Introduction to Economics                                                  Lesson  7 / 07



Federalism is a concept more usually considered in the context of Political Philosophy or Political Science.  However, as with most if not all, human activity, it has a significant connection with Economics.  It is pertinent, given the fact that Australia is one of approximately 25 nations around the world with a federal system of government, with the number seemingly likely to grow in the near future.  Also, by the reference, by a number of Australian politicians in recent times, to the concept of a new Federalism.


What is Federalism?

Federalism is a political system in which sovereignty [or the ultimate power] is divided between a central governing authority and the governing authorities of its 2 or more constituent parts, in English generally referred to as states.

 Federalism is inextricably intertwined with Constitutionalism, which is the concept that power within a political entity is limited by an ultimate or overriding set of laws, which must be obeyed by the governing authority or authorities.  Whilst Constitutionalism is not a necessary part of a non- federalist [or unitary] system of government, it follows that in Federalism, such ultimate or overriding set of laws is necessarily contained within the covenant that binds the constituent states together and defines their relationship with each other and with the central governing body.  Thus the source of the word Federalism is said to be ‘foedus’, the Latin for covenant.

A Federalist nation is referred to as a Federation or Union.  It can arise in 1 of 2 ways; a partial but not total breaking apart of a previous unitary entity, or a coming together of previously separate states or political entities.  Belgium is an example of the former, Australia of the latter. 


Aspects of Federalism

Federalism is often depicted as one of the checks and balances forming part of Constitutionalism.  As such it has traditionally been seen as a major constraint on the power of government generally vis a vi the citizenry.  This arises from the fact that power divided is power diminished. 

A government wishing to impinge upon its citizens may not have the power to do so, or be able to do so only in cooperation with one or more of the governments with whom power is shared.  Such cooperation takes time and compromise.  Those who believe in the ultimate power of government as a source of good see this as a problem.  Conversely those who believe that the least government is the best government regard it as a virtue.

Apart from its role, within the ambit of Constitutionalism, of constraining the power of government generally, and hence acting to preserve and enhance the freedom of the citizenry, federalism can be a major factor in the economic development of a nation, typically by effecting, free trade within its territory.

The Council of Australian Federation was created in 2006 by the Premiers and Chief Ministers of all the States and Territories as a means of coordinating and improving the scope and quality of their activities.  A report was prepared for it by Law professors Anne Twomey and Glenn Withers on Australian federalism.  Perhaps unsurprisingly, given the body for which they had reported, the report was very positive in its support for federalism as a system of government.

Some of the benefits of federalism, as listed by the report’s authors include the following;

·          Competition—The element of competition inherent in federalism tends to result in an overall superior performance of federal compared to unitary nations.  The states compete with each other to achieve superior practice and results.  Since citizens in a federation are prima facie free to move their person or economic activity from one state to another [voting with their feet] the states are driven to achieve the best result or else risk losing their population and wealth to a better performing state. 

·          Efficiency---Studies suggest that federations are more efficient and have proportionately fewer public servants and lower public spending than unitary states.  Such finding tends to contradict the views of the typical critic of federalism such as Professor George Williams, who regards present day Australian federalism as a bloated and inefficient system.  Of the 8 major advanced industrial nations forming the G8—Germany, France, Italy, UK, Canada, Russia, Japan and the USA--- commanding 65% of the world’s economic activity, 4 are federations.

·          Customisation---Basic differences, particularly in a large country such as Australia, including climate, geography, demography, culture, industries and resources makes for better government being provided, in most respects, by governments attuned and connected to such differences, rather than to the ‘one size fits all’ approach of a centralized government.

·          Innovation---With a number of governments rather than just one, federalism provides greater opportunity for new and potentially superior ideas to be introduced and tested 

·          Freedom of Choice--- In those regards that are important to them, people are enabled to pick and choose the government that best suits or provides for them, and if necessary to relocate.

The authors point out that in the last 50 years federations economically have outperformed unitary nations.  Greater decentralization leads to better performance.  They purport to put a figure on this and to suggest that each Australian in 2006 was on average $4507 better off as a consequence of federalism.


Federalism in Australia

Federalism in Australia has not fared well, particularly since 1920 when the High Court decided the famous Engineers’ Case.  This did away with the implied constitutional concepts of immunity of state instrumentalities and reserved state powers. 

In many respects Australia today is a formal rather than an actual federation, with the states retaining little actual authority.  This has come about largely by the practice by the federal or central government of what has been described as ‘opportunistic federalism’; the selective and gradual appropriation of what had previously been state areas of authority, and the consistent willingness of the High Court to endorse such action 

Critics of the High Court’s consistent support for centralization have suggested that it has come about as a consequence of two considerations, neither of which today is as significant as it once was; first Australian nationalism and the belief that to achieve this fully federalism should be seen as only a transitional system of government leading to a fully centralized nation.  Secondly, since the late 1930s, the influence of Keynesian economic theory, which was seen as requiring an all-powerful central government effectively to implement.

Perhaps the single most debilitating factor for Australian federalism, brought about by the above considerations, is the current fiscal imbalance between the revenue raising capacity of the states and that of the federal government.  The revenue raising capacity of the states has largely been stripped away to the extent that, amongst federations, Australia has the greatest such fiscal imbalance. 


The Future

In recent times federalism worldwide has been taken up or supported as a superior system of government.  Of the 2 emerging major powers of India and China, India is a federation and China is inclining that way.  Countries with problems of regional autonomy such as Spain and Iraq are potential candidates therefor as is the European Union.

In Australia politicians of the major parties have expressed interest in reforming federalism, particularly in the direction towards a more cooperative rather than competitive federalism.  By this they mean a more appropriate and clear-cut division of power between the federal and state governments.  It may be however that they are missing the point.  In carving up power between them, the capacity of such division to protect the citizenry from arbitrary government power will be diminished or lost.  In economic considerations, moreover, it is the element of competition, not cooperation, which is responsible for the main benefits of federalism.


                                              David Sharp

                                                  8 May 2007             





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