Industrial Policy for Australia
by Helen Hughes

‘Industry policy’ has been a central feature of economic debates since World War II. Initially, only liberal, market oriented economists argued that introducing economy-wide policies – the rule of law, macroeconomic management, financial policy, tax regimes, free trade, flexible labour markets, a competitive infrastructure, efficient and equitable education and welfare policies – was essential and sufficient for the development of industry and the economy as a whole. Marxist and neo-Marxist planners saw industrial development in terms of catching up with the technological advances of industrial countries; hence industry had to be directed by Government and subsidised at the cost of the rest of the economy. The Japanese Ministry of International Trade and Industry (MITI) was a leading exponent of this view. Its industrial intervention included an attempt to prevent the development of electronics by Sony and the manufacture of cars by Honda. Over time, MITI came to agree that sound economy-wide policies were necessary for industrial development, but, because of its continuing misunderstanding of the role of technology and investment in industrial development, it continued to argue that getting the basic policies right was not sufficient for industrial development. MITI influences, modified by Japan’s Ministry of Finance in Government circles and strongly contested by Japanese business, were far less pervasive than wide misrepresentations of the ‘Japanese model’ from the 1960s to the present day suggest. Nevertheless, direct government intervention in industry persisted. The effects have become evident in years of economic stagnation, financial and fiscal crises and widespread economic and political corruption, arising from the close collaboration of the public service and large-scale business.

Most of developing East Asia followed the same path. Singapore and Taiwan (and until recently Hong Kong) have been the exceptions. Singapore since the 1950s and Taiwan since the 1980s have been essentially market dominated economies. They have accordingly escaped the difficulties that face those East Asian countries in which government intervention in industry has prevailed. They understood that interventionist industry policy is inherently inefficient because it substitutes the judgements of public servants (even if they are former business executives) for market signals. Public servants are not subject to the disciplines of market risk and the ultimate possibility of bankruptcy. Industry policy interventions make financial institutions subject to ‘moral hazard.’ Financial flows are directed to government guaranteed investments, with large profits in the short term but with a build up of non-performing loans. Land and labour, as well as capital, are misdirected by subsidised investments into low efficiency production. Subsidies to industry (whether in the form of subsidised credit or tax concessions) undermine budgets, putting pressure on macroeconomic management, price stability and real interest rates. As budgets run into deficit, currencies become overvalued, reducing exports.

Toward the end of the 1980s, the collapse of the centrally planned economies, which had practised extreme forms of industry policy, added to the weight of liberal voices in policy debates. Currency and financial collapses in industry policy East Asia have followed. It has become clear that unless the East Asian countries, including Japan, press on with liberalisation, their economies will follow the Latin American ‘stop/go’ industry policy path to economic disaster, social division, corruption and crime. Chile, since it adopted a liberal market orientation, has been the only Latin American economy that has been able to sustain growth.

The fall in the cost of transport and communications has not only led to international flows of goods and services, but also to flows of ideas. Policy debates world-wide reflect the result of research on the policy causes of slow growth and inequality. In many West European countries, high unemployment is undermining living standards and creating ghettos of the poor. The English- speaking market economies – the United States, United Kingdom, New Zealand and Australia – have, in contrast, sought to improve their basic economic policies, albeit in fits and starts and only to varying degrees, from the early 1980s. In Australia the progressive freeing of capital and foreign exchange markets, trade liberalisation, a start on reducing labour market inflexibility, the movement towards privatisation of the public sector, increased domestic market competitiveness and, in the second half of the 1990s, improved macroeconomic policies, have delivered the strongest economic environment since Federation. Low inflation, low interest rates and recent labour market improvements have made it possible for creative entrepreneurs and managers to achieve remarkable business growth (Charles Report).

Unfortunately, after some 200 years of direct government intervention and trade protection, most Australian entrepreneurs and managers have not been able to take advantage of the improvements in the domestic environment and the accessibility of international markets. The main exceptions are mineral and agricultural producers, because they have long been exposed to international competition. Most are performing well, although they are hampered by non-performing sectors and policies, notably transport and communications, and tariffs and subsidies for manufactured inputs. Taking manufacturing and services as a whole, most entrepreneurs and managers are failing Australia. Decisions that result in high unemployment and low profitability are taken daily in boardrooms and CEO offices across the country. High unemployment and low profitability prevail.

