The importance of manufacturing and industry policy

Peter Brain, Executive Director, NIEIR

AbstractDuring the decade to 1995 Australia reduced import tariffs on manufactured goods and, therefore, exposed many of its hitherto-protected manufacturing industries to overseas competition. At the same time, it implemented a series of targeted and highly cost-effective industry policies that assisted a wide range of Australian manufacturing businesses to become internationally cost-competitive, gaining export markets at the same time as they met import competition. With the obvious success of the previous government’s industry policies, the stated intentions of the Coalition government elected in 1996 were to leave the existing structure largely unaltered and continue with the general government–industry partnership model. However, the first national budget of the new government for 1996–1997 revealed a different intention. There was a significant change in philosophy away from targeting firms and industries and towards an neutral approach in line with the ideals of the Washington Consensus. The Commonwealth government moved from targeted to generalised industry assistance and, hence, moved from cost-effective to ineffective policies. During the mineral boom it was possible to pretend that this did not matter; Australian prosperity would be guaranteed by mineral exports. The time of reckoning now approaches. Mineral prices have slumped and manufacturing has been decimated. The Washington Consensus has already been discredited within the world economic development community; the time is long past that it should likewise have been discredited in Australia.

IntroductionIn Beyond Meltdown (Brain, 1999) it is argued that manufacturing industry plays a critical role in introducing advanced technology into an economy, and hence that the size of the manufacturing sector is an important determinant of a country’s overall economic performance. In the first instance, the advanced technology is either embodied into the design of manufactured products or into the capital equipment and skills used to produce products. Churn in skills and experience between manufacturing enterprises and the rest of the economy create spillover effects which strengthen the competitiveness of the non-manufacturing economy. These favourable effects are summarised by the empirical rule that a 1-per cent reduction in the manufacturing–productivity gap between any selected economy and the United States (which still sets the standard for manufacturing productivity) will lead to an approximate 0.5-per cent reduction in the gap between the two in per capita GDP.

Beyond Meltdown also highlights the role of manufacturing as the ‘swing’ industry essential for macroeconomic balance and long-run growth sustainability. Too small a manufacturing sector would result in:

(i) deficient internal demand (not enough exports or too many imports required to achieve the level of internal demand necessary to meet desired employment levels);

(ii) insufficient earnings from net external trade to achieve the desired current account balance; and

(iii) deficiency in skills development to support the growth of a modern knowledge economy.

The optimal size of the manufacturing sector will depend on the circumstances of each country, such as the size of the primary sector (agriculture and mining) or the value-added services sector. The greater the size of each of these sectors, the lower the optimal size of the manufacturing sector.

As suggested in Beyond Meltdown, the best overall indicator of the optimal size of the manufacturing sector is the average current account deficit. The higher the current account deficit on a sustained basis, the greater the gap between the actual size of the manufacturing sector and the optimal size. In Germany, Sweden and South Korea, all of which report current account surpluses or relatively low deficits, the manufacturing sector’s size averaged 20, 18 and 27 per cent, respectively, from 2000 to 2013. The size of the manufacturing sector would be close to optimal in these countries (indeed, perhaps a little excessive). By contrast, countries like Australia, the United States and the United Kingdom, with manufacturing sector sizes of 9, 13 and 11 per cent, respectively, ran relatively high current account deficits over the same period. For these countries, the optimal size of the manufacturing sector in relation to GDP is likely to be 3 to 5-percentage points higher than is currently the case.

Influencing the size of the manufacturing sector: Industry policy

At the macroeconomic level, the exchange rate is the key instrument that can be used to target the size of the manufacturing sector. However, it is a blunt instrument and may also be required for other purposes, such as inflation targeting. Beyond the point of establishing general cost competitiveness for all industries, further use of the exchange rate to encourage industry growth will be inefficient. This is because industries differ in terms of their circumstances and obstacles to growth; therefore, specifically designed policies that address the unique obstacles to growth of each particular industry (targeted industry development) is likely to yield better value for money than imposing the costs of further devaluations on the economy.

