The four’s influence relied in large measure on the open-mindedness of the minister responsible for national economic management, Percy Spender, the new breeze in the listless United Australia Party. He had entered parliament in 1937 by defeating the UAP minister for defence. He was quickly recruited into the government, made Assistant Treasurer in April 1939, Acting Treasurer in November 1939, and Treasurer in March 1940. In 1943 he was to stand for leadership of the UAP, and lose by a single vote.

Spender was all energy and new ideas, and was a good foil for Giblin’s proselytising of novel Keynesian precepts. There was sometimes tension between the two. On one occasion Giblin told Eilean:

But Spender was a ready pupil of Giblin.^[14]

The first lesson involved the appropriate stance of government spending and taxation in the face of unemployment.

Unemployment had remained significant throughout the 1930s. In the September quarter 1939, unemployment of unionists was measured at 10.3 per cent.^[15] Shortly after the outbreak of war Giblin drew Spender’s attention to current levels of unemployment, asserting that unemployment ‘threatens to become quickly an acute embarrassment to the government’ (17 October 1939). The outbreak of war, he said, had sent a psychological shockwave through the business community, and consumers had stopped spending.^[16]

The government, said Giblin, had compounded the unemployment problem by excessive timidity in defence spending. ‘The difficulty’, Giblin argued, ‘can only be met by more rapid spending – not planning, or commitments or raising loans, but spending; and spending for employment as much as and more than for defence’.

In his notes for the supplementary Budget speech of November 1939, Giblin asserted that: ‘This is not the time to provide against the possibility of a deficit either by reduction of expenditure or by new taxation. For the next few months, the unemployment situation will be critical. Reduction of expenditure or increases of taxation would further depress unemployment. This is a proper occasion for deficit financing … The same reason holds against any present increase in taxation to meet war expenditure’^[17]

Treasury, however, was implacably opposed to any further increase in Commonwealth spending. But Spender refused to endorse the view of his own department. In this spirit of dissent, Spender put to Cabinet (13 November 1939) that ‘no measures should be imposed now which would obviously have the effect of increasing unemployment’; any further ‘increases in direct taxation at this juncture would cause uneasiness and tend to reduce employment’. ‘An integral part of this policy is to avoid any increase in taxation likely to depress private enterprise.’^[18]

Giblin’s concern about aggregate demand was underpinned by a vision that efficient conduct of the war effort required looking at the economy as a whole. The key insight here was that, in an economy seeking to maximise war material, unemployment was as wasteful as consumption. Spender took this point readily. Thus, in response to Giblin, Spender wrote to Menzies on 25 October saying that the ‘the view of our economic advisers’ is that ‘maintenance of employment … is of paramount importance in lessening the burden imposed by war. In short, the burden is the diversion of human labour to war purposes, which can only be lessened, apart from reducing expenditure, by increasing the national income, which in turn can … be accomplished by bringing into productive employment people not presently engaged therein.’ And Spender went on: ‘One of the objectives of our present policy is to restore and increase the national income. This will enable us to divert resources to defence without encroaching unnecessarily on existing standards of consumption.’^[19] He was convinced that ‘Giblin’s suggestion means a sound national approach to our national problem, which I need hardly say would be of tremendous political value to ourselves’.^[20]

A third lesson was the outlook on the government budget. The F&E put to him that the budget should be regarded not only as a device to manage the government’s own incomes and outlays, but also as a part of an algorithm that assisted the government to manage aggregate demand in the economy as whole.

In his memoirs Spender found fault with the first Menzies war budget for not recognising this:

In contrast, Spender’s supplementary Budget brought down in 30 November 1939 was built around Giblin’s approach to war finance. Spender argued that:

If there ever was a ‘Keynesian Revolution’ in Australian economic policy, it may be argued that it arrived at this time and in this way: in 1939, and from Giblin, through the F&E, to Spender.

A second difference between orthodox finance and the F&E came over the prudence or imprudence of funding some war requirements from central bank borrowing (that is, ‘printing money’). The Commonwealth Treasury had resolved in its own mind that war expenditure should be financed from taxation and loans from the public. Borrowing from the banking system, especially from the central bank, was to be avoided like hellfire. That expedient had been over-used in Australia – and elsewhere – during the First World War, and had led to inflation or even hyper-inflation, exchange rate depreciation, and economic turbulence.