The demand for tariffs and subsidies is led by business interests not competing effectively in domestic or overseas markets. Department of Industry, Science and Tourism officials and the media pander to those businesses that shift the blame for their incompetence to ‘uneven playing fields’ resulting from other countries’ practises – protective tariffs, preferences to domestic firms in government purchasing, the unfair use of health and other regulations to bar imports, and ‘dumping.’ When Australian firms finally had to recognise the large and growing opportunities in East Asian markets, they attributed their small share of East Asian imports to import barriers rather than to their lack of competitiveness. Asia Pacific Economic Cooperation (APEC) was developed in part to support Australian business in its belief that Australia’s low exports are the result of Asian policies, not of the weakness of Australian management. The political euphoria that accompanied the vision of an Australian-led East Asia helped to misdirect weak Australian firms to an unbusinesslike concentration on trade with East Asia, regardless of other markets.

The Mortimer, Goldsworthy, Marceau and MTIA-EIU reports

Almost as soon as the Howard Government assumed office, that section of Australian business which has traditionally sought its profits from government handouts rather than on the shop floor, began to lobby for additional subsidies. The auspices were not promising. Inheriting a large budget deficit, the Treasury turned to cutting down and even eliminating subsidies which were widely regarded as ‘rorts.’ Although the resulting 1996/97 budget cuts for subsidies were modest (Charles: 75-76), major business organisations were horrified. Policy measures that sought to improve the fundamental business environment were not appreciated; managers were not sufficiently competent to take advantage of them. Legislation facilitating wage settlements by enterprise agreements has thus been ignored or not effectively utilised. Most wage settlements did not incorporate productivity increases as a condition for wage rises. Industrial relations consultants were often incapable of assisting managers to achieve rising productivity in enterprise agreement outcomes.

Business opted for a return to the policies that had steadily reduced Australia’s relative per capita income since World War II. Tariff reform was halted despite the overwhelming weight of evidence that tariffs do not save firms or jobs. Under the backsliding umbrella raised by Australian business, the maintenance by Japanese and American motor vehicle firms of discriminating monopoly in Australian markets was upheld, at the cost of Australian consumers, for the benefit of their shareholders. Pressure to improve productivity in the motor vehicle industry in Australia was reduced. Tariff retention in textiles, footwear and clothing followed, destroying Australia’s credibility in international trade negotiations.

Business, bureaucrats and states pushed the Howard Government in its second year of office to commission a review of business programs with a view to increasing subsidies for industrial production (the Mortimer report), and to appoint an Information Industries Task Force to advise on how these ‘high technology’ industries could be assisted (the Goldsworthy report). Two business initiatives were taken at the same time: the Australian Business Foundation produced an interventionist industry policy oriented monograph (the Marceau report), and the Metal Trades Industry Association, with the assistance of the Economist Intelligence Unit (Australia), produced an industry policy wish list that, given the season, was no doubt intended for Santa Claus.

These four reports have a great deal in common. They are long on stating the obvious, notably in relation to technological change and the internationalisation of markets – neither of which, however, they understand. Their lengthy descriptions of the Australian economy marshal data to make the case for interventionist policies and corporatist government-business links. They see the importance of prudent macroeconomic and other economy-wide policies for growth and development because these arguments have won the policy debate worldwide. They recognise the value of microeconomic reform. Without presenting any evidence, however, all these reports centre on the need for MITI type interventions in the economy. They all allege, without any evidence, that domestic and overseas investment is inadequate, notably in what they regard as technology intensive industries. Technology intensity is never defined, but assumed to be concentrated, together with high skills, in information industries. It would no doubt come as a surprise to the authors that some of the most technology intensive industries in Australia (defined in terms of the technology share of value added at international prices) are in the outback. It is assumed, again erroneously, that multiplier effects are proportional to the undefined technology intensity rather than to the competitiveness of domestic resource use (land and minerals, labour and capital) at international prices.

International experience is constantly used out of context to bolster the interventionist case. Ireland, for example, is quoted as a great industry policy success, whereas its recent arrival is largely the result of European Community regional transfers (subsidies). Elementary economic analysis is ignored. To a greater (Goldsworthy and MTIA-EIU) or lesser (Mortimer) degree, all these reports break with the little analysis they contain to make intervention and subsidy recommendations, mainly for investment and technology. Yet, frighteningly, the implementation in East Asia of the policies that Mortimer, Goldsworthy, Marceau and the MTIA-EIU recommend indicates their potential for undermining Australian productive efficiency and exports. They open an insidious gate to corruption. The quality of these reports raises serious doubts about the analytical capacity of the principal authors, the staff of the Department of Industry, Science and Tourism who assisted them, and the consulting firms that claim substantial contributions in all four reports.