The rest of this article will examine the empirical evidence on the impact of industry development policies in Australia.

Industry policy in Australia since the 1980s

Australia’s main agency for assessing the effectiveness of industry policy is the Productivity Commission. Originally called the Industry Assistance Commission and then the Industry Commission, it became apparent that these names contradicted the policy agenda of the agency. The main objective of the Productivity Commission was to reduce pre-1980s Australian industry assistance in general, and tariff protection in particular, to low levels. This objective has been achieved.

More broadly, the Productivity Commission has promoted the implementation of neoliberal economic policy within Australia, following the agenda known as the Washington Consensus (a set of policy targets adumbrated during the early 1990s by US and international financial institutions based in Washington). The Consensus fell apart after the global financial crisis but is still being pursued by Australia’s Productivity Commission.

In the Productivity Commission’s view, Australia’s economic objectives and policies should be:

(i) a stable macroeconomic environment with continuous growth, low inflation, a government fiscal surplus and monetary policy aimed at a low inflation target;

(ii) secure property rights;

(iii) industry regulation subject to rigorous cost/benefit analysis;

(iv) strong education, health and infrastructure development policies; and

(v) efficient labour markets with minimum obstacles to market operation.

The Productivity Commission has succeeded in its objectives. Many of these objectives are compatible with a strong manufacturing sector, but not all; in particular, the principle of secure property rights has been interpreted to mean that governments should treat all businesses equally whatever the differences in their development opportunities; the fixation on fiscal surplus has made governments excessively wary of exposing themselves to the risks of economic development while the limits of strict cost/benefit analysis have hampered strategic planning. In pursuit of its objectives, the Productivity Commission has ensured that Australia has failed to replace its outdated tariff protection policies with industry policies of the type practised by, for instance, China and various economies in continental Europe, countries in which outdated tariff protection policies have been replaced by active, targeted industry policies.

The basic history of Australian industry policy since the mid-1980s appears to fit the Productivity Commission’s view of the world. The industry policy debate in Australia has revolved around the following facts. Up until 1985–1986 manufacturing exports were around 0.8 per cent of GDP. They then increased to 1.1 per cent by 1990, after which they rose very sharply to reach 3 per cent of GDP by 2009. The rate of growth of manufacturing exports over the 1990s is shown in Figure 1. This rapid growth occurred when the rate of effective protection for manufacturing fell sharply, at least as measured by the Productivity Commission. The subsequent collapse of manufacturing is then treated as a different story: basically that manufacturing had to downsize to make room for the expansion of mining. Our concern here, therefore, is with the position before the mining boom.

As far as the Productivity Commission is concerned, Figure 1 tells a simple story. Protection was a deadweight cost on the economy and its reduction to low levels by 2001 was just what was needed to unlock growth potential. However, closer examination shows that this interpretation is wrong.

Figure 1: Manufacturing export performance(manufacturing exports 1990 to 2004)

Source: Australian Bureau of Statistics (ABS) (cat 5638) for export data; calculations by NIEIR. The effective rate of protection was calculated by the CIE, 2009.

Post-1983: Industry policy and the centre-left government

The incoming centre-left government of 1983 was elected on a traditional centre-left platform of fiscal expansion and industry protection. However, it quickly deregulated the financial sector, the foreign capital account and the exchange rate. In relation to the labour market, an Accord was established under which general average wage rates were negotiated between the government and the unions, taking into account total effective household income increases arising from tax changes and government expenditure and income transfer increases. These arrangements stayed in place until inflation returned to satisfactory levels in the aftermath of the 1991 recession.

Industry policy trade-offs were part of the Accord bargaining process. The government realised that tariff protection was losing its effectiveness as an industry development instrument in many industries if only because the scale of plant required for efficient production (production at levels with unit costs within striking distance of world best practice) was expanding beyond the range of the domestic market. To reach competitive scale, exports were required to supplement domestic sales. Without such sales, the costs of protection would become prohibitive. Further, as will be seen below, it was realised that targeted industry policy was a more effective form of industry assistance than tariffs. These realisations, rather than the traditional arguments for free

trade espoused by pastoralists, miners and the finance sector, were crucial in persuading the centre-left government to embark on a program of tariff cuts.