But whereas the Treasury dismissed such borrowing as unsound, the economists were more ambivalent. Giblin, as chairman of the F&E, helped to forge a common view among economists: as long as resources – particularly labour – were not being used at full capacity, it was legitimate to ‘borrow’ from the Commonwealth Bank. As Giblin told the Secretary to the Treasury, S. G. MacFarlane: ‘central bank credit should be injected in times of depression and withdrawn in times of prosperity and the net result should be zero’.^[22]

Not long before the outbreak of war, at the invitation of the then Treasurer R. G. Casey, both Wilson and Brigden had prepared notes on the efficacy of borrowing from the central bank.

Wilson had argued that ‘if the economic system is not working to full capacity’, ‘there is in general a good case for finding money for reproductive works. There may even be a good case for finding money for works which are not reproductive in the financial sense of returning full interest to the Treasuries, but which are reproductive in the wider economic sense.’ He declared, moreover, that it ‘may well be that this money should come from an expansion of central bank credit …’. It was true that foreign reserves might be depleted in the process; that private enterprise might be adversely affected if interest rates were to rise; and that appropriate labour skills might not be available from among the unemployed. But when ‘incomes have fallen and unemployment is increasing’, he concluded that ‘an increase in public spending, assisted by central bank credit, is probably desirable to stimulate activity’.^[23]

Brigden, vigilant as ever in the face of the siren call of inflation, was more wary than either Wilson or Giblin. He did acknowledge that ‘present opinion tends … to support the use of central bank credit as a substitute for taxation or as a means of increasing employment or the national income or both’. But this opinion, he said, had been influenced by the writings of Keynes, and had been based on the assumption that wages would not increase when there was unemployment. Yet in Australia, according to Brigden, ‘each degree of increase toward full employment is accompanied by increases in wage rates and … labour costs’. If central bank lending was resorted to, controls over foreign exchange, investment and labour would be required: ‘control must follow as the Government under public pressure, seeks to avoid the adverse consequences of its action’.^[24]

As for Giblin, since unemployment existed, he believed it was quite legitimate for central bank credit to be used ‘to set working all the unused resources of labour in the country’. ‘In general an excessive issue is necessary as a first step followed by a corrective withdrawal of the excess’.^[25]

But Giblin foresaw an inflationary pressure. In his notes for the November 1939 supplementary Budget, he wrote that: ‘The policy proposed is to use the stimulus of central bank credit to finance the initial period. So far the procedure may be called reflation. If this method were to be continued we should have inflation beginning gently but accelerating to a dangerous rapidity’. As a consequence, ‘After the initial period then, say from next May, the war should be financed jointly by taxation and current savings, invested in loans on the market. Only by adhering to this principle of finance can inflation be controlled’.^[26]

The end of Giblin’s ‘initial period’ might be said to be signalled by Coombs’ F&E paper of 7 December 1940 headed: ‘The banking system and war finance’. The banks were now in a highly liquid position and were seeking investment opportunities to maintain their profits. Coombs was fearful that these circumstances might spark a ‘dangerous inflationary process’. He proposed that the banks’ advance policy and their liquid assets should be subjected to tighter control. Two alternatives were proposed: a system of minimum variable liquidity ratios, or a uniform minimum ratio that would be sufficient to control the most liquid of the banks, bringing the other banks up to that level by exchanging liquid assets for government securities. Wilson suggested, however, that the time might be right for the introduction of what he called the ‘100% money plan’, by which he meant that all increases in bank assets from a particular date should be lodged with the Commonwealth Bank. Later, Wilson’s plan was adopted by the Curtin Government as a central device to restrain the impact of excessive monetary expansion.^[27]

These ideas were aired with increasing alarm by the F&E at its meeting in December 1940, but already by April 1940 it began to advise the government that reliance on bank credit would soon have to end, and, in consequence, taxation would have to be raised. It was aware that taxation on low incomes would be politically difficult.^[28] In response, Spender acknowledged that, with respect to bank credit, ‘This possibility is now largely closed. We must in the future rely almost entirely on taxation and public loans’.^[29]

By March 1941 the matter had become more urgent. It was in this context that Giblin raised the political difficulties of dispensing with credit expansion. ‘With resources fully used’, he said, ‘there can be no case for further credit expansion in 1941–42 but rather for contraction. Nevertheless it may be politically impossible to finance a growing war expenditure by market loans and taxation, so that immediate recourse to credit expansion may be forced on the government.’^[30] Drawing upon the ideas of Coombs, Melville and Wilson, Giblin then put three alternatives to the F&E:

Copland, however, was inclined to seek voluntary cooperation from the banks. But the problem here seemed to be that the banks would define ‘cooperation’ in different ways, and would be unlikely to accept the Commonwealth Bank’s definition.^[32]

Since the F&E was unable to agree, it decided to seek political direction, especially on how bank profits might be controlled.

The new Keynesian approach did not mean unconditional deficits and low taxes. With the end of unemployment and the inexorable rise in war expenditure, the convenient policy of low taxation became more doubtful. Not because it meant deficits, but because it meant an excess of demand over supply.

The F&E became increasingly preoccupied with calculating the gap between expected war expenditure in the months ahead and the resources required to meet the increased demands from taxation and loans. The use of the so-called ‘gap’ methodology was initiated by Giblin, drawing on the terminology and method of Keynes in How to pay for the war (Keynes 1939, 1940). He corresponded frequently with Keynes throughout the war on aspects of war finance, including the principles underlying the gap approach. In its simple form, and abstracting from external flows of income and expenditure, the ‘gap’ methodology was commonly expressed as follows: from expected war expenditure, deduct current taxation receipts and loan revenues. The residual was the measure of the ‘gap’ which would have to be funded either by new taxation, new loans, or borrowings from the banking system (including the central bank), or by some combination of these three sources.

There were, in effect, four policy choices that faced the government.

One was simply to allow inflation. This would transfer resources from consumption to war-related activities, since wages lagged behind price increases and taxes on profits and progressive rates of income tax would divert income from employers to the government.

A second was rationing and price control. But the F&E hesitated to recommend direct controls, particularly rationing.^[33] Several members of the F&E did, however, think rationing was inevitable. Certainly, Copland was sanguine about the efficacy and practicality of controls. Although he still took the view that the best way to drain purchasing power from the community was through taxation, he was far from confident that the rate of taxation necessary to maintain the war effort and ward off inflation would be politically acceptable. Hence he lent his support to a limited scheme of rationing covering a restricted range of goods.^[34]

The third device was borrowing from the private sector. But there were limits to which individuals and institutions would respond to war loans without the incentive of higher interest rates.

The fourth device – and that preferred by Giblin and the F&E as a whole – was taxation. Keynes had proposed a useful variant of this device: that orthodox taxes be supplemented by what he initially called ‘deferred pay’, and later ‘post-war credits’. Here a certain proportion of revenue levied from taxation – or from a compulsory loan – would be earmarked for repayment to taxpayers after the war. Keynes was concerned that steep rates of taxation might create disincentives to work, whereas a system of deferred pay would not, since the revenue would be returned later to those from whom it had been collected. Moreover, it could be repaid after the war, when it was expected that a slump would occur after an immediate post-war boom; tax refunds in these circumstances would provide a boost to effective demand when they were spent upon goods and services.

As early as its meeting on 16 December 1939, the F&E had discussed for the first time the possibility of introducing a system of compulsory loans (‘post-war credits’) along the lines of the scheme proposed by Keynes. The committee concluded, however, the compulsory loans scheme should be kept in reserve.^[35]

By July 1940, and with war expenditure accelerating rapidly, the F&E was adamant that taxation would have to rise, and that meant taxing lower-income groups, in spite of critics arguing that there remained considerable spare capacity, and so excessive taxation could be avoided. The F&E proposed that the government consider imposing a consumption tax at the point of retail sales of 1d on every shilling spent. It was Wilson who suggested this idea, allowing for the possible exemption of bread and milk.

It was at this point that Giblin raised once more the idea of the compulsory loan scheme, but now in the context of a national program of uniform taxation. The Commonwealth should levy a uniform national income tax, he argued, and the difference between the levy and income taxes already imposed by the Commonwealth and the states should be collected as a compulsory loan. The compulsory loan component would be greater for taxpayers in wealthier, low-taxing states, such as Victoria and New South Wales, than in other states. Not only would this bring in additional revenue, but it would help to make the sharing of the cost of the war more equitable across the states.^[36] By October 1940, Giblin had further refined his proposal for a uniform income tax via a compulsory loan. The Commonwealth would introduce a uniform income tax on personal and company income, and from the amount assessed, income tax payable to the states would be deducted on the basis of existing state income tax. The residual would constitute federal tax. Of the residual, a part would be taken in the form of current or future federal income tax; the surplus would be regarded as a compulsory loan. The amount taken as a compulsory loan would be relatively small in high-taxing states, and relatively large in low-taxing states.^[37]

The Treasurer, now Arthur Fadden, was said to have been impressed with Giblin’s scheme but considered that it was too late to be introduced in the 1940/41 financial year.^[38]

Therefore, the F&E was left with the problem of how to raise taxation upon lower incomes without creating political difficulties. It was clear that the magnitude of the resources needed for the war effort could not be realised simply by taxing upper and middle incomes; it would have to reach down to lower incomes. But the Labor Party and its trade union affiliates were opposed to any such attempt. The decision to introduce child endowment, suggested initially by Dick Downing, who worked for Copland in the Office of the Economic Consultant to the Prime Minister, and supported strongly by Wilson, was intended in part to dampen criticism from low-income groups.

Giblin’s contribution to the impasse was to draft a major paper, ‘Prospects for 1941–42’, in which he suggested how ‘the political opposition’ to expanding taxation ‘could be overcome’. He suggested, as a bargaining strategy, even heavier taxation on high incomes; a 90 per cent excess profits tax; and a levy on wealth of perhaps 3½ per cent. The committee gave its tentative approval to each of these recommendations, going further on excess profits tax (to 100 per cent), and less on the wealth tax (no more than two per cent a year).^[39]

Shortly after submitting his paper to the F&E, Giblin wrote to Fadden saying that the ‘key to the financial situation is taxation. With taxation equitably distributed over all incomes, there is a fair chance of avoiding any drastic all-round rationing control.’ He acknowledged that, while there was likely to be some immediate hostility from low-income groups to any proposal for increased taxation, he did not believe that it would prove to be very deep. ‘It could give way’, he said, ‘to a good statement of the case for taxation, addressed to them by their leaders. But it must be their leaders who do the job.’ He added that ‘it is largely regarded as good Labor policy to resist’. Giblin proposed that Labor’s representatives on the Advisory War Council be counselled.^[40]

There was a drift back in interest to a compulsory loan. In June 1941, Giblin prepared a detailed paper on a system of post-war credits. What Giblin now proposed was a ‘National Contribution’, from which Commonwealth and state income taxes would be deducted, leaving a special war contribution in the form of a compulsory loan, for which a post-war credit would be given.^[41]

It was clear that by July 1941 a crisis in war finance had been reached. Fadden wrote to Menzies on 1 July 1941 saying that ‘we face the biggest budget problem in the history of the Commonwealth’.^[42]

In the Budget of September 1941 the government proposed a borrowing requirement of £122m, compared with £60m the previous year. It was acknowledged that borrowing of this magnitude would be difficult to achieve. In the budget Fadden announced the government’s intention to introduce a compulsory loan scheme along similar lines to that proposed by Giblin (and similar to the one that Keynes had proposed in the United Kingdom). A ‘National Contribution’ was to be assessed on every income earned in Australia (exempting incomes below £100); after the deduction of state and Commonwealth income taxes, the remainder was to be collected as a compulsory loan (or as post-war credits), which would attract an interest rate of two per cent a year, to be repaid after the war.^[43]

In the Budget of September 1941 the influence of Giblin and the F&E committee had reached its high watermark.

Labor opposed the budget, largely because of the National Contribution, on the grounds that low-income groups were to be taxed and because the lighter-taxing states would be the greatest beneficiaries of the post-war credits. The Opposition successfully moved a motion of no confidence in the budget and it was defeated in House of Representatives on 3 October 1941 when two independent members of the parliament crossed the floor and voted with Labor to defeat the budget. The government resigned, and a Labor Government took office the same day. Curtin was sworn into office as Prime Minister with Chifley as Treasurer.

The inability to implement a politically acceptable policy of war finance was the principal reason for the failure of the Menzies and Fadden Governments. The dependence of the government on two independent members of the House of Representatives encouraged a degree of timidity in the formulation and application of economic policy, and hesitation over the advice of the F&E. In particular, the resort to taxation was clearly inadequate, given the extent to which resources had to be transferred from civilian to war activities in conditions of full employment. Menzies and Fadden were also unable to convince the states of the need to transfer some of their taxing powers (particularly in the field of income tax) to the Commonwealth; and they took a somewhat pusillanimous attitude toward the credit expansion of the private trading banks. Labor attacked the Menzies and Fadden Governments unmercifully on the grounds that their financial and economic policies – including the compulsory loan – were inequitable.

With the arrival of the Labor Government a marked shift in economic policy began, as market-oriented instruments of policy were replaced by direct controls. The new Treasurer, J. B. Chifley, quickly introduced a revised budget (on 29 October 1941) to replace the one that had been presented by Fadden: the National Contribution was jettisoned; heavier taxation was imposed on higher-income groups; and taxation was reduced on lower incomes.

With the entry of Japan into the war it was clear that a significant increase in taxation and voluntary borrowing from the public would be required. Shortly after the beginning of the war Giblin had predicted an annual war expenditure of about £100m in current prices, with ‘the possibility but not probability of it rising to £200m per annum (still at present prices) at a later period of the war.’ But after Pearl Harbour this was utterly outmoded. Defence spending was, in fact, to reach £500m, and absorb not one-fourth of GDP, but about 40 per cent of it. Some increases in taxation were introduced, and loan programs of a considerably greater scale than hitherto entertained were foreshadowed. But these policies failed to match the real resources that were needed to meet the demands of the armed services and war industries, such as munitions.^[44]

By the early months of 1942, prices were beginning to accelerate at a rapid rate. As a consequence, on 10 February 1942 Curtin announced a dramatic change of economic policy. A National Economic Plan was to be introduced based on a powerful set of direct controls, which were to be promulgated under the National Security (Economic Organisation) Regulations.

The principal elements of the plan were the pegging of wages and profits; private spending was to be curtailed by direct controls on production, consumption and trade; price rises were to be reduced by tighter price controls; profit margins were to be squeezed; and spending by state governments was to be limited by the introduction of a uniform system of income taxation. The rationing of basic consumer goods was introduced from the middle of 1942. The administration of capital issues control similarly underwent a transformation aimed at tightening non-essential private investment. Credit creation was also used, on the basis of Labor’s claims that reserves of labour still existed, but stringent National Security (Wartime Banking Control) Regulations were introduced. These tightened government control of the private banks and required increases in bank assets from a designated date (August 1941) to be lodged with the Commonwealth Bank ‘as special deposits’, both as a means of controlling credit expansion and limiting bank profits.

This system of direct controls marked a decisive shift in the nature of Australian economic policy. The war economy henceforth was shaped in large measure by direct controls and other policies associated with the National Economic Plan. The F&E and the Treasury were now to take back seats as new government agencies, such as War Organisation of Industry, the Production Executive and the Manpower Directorate took the leading roles as providers of policy advice.

Even so, the F&E continued to advise the government on war finance after October 1941. Giblin remained in ‘daily touch’ with Chifley, the Treasurer (Day 2001, p. 148), including on the subject of uniform taxation. ‘Luckily I have a thoroughly good understanding with Curtin, and also Chifley’, Giblin told Keynes on Labor’s accession. ‘But they have some very difficult colleagues, and their independent “majority” is quite crazy on finance’.^[45] Giblin noted with alarm the burgeoning of central bank credit following the introduction of the National Economic Plan. The F&E – particularly Giblin – warned the government that suppressed inflation was building up for the post-war era, as extensive direct controls placed a lid on inflationary pressures. But the government’s requirements shifted to the efficient ‘administration’ of the war economy and planning for post-war reconstruction, and new administrative agencies began to recruit their own economists. The need for the F&E’s expertise was reduced. Its influence diminished, and it scarcely met after 1942.^[46]