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Costello was born in Melbourne, into a middle-class family of committed Christians: his brother, Tim Costello, is a prominent Baptist minister. He was educated at a Baptist school and attended Melbourne's Monash University, where he graduated in arts and law. During his student years he was active in student politics as a radical Christian, and for a time was a member of the youth wing of the Australian Labor Party, but after graduating he rapidly became more conservative, while retaining liberal views on some social issues.
During the 1980s Costello became a well-known industrial lawyer, representing employers in some of the best known industrial relations cases. He became counsel to the National Farmers' Federation and to organisations representing small business. Costello made his name in the 1985 Dollar Sweets case, in which he successfully represented a confectionery company involved in a bitter dispute with a militant trade union. In the late '80s he was identified as part of a "new right" movement in the Liberal Party, organised in an anti-union group called the H. R. Nicholls Society.
In 1990 Costello organised a coup against a sitting Liberal member in the safe Liberal electorate of Higgins and entered the House of Representatives at the age of 32. He was immediately promoted to the Opposition front bench and proved an effective debater against the entrenched Labor government of Bob Hawke and Paul Keating. By 1992 he was shadow Attorney-General, and in 1993 he became shadow Finance Minister under Dr John Hewson. He was a strong supporter of Hewson's radical policy proposals at the 1993 elections, including the goods and services tax (GST).
Hewson's shock defeat in 1993 brought Costello into consideration as a leadership contender. When Hewson was deposed as Liberal leader in May 1994, Costello supported Alexander Downer for the leadership, and became his Deputy Leader and shadow Treasurer. But this "dream team" soon proved a disappointment. In January 1995 Downer resigned, but Costello decided not to seek the leadership himself. Instead he supported John Howard's return to the leadership. The collapse in the credibility of the Keating government gave Howard and Costello an easy run to power in the March 1996 elections.
As Treasurer, Costello presided over a conservative fiscal policy and sharp cuts to government spending. This reduced the level of government debt and improved Australia's international standing, but led to a rapid increase in the gap between rich and poor which had already begun to widen as a result of the economic deregulation under the Hawke government. Costello had a relatively easy run as Treasurer, with none of the economic crises that marked the 1980s. Inflation continued to fall, interest rates reached record lows, and unemployment also fell. Whether this was due to luck or good management was hotly debated by Australian economists.
The Howard Government's major economic policy was tax reform, despite the fact that Howard had gone into the 1996 election promising that he would "never, ever" introduce a GST. The GST returned in the government's 1998 election policy, and Costello was an effective campaigner for it. When the GST legislation was finally passed through the Senate with the help of the Australian Democrats, however, it was Howard, rather than Costello, who took the credit. Costello's own agenda of labour market deregulation remained blocked by the government's lack of a Senate majority.
Costello became Treasurer aged only 38, and expected a fairly long wait before he could hope to inherit the Liberal leadership. After the 2001 election, however, he began to show signs of impatience, and was visibly disappointed when Howard announced in July 2003 that he intended leading the government into the 2004 elections.
Despite his very conservative financial policies, Costello remained notably more liberal than Howard on some other issues. Most notably, he supported the 1999 referendum to make Australia a republic. After the 2001 election Howard gave Tony Abbott the key Workplace Relations portfolio, and in 2003 promoted him to the even more important Health portfolio. This led to suspicions that Howard had decided to stay on as Prime Minister so that he could groom Abbott - a Catholic who was much more conservative than Costello on social issues - as his successor.
Costello was to some extent the victim of his own success. The strong performance of the Australian economy during his time as Treasurer meant that his political mettle was never really tested, as Abbott's certainly was in the demanding Health portfolio. During the 2004 election campaign, Howard avoided saying whether he would serve a full term if re-elected, saying only he would remain as long as his party supported him. His success in winning control of the Senate raised further speculation that he would delay his retirement, and the prospect of a Costello leadership succession appeared to recede, although Costello remains the likely successor.
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