Between 1983 and 1990 a policy strategy was introduced that resulted in reductions in tariffs, particularly for motor vehicles, clothing, textiles and chemicals, in exchange for targeted strategic interventions on a case-by-case basis, in some cases for industries and in other cases for individual firms (Australia had a number of instances of single-firm industries). The objective was to increase competitiveness to boost exports and import-competing domestic sales, with the emphasis increasingly focused on exports. The program of tariff reductions in Australia resulted in the average effective rate of tariff assistance for Australian manufacturing falling from 35 per cent in the early 1970s to 5 per cent in 2001. The strategy was to use the pressure of the tariff phasedown coupled with the carrot of industry assistance programs to restructure previously highly-protected industries to improve productivity and to offset the loss of domestic markets with export markets. Programs were also established to assist in the development of new industries. This strategy, rather than tariff cuts by themselves, explains the buoyancy of manufactured goods exports shown in Figure 1.

The programs were wide-ranging and, in most cases, involved relatively small amounts of budgetary assistance, generally ranging between $1 and $10 million annually. Among the small programs were the agri-feed business programs, an Australian magnesium metal technology initiative, heavy engineering adjustment and development programs, information technology development programs, metals-based engineering programs, a motor vehicles components development grants scheme and a national space program. In addition, larger-scale targeted industry assistance programs, including textile, clothing and footwear adjustment programs and the pharmaceutical industry Factor F program, peaked at an expenditure of $260 million in 1997–1998 in 2013 prices.

There were a number of programs implemented to directly assist firms establish and develop export markets. The Export Market Development Grants scheme peaked at $270 million of expenditure in 1997–1998, while the Export Formation Operating Expansion scheme peaked at an assistance expenditure of $84 million in 1995–1996. The Development Import Finance Facility, which assisted the financing of Australian exports, peaked at an expenditure of $163 million in 1995–1996.

There were also several production subsidy programs. The computer bounty program peaked at $110 million in 2013 prices in 1994–1995, while the ships and boats bounty programs peaked at $70 million in the same year.

The centre-left approach to non-tariff industry assistance: Two examples

The list of program names says little about how each individual program worked or how it yielded benefits, especially where the market power of the government was brought to bear to ensure success. This is the essence of the following two examples of the targeted approach, the Partnership for Development Program and the Pharmaceutical Factor F scheme.

Partnership for Development scheme

Applications to the Partnership for Development scheme were invited according to the following guidelines:

(i) partners agreed to implement within 7 years strategic plans to commercialise Australia’s competitive strengths in the information technology and communication industries; and

(ii) the basic plan was expected to have the following characteristics:

5 per cent of annual turnover on R&D in Australia;

achieved exports equivalent to 50 per cent of imports for hardware companies and 20 per cent for software companies; and

achieve 70 per cent local value across all exports by the 7th year.

The main reward for participation was preferred supplier status to governments. By June 1993, 24 companies had entered the program with commitments of annual export sales of $1.7 billion and average R&D expenditure of $60 million (Sheehan et al., 1994).

The success of the scheme can be gauged from the responses of companies to a questionnaire administered by the Bureau of Industry Economics in 1996. The results are given in Table 1. Although the questionnaire considers all enhanced supplier arrangements, the Partnership for Development scheme would have been well represented. A clear majority of respondents claimed that such schemes were either effective or very effective in increasing domestic economic activity across a range of activity segments. They were particularly effective in increasing value-adding activity in Australian investment and R&D.

More importantly, 90 per cent of survey respondents said that they did not invoke higher prices for goods and services to governments in terms of the impact on tender prices.

Table 1 Survey responses: Firms’ views on the effectiveness of the endorsed supplier arrangements for industry development

Ineffective Effectivea Very effective

Increasing value-added activity in Australia 23 58 19

Increasing industry investment 28 59 13

Increasing R&D 33 58 9

Enhancing access to government markets by SMEs

28 52 20

Increasing exports 45 48 7

Increasing innovation 46 48 6

Improving product/service quality 25 56 19

Note: aIncludes ‘quite effective’. SME, small and medium enterprises.Source: BIE (1996, p. 65). Percentages adjusted to exclude ‘don’t know’ or ‘not relevant’.

Pharmaceuticals: The Factor F scheme

The Factor F scheme introduced in late 1988 is a classic case of using purchasing power to acquire offsets. Basically, the scheme allowed pharmaceutical manufacturers to receive higher prices for products listed on the Pharmaceutical Benefits Scheme in return for significant commitment to local manufacture.

Two requirements had to be met for a company to be eligible for the scheme:

(i) an export/import target of 50 per cent had to be achieved within 3 years; and

(ii) R&D spending equal to 3 per cent of turnover had to be achieved in 3 years.

These requirements had to continue to be met if the company was to continue to receive increased prices under the scheme.

In 1995, NIEIR conducted a review of the scheme for the government. It found that by 1994, at a cost of $109 million to the taxpayer, companies in the scheme had delivered:

(i) $416 million in export value added;

(ii) $419 million in domestic value added and import replacement; and

(iii) $152 million in R&D.

Post-1996: Industry policy and the centre-right government

A centre-right government came to power in 1996. With the obvious success of the previous government’s industry policies, the new government’s stated intentions were to leave largely unaltered the existing structure and continue with the general government–industry partnership model. However, the first national budget of the new government for 1996–1997 revealed a different intention. While the overall initial annual costs to industry assistance remained at $300 to $400 million in 2013 prices, there was a significant change in philosophy away from targeting firms and industries and towards an industry/firm neutral approach in line with the ideals of the Washington Consensus.

In due course, the Factor F program was scaled down and eventually replaced. The bounty programs to shipbuilders, printing and computers were also abolished. The export assistance schemes were either capped or ended, as was the case for the export promotion and Development Import Finance Facility scheme. The R&D 150-per cent tax concession was reduced to 125 per cent. These programs were replaced by more general industry programs focussed on R&D and innovation support, technology diffusion and, in Tasmania, the freight equalisation scheme.

Although industry partnership remained part of the rhetoric in the early years of the new government, implementation of the rhetoric was undermined by the government’s Washington-style philosophical belief that it was wicked to use the market power of the government to

leverage economic development. This can be seen from the government’s reaction to two reports it commissioned. The two reports, each named after its committee chairman, were the Mortimer Report, Going for Growth: Business Programs for Investment, Innovation and Exports, Review of Business Programs, and the Goldsworth Report, The Global Information Economy: The Way Ahead. Both reports endorsed the centre-left government’s approach to industry policy by recommending the continuation of a targeted approach to industry assistance. Both recommended increased funding (in the Mortimer Report to $1.7 billion a year in 2013 prices). Both reports also recommended:

(i) that investment subsidies, grants etc. should be used to attract international investors to Australia;

(ii) greater financial support for private R&D and the commercialisation of successful R&D;

(iii) greater export financial support; and

(iv) closer cooperation between government and business cooperation in industry planning.

The reports recognised that innovations by leading firms spill over to other firms through technological diffusion, that activities once established will be sustained, and that there should be a constant flow of ‘infant industries’ in the belief that target budget outlay assistance policies will be effective (Department of the Parliamentary Library – Information and Research Services (1999–2000).

The centre-right government accepted the reports and set up a foreign investment attraction agency along with industry action policies. However, the funding in the main was not forthcoming. The government increasingly aligned its rhetoric on industry policy with the Productivity Commission’s view that the focus should be on fundamentals. Then, with the onset of the mining boom, interest in industry policy evaporated.

Productivity Commission: Statistical distortion in evaluating the effectiveness of industry assistance

The Productivity Commission has been involved in a statistical fraud in assessing the effectiveness of industry assistance. The deception lies in the empirical concept which it has developed to estimate the industry nominal rate of assistance. The core assistance rate in the Commission’s calculations is the nominal tariff rate. The Productivity Commission converts all non-tariff assistance measures to tariff equivalents. Budget outlay measures, such as export grants, subsidies and local performance schemes, are all expressed in terms of subsidy equivalents and added to the base tariff rate and treated as though they were tariffs. This is not valid. The reason is that tariffs are restricted to providing a price advantage for import-competing products while many of the other assistance measures act on industry productivity, capacity installed or export levels, which can have very different impacts on the economy than the equivalent tariff.

The Productivity Commission likes to demonstrate, at least to its own satisfaction, that tariffs are a net cost to the economy. The equivalent burden assumption allows the Commission to simply assume that any industry assistance measure must impose the same cost as its tariff equivalent and, therefore, is equally bad. Despite the lack of any evidence that this is the case, the argument

is repeated annually in the Productivity Commission’s reviews of industry assistance (Productivity Commission, various years). The core premise is that any government intervention in the economy, whatever the benefits may be, must impose net long-run costs on the economy.

Strategic versus non-strategic industry assistance

It is useful at this point to distinguish between strategic and non-strategic industry assistance. Strategic industry assistance is here defined as a measure which, when applied on a one-off basis, will produce cumulative benefits for a number of years after the application of the assistance instrument. For example, a capital grant for a new factory that otherwise would not have been built yields years of benefit, and for all these years the production from the factory represents net additionality, either in import replacement and/or export expansion. The ratio of production to assistance will be x in the first year and 2x in the second year, until the factory reaches the end of its life or a point is reached where market forces would have triggered the factory investment. Similarly, a one-off export grant that enables a firm to establish an export order is likely to lead to the firm gaining repeat orders in the second year and, indeed, may enable the firm to increase orders compared to the first year.

Strategic assistance is at the core of Chinese industry development strategy: first establish the market opportunity for a new factory, then provide the capital for the factory to be built, and, finally, provide the resources to establish export markets.

Tariffs are not a strategic industry assistance instrument. A tariff has to remain in place to repeat the previous year’s impact. Therefore, whatever the benefit–cost of a tariff in the first year in encouraging import substitution (the cost being the increase in domestic prices for all industry using the tariff supported product), the cumulative benefit–cost ratio will remain near the first year benefit–cost ratio.

From this discussion it is clear that the Productivity Commission’s estimates of the effectiveness of industry assistance are invalid because they combine strategic and non-strategic measures of assistance assuming that they are the same. This statistical distortion has resulted in serious underestimation of the effectiveness of targeted industry assistance and has contributed mightily to Australia’s chronic balance of payments deficits.

Trade liberalisation: The benefits

Statistical distortion has, thus, underlain claims by the Productivity Commission and governments which have relied on the Commission’s advice that the tariff phasedown was responsible for whatever industry success occurred between the 1980s and 2000s. Typical of such reports was the 2009 report commissioned by the then Department of Foreign Affairs and Trade into the benefits of trade and trade liberalisation (Centre for International Economics, 2009). The findings of the study were as follows:

(i) the rate of assistance by industry has declined over the past three decades;

(ii) this was due to the decline in tariffs;

(iii) tariffs lower productivity by focusing firms inward on domestic markets;

(iv) they impose costs on industry as a whole;

(v) manufactured exports grew strongly in the period since the early 1990s; and

(vi) this is due to tariff reductions improving productivity and forcing firms to become competitive with foreign producers.

That is the logic of the simplest interpretation of Figure 1. The evidence, however, points to a different conclusion. The import phasedown did force an external focus but in many cases the focus would not have been reached without the non-tariff assistance measures that were introduced. As the tariff phasedown dominated the offsetting increase in assistance measures, the overall rate of assistance declined sharply by the Productivity Commission’s equivalent-cost measures. However, the effectiveness of non-tariff assistance measures was considerably greater, dollar for equivalent dollar, in expanding local production and exports than import tariffs had been. Therefore, Australia’s significantly improved export performance over the 1990s was due to the substitution of strategic industry assistance for tariff assistance.

Allan Oxley is a leading neoliberal and a strong advocate for trade liberalisation. However, as a competent economist who acknowledges the facts as they fall, he explicitly notes that the rebirth of Australian manufacturing exports over the 1990s cannot be attributed to tariff cuts alone. In Seize the Future: How Australia Can Prosper in the New Century (Oxley, 2000), he states:

One of the great changes that has occurred in Australia since the 1980s is that we now earn more from exports than we have for 30 years. ... It is manufacturing (that has driven this change) (p. 99).

Oddly enough the free trade economists have not claimed the turnaround in manufacturing as a free trade victory. ... The Hawke Government spent a great deal of money doing distinctly non-free trade things (p. 108).

Oxley notes in relation to the industries most impacted by tariff cuts that the Hawke/Keating Government spent an average of between ‘$500 million and $1 billion .... to finance restructuring’ (p. 108)

Oxley also cites the 1995 Victorian University of Technology Paper ‘The Rebirth of Manufacturing’ (Sheehan et al., 1994), where:

it analysed the remarkable increase in exports by manufacturers of elaborately transformed products noting that they have been increasing at twice the rate of all other exports. It concluded that the sectors which received government subsidies did best and recommended more subsidies. (p. 109)

Oxley also notes (but does not necessarily accept) the claimed importance of non-financial assistance measures in driving exports. The rapid growth in exports of telecommunications products has been attributed to:

a Federal Government program called ‘Partnership for Development’. In this program companies especially multinationals become approved ‘partners’ if the government deemed that their research and development, export and investment activities were satisfactory. Once approved as a partner they were designated as ... eligible to bid for government business.

Why strategic industry assistance works

From their inception 1980s Australian governments intervened in industry development, often through state investments in infrastructure but also through various industry assistance measures; it was only from the 1980s that they listened to the siren call from Washington that they should abandon such efforts. Most of the governments which implemented Washington Consensus policies did so under the duress of debt; Australia was among the few (mostly English-speaking) countries that implemented the Consensus voluntarily. While this implementation was under way, a number of the countries that refused to hear the siren call (notably Germany and China) flourished because their governments were unafraid to pick winners and focus on large-scale ‘strategic’ industry assistance. They unashamedly targeted industries and firms and delivered to them the necessary resources to succeed. Success was not guaranteed, but was achieved sufficiently often for the policies to succeed overall. By contrast, in Washington Consensus countries such as the USA and to an extent Australia the process was reversed: firms and industries with large cash surpluses lobbied governments for policies to maintain their profitability. These established industries are almost by definition not the industries of the future and their success in capturing governments does not auger well for the countries that repudiate public responsibility for directing the course of economic growth.

Australia did not, at first, wholeheartedly adopt the Washington Consensus. The centre-left government of 1983 to 1996 implemented strategic industry assistance, albeit with minimal levels of resources. The centre-right government of 1996 to 2007 moved gradually towards wholehearted implementation of the Washington Consensus. By 2004 it was clear that the shift away from targeted assistance to the level playing field approach had failed; manufactured exports were no longer increasing. One cannot go beyond 2004 because of new policy environment posed by the mining boom.

Why the Washington approach to industry policy failed is obvious in logic. At any point in time there is a wide distribution in firm capabilities, in business opportunities, in obstacles to growth and in stages of technological innovation. For example, if an economy consists of 100 firms and you ask what each could do with a $10 million grant, there may be a particular firm with the opportunity to invest in new capacity which would lead to a $30 million gain in output, given their technology. However, because the firm is a start-up it has no capacity to borrow from the banks or raise capital from the share market. So, it is a case of a $10 million grant or nothing. However, another firm may only need the risks reduced for marketing overseas, and, hence, produce gains from a $1 million grant for export market assistance. The case of large multi-nationals operating in Australia is different again: such firms may require, say, a 15-per cent internal rate of return to justify investment projects in Australia. Can government purchasing programs be designed to push the rates of return above the threshold level?

The first thing to note is that general firm neutral, industry neutral policies such as R&D tax deductions and workforce training allowances will be ineffective in bridging the gap between the assistance needed to make a difference and not much happening at all. They are a waste of resources. Industry development programs need to be diverse. A capital grants scheme is not going to help companies with excess capacity or with good access to funding from capital markets. It is not going to help firms when the constraint is the risks of developing export markets. It’s not going to help firms with an internal rate of return that is below the threshold value of attracting internal investable funds. Thus, a modest industry assistance budget should be

split into many programs, each designed to overcome particular obstacles to enterprise growth. Such policy design is ultra-efficient because it maximises the return on assistance resources. Thus, the five or six firms that each receive a one-off export development grant of $1 million may each generate a $5 million return over, say, 4 years. A capital grants program that gives $10 million to the appropriate firm will generate $30 million a year for the effective life of the plant (a very high rate of return), but it would be foolish to allocate all the available funds to this scheme due to the limited number of firms that can make good use of this type of grant.

As the Mortimer and Goldsworth inquiries concluded, this was the correct approach to industry policy. Unfortunately for the centre-right government, widespread media and academic infatuation with Washington Consensus policies, the negativity and statistical distortions of the Productivity Commission and the wide-ranging, although low-budget, program structure created a widespread perception of ‘industry welfare’ out of control. This perception became conventional wisdom by 2000.

The departure of industry policy from centre stage had a further cause; namely, increased complacency about the balance of payments. As a result of bitter experiences in the 1890s and 1930s, generations of Australian financiers had insisted that Australia should control its overseas debts, borrowing only to finance investments that would generate foreign exchange earnings with which to repay the debts. From the 1980s the deregulated finance sector proclaimed that these anxieties were unwarranted; the market would ensure that the balance of payments managed itself, and there was, therefore, no need for concern over export-generating policies such as ‘industry welfare’. The deregulated finance sector has, accordingly, presided over a considerable accumulation of overseas debt: a growth that will almost certainly turn out badly.

Australian manufacturing export performance: The correct facts

The evidence presented above in support of the effectiveness of carefully interventionist industry policy in Australia is strong. Are there further empirical observations to support this judgement?

Figure 2 presents the first of these facts. It shows the relationship between the share of manufacturing export growth from 1990 to 1998 (excluding processed food exports because of their clear relationship with the agricultural weather cycle) and the share of manufacturing in budgetary industry assistance resources from 1990 to 1998. The correlation is about as perfect as can be expected in economics.

Another conclusive piece of empirical evidence emerges from a straightforward statistical model testing whether the level of assistance or the change in assistance was the most important driver of manufacturing export growth from 1990 to 1998. If the assistance was strategic then the level of assistance will be important. If non-strategic, then the change in the rate of assistance will be important. The results clearly show that the level of assistance was important. For manufacturing industry over 1990 to 1998, a 1-per cent of level of assistance measured by the ratio of budgetary assistance to lagged exports led to a 0.7-per cent growth in annual exports, and this would continue even if assistance did not.1 The change in assistance rate variable was insignificant.

1 The estimated model is from pooled time series in cross-section data for the following industries: textiles, clothing and footwear; wood and paper products; printing and publishing; chemical products; non-metallic minerals; metal products; machinery and equipment; and other manufacturing. The estimation period was 1991 to 2004.

Figure 2: Relationship between export growth and the level of assistance

Source: Real exports Australian Bureau of Statistics (ABS) deflated by index of world trade and Productivity Commission (various years).

The estimated equation was:EG = −0.039 * −0.012.EGt–1

(1.5) (0.11)+ 0.726.ERA * −0.366.CRD.RA (4.6) (1.9)+ 0.159.(RA – RAt–1) (0.4),

where:EG = industry annual growth in exports less world trade indicator growth;RA = industry rate of assistance or budgetary assistance outlays for industry divided by lagged

industry exports; andCRD = centre-right government dummy, 0.3 in 1998, 0.5 in 1999, 0.8 in 2000 and 1 thereafter.

Not only is the change in industry assistance variables insignificant, the lagged dependent variable also reflects weak negative impacts if the assistance level is eliminated. That is, what is created by strategic assistance stays in place once assistance is withdrawn.

More importantly, the centre-right government’s shift from strategic to non-strategic assistance, which opened assistance to a wider group of firms and industries with fewer strings attached, reduced the effectiveness of assistance by 50 per cent.

Australian industry assistance: A counter-factual case to 2014

A counter-factual case may be developed based on the assumption that the funding recommendations of the Mortimer and Goldsworth reports were accepted. As a result, strategic budgetary assistance to manufacturing would reach $4 billion (in 2013 prices), increasing in real terms to $5 billion by 2014, in line with GDP growth. In terms of the estimated equation in footnote 1, this would deliver additional manufactured exports of $74 billion in 2013 prices in excess of what would have been achieved by trends based on world GDP/world trade growth, but excluding the impact of the high exchange rate that accompanied the mineral boom. The approximate empirical rule that results from this is that $1 of accumulative assistance from period t to t + n will result in $1 of additional exports by year t + n compared to year t.

This illustrates the difference between strategic and non-strategic assistance. For strategic assistance the increase in economic activity after n years of average annual assistance of y will be approximately ny. For non-strategic assistance the increase in direct economic activity after n years of average annual assistance y will be close to y.

ConclusionDuring the decade to 1995 Australia, indeed, reduced import tariffs on manufactured goods and, therefore, exposed many of its hitherto-protected manufacturing industries to overseas competition. However, at the same time, it implemented a series of targeted and highly cost-effective industry policies that assisted a wide range of Australian manufacturing businesses to become internationally cost-effective, gaining export markets at the same time as they met import competition. The combination of tariff cuts with targeted industry assistance was acknowledged as effective at the time. However, the myopic economists of the Productivity Commission and their media, academic and finance sector allies could not see beyond their long-advocated tariff cuts and, indeed, cooked the numbers to support their belief that the revival of Australian manufacturing during the 1990s was due simply to animal spirits released by the tariff cuts. They refused to concede the importance of targeted assistance programs. The Productivity Commission and its allies in the advocacy of Washington Consensus policies had their way; the Commonwealth government moved from targeted to generalised industry assistance and, hence, moved from cost-effective to ineffective policies.

During the mineral boom it was possible to pretend that this did not matter; Australian prosperity would be guaranteed by mineral exports. Not only did the Commonwealth withdraw from targeted industry assistance, it stood idly by while an overvalued exchange rate wreaked further havoc in Australian manufacturing. The time of reckoning now approaches. Mineral prices have slumped and manufacturing has been decimated. The Washington Consensus has already been discredited within the world economic development community; the time is long past that it should likewise have been discredited in Australia.

References

Centre of International Economics (2009), ‘Benefits of Trade and Trade Liberalisation’, May, Department of Foreign Affairs, Canberra.

Department of the Parliamentary Library – Information and Research Services (1999–2000), ‘Industry Policy in Australia’, Research Paper No. 3, Department of the Parliamentary Library, Canberra.

Goldsworth, A. (1997), The Global Information Economy: The Way Ahead’, Department of Industry, Science & Tourism, Canberra.

Mortimer, D. (1997), Going for Growth: Business Programs for Investment, Innovation and Exports, Review of Business Programs, Department of Industry, Science and Tourism, Canberra.

Oxley, A. (2000), Seize the Future: How Australia Can Prosper in the New Century, Allen and Unwin, Sydney.

Productivity Commission (various years), Trade and Assistance Review, Productivity Commission, Canberra.

Sheehan, P. J., N. Pappas and E. Cheny (1994), ‘The Rebirth of Australian Manufacturing’, Centre for Strategic Economic Studies, Victorian University.