The Mortimer Report

Some economic sense is evident in the overall assessment of the Australian business environment, although the conclusion that opting for growth involves strategic (that is interventionist) government inputs is reminiscent of the corporate state and French ‘indicative planning’ philosophy that has culminated in very high unemployment and economic stagnation, with worse to come.

Chapters 3 and 4 reiterate the view that the problem with existing business programs is not that they are by their very nature ineffectual, but that the specific details of their composition, their organisation and co-ordination are at fault. Chapter 5 argues that business investment needs to be expanded. There is no evidence that either domestic or overseas inflows (and outflows) are inadequate. The authors are evidently unaware that the principal investment problem in Australia is the low utilisation and hence the low returns/high costs of investment. Low capital utilisation arises from labour market rigidities and poor management. In most manufacturing, service enterprises and government offices, capital equipment and buildings are only used about 20 per cent of the 24 hour, 365 day time available each year. Low capital utilisation means that equipment and buildings are technologically obsolete before they are worn out. If capital utilisation were increased by improved industrial relations and other economy-wide policies, with corresponding increases in productivity, existing investment would lead to considerably greater volumes of output and accelerated technological change. Pouring more investment into production under existing conditions in industries such as motor vehicles maintains low profitability and hence requires tariffs or subsidies. Chapter 6 lacks an appreciation of the factors that lead to poor management, merely repeating tired clichés about the need to encourage innovation.

The concluding chapters are even weaker. The underlying reasons for Australia’s low export to GDP ratio (still only a little over 20 per cent, instead of the 30 per cent plus that would seem desirable for an economy of Australia’s size), are ignored. Australian mineral and agricultural exports are undermined by high infrastructure costs, remaining labour market rigidities, the protection of domestic markets and an inefficient taxation system. Although successive reviews have shown that the Export Market Development Scheme has made a negligible contribution to expanding exports, it survives the superficial glance thrown in its direction. So does Austrade, a service that many exporters see mainly as an employment service for failed business people, bureaucrats and politicians. The Mortimer report fortunately recognises that the threat of illegality under WTO rules means that some of the grossly inefficient subsidies to exports will have to go. As in the discussion of investment, Chapter 9 on resource management ignores the main obstacles to more sustainable and efficient uses of Australia’s natural resources. Why have Australian and international mineral firms shifted their interest and exploration expenditures away from Australia?

Despite its slender analytical base, the Mortimer report makes over a hundred detailed recommendations for subsidies, other government interventions in industry and for corporatist co-operation. The detail indicates that the officials who design and implement business programs have been busy. Only they know the twists and turns of the cash flows available, of regulations and their compliance implications. This is the source of their power. When the Department of Industry, Science and Tourism finally computerised the business programs available, it discovered that it had some 500 major programs and many more sub-programs of assistance to industry. States run additional programs. The resulting confusion and program overlaps are well known. Firms are usually eligible for a number of programs, but must exercise considerable ingenuity in finding out where the bags of gold are and how they may be made available. For example, former government officials who devised and administered programs, now, as consultants, assist those firms that want to access $250,000 a year from the Export Marketing Development Grants scheme rather than attend to problems on the shop floor and in export markets.

Ausindustry was to be a one stop shop for at least the Commonwealth business programs. It has clearly failed. The Mortimer report sensibly recommends its abolition. But Australinvest is to be created in its stead.

Astonishingly, the Mortimer Report recommends the establishment of export zones in Newcastle and Cairns. The former is to replace the steel industry which was once the principal employer in the area, and which could have employed several hundred thousand workers in (unsubsidised) exports. Over 1,000 export processing zones throughout the world aim to provide internationally competitive infrastructure and duty free inputs into labour intensive exports. The principal objective is to soak up reserves of low cost, unskilled labour. Only a handful of these zones have succeeded. Australia already has an export processing zone in Darwin. It represents a public investment of $60 to $80 million. The consultants that planned the zone are not eager to be contacted. The Northern Territory Government has not produced a cost/benefit evaluation. It is well known, however, that annual exports have been negligible throughout the zone’s existence. Kangaroos patrol the grounds. Cairns, with its thriving tourist industry already competing for skilled labour and its high cost infrastructure, is set to replicate the Darwin experience.

The Newcastle situation is somewhat different. Having lost its steel business, BHP is left with derelict real estate. Making this into a zone for export industries with the assistance of Commonwealth and state subsidies would turn a liability into an asset. At a time when BHP is negotiating redundancies worth $140 million for 2,500 workers at Newcastle (with a few in Sydney and Geelong) who are at the tail end of the steel industry fiasco, an injection of taxpayers’ money is welcome – though only some 12,000 workers are expected to be employed in the Newcastle export zone when it is filled, that is, some 5 to 10 years down the track.

