about.

HENRY: I like it. I like it. I do like it. And it’s certainly true. You’re absolutely right. You travel through North America. You travel through the United Kingdom. See those rust belts exactly as you've described them.

WALKER: And these are the cities that turned against the European Union in the UK and voted for Brexit en masse.

HENRY: See, the same thing playing out in Scotland, too. It’s the other way around, but people, I think, still blame Maggie Thatcher for the closure of the shipyards up there or something. Somebody was trying to explain this to me. They said they’ll always vote Labour. They’ll always vote Labour. I don’t know whether that’s true or not, but they intended to.

So, that makes perfectly good sense. And it comes back to something that we’re discussing earlier, which is about the dangers, the risks, associated with people losing their jobs, losing their self esteem, losing their capabilities to function properly in society. That’s fertile ground for the demagogues, as you say. Absolutely. Sure. I find that quite an attractive, if also unattractive, explanation.

WALKER: Ken, this has officially been my longest podcast ever.

HENRY: Oh, my goodness.

WALKER: I have enjoyed every minute. Thank you so much.

HENRY: It’s been a pleasure. I don’t often get to talk to anybody about these issues, and certainly not in this depth and length. And I never get questions of this quality. So there you go. Thank you.

WALKER: Well, it’s my honour. Thank you.