The total cost of the Mortimer welfare-for-business recommendations came to $20·75 billion for the 5 years from 1998/9 to 2002/3. $13·26 was to enhance ‘business competitiveness,’ $3·6 billion for innovation, $1·7 billion for exports and $1·1 billion for investment. But somewhat surprisingly, given the report’s rhetoric, the Mortimer recommendations propose that industry policy spending should continue at the present rate of some $4 billion a year. The report suggests an expenditure reshuffle rather than a rethink.

The Goldsworthy Report

The central theme of the Goldsworthy Report is that Government has to be the driving force of the information industry. This runs against United States information policy, quoted in the Report, which specifically states that for an effective partnership in electronic commerce between the public and private sectors, the private sector must be in the lead (p. 68). The industry is too technical, too international and developing too rapidly to permit any government, even as large a one as that of the United States, to be the industry’s driver. The industry is essentially a bottom up, not a top down sector. What governments can do is ensure that telecommunications and other services operate at internationally competitive prices so that information firms can develop and expand internationally. Competition policy has to be in place to prevent monopolistic practices. The government also has responsibilities in the area of security and privacy. All these are ignored or given little weight in the Goldsworthy report.

The report implies that Australia is lagging in information industries by stressing the need for more investment, research and innovation. In fact Australian firms are well integrated into the international information economy, with a considerable number of small firms working at the leading edge of software and hardware development. Some are among the fastest growing firms not only in Australia, but also in the world. Because the information industry is very open, particularly in terms of software technology, Australia as a small country, cannot expect to play a disproportionately (in relation to population) large role in global markets. The current rate of development is adding substantially to business income, high-skilled employment and exports and is supporting other industries.

The Report, showing total ignorance of the economics of trade, is concerned that exports do not balance imports in this industry. Nor do the imports of wool, coal or iron ore balance exports. Economies of scale are considerable in much of the hardware component of the information industry so that a firm cannot economically produce for the Australian market alone. Because barriers to exporting from Australia (in terms of labour market rigidities, costly infrastructure, inefficient taxation and remnants of protection) are only slowly declining, the offers of subsidies through ‘partnership schemes’ have not attracted hardware producers to Australia on a significant scale. If barriers were lowered, subsidies would become redundant. In any case there is no evidence, and the Goldsworthy report certainly does not provide any, that information industries add more value per unit of capital and labour invested, or have greater multiplier effects, than, say, the production of fashion underwear.

The MTIA-EIU Report

A dialogue between government and business is an important component of democratic processes. The MTIA represents a large sector of Australian manufacturing industry. Believing in the industry policy school of development, the MTIA has long been protectionist; it has supported export subsidies to motor vehicle and motor vehicle component manufacturers and favoured other forms of welfare for business. It has strongly supported rigid labour markets with central wage fixing. Commissioning the EIU to write its industry policy has put a contemporary gloss on traditional attitudes. Three of the seven steps considered necessary to Make or Break the metal industries – continuing to deliver good macroeconomic policies, fundamental tax reforms and carrying through with reforms to industrial relations – make good sense. The fourth step is giving urgent priority to linking Closer Economic Relations (CER) into the ASEAN Free Trade Agreement.

The crux of the Report and the detailed recommendations, however, are contained in the other three steps, which include large increases in investment incentives (that is, subsidies), the establishment of a powerful Australian investment agency, and strong, central co-ordination of industry programs. Evidence that investment flows are uneconomically low is not forthcoming. There is not a word about the depressing effects of low capital utilisation on technological change, productivity and profits. Like the Mortimer and Goldsworthy reports, the MTIA-EIU report essentially makes a loud plea for a business welfare program and business-government corporate institutions to implement it.

The EIU interviewed 150 CEOs of Australian companies, 20 multinationals in Europe, United States and Asia, as well as ‘senior managers’ of investment agencies in Malaysia, Singapore and Ireland and investment consultants in these countries. Although the EIU’s work was being undertaken when astute observers were predicting that investment subsidies and government-directed investment decisions were about to create enormous problems in East Asian economies, the EIU was still able to find respondents who argued for substantial subsidies for private investment in a framework of government and business ‘co-operation.’ The report provides a casebook of the effects of years of protection on Australian management. If all Australian managers were as little aware of the benefits of international competitiveness, of the macro-economic costs of subsidies, and above all, of what the role of CEOs in expanding business must be, Australia would, indeed, be in poor shape.

The Marceau and Charles Reports

The Australian Business Foundation Limited is a ‘recently formed independent economic and industry policy think-tank.’ Its ‘mission [is] to commission and conduct high quality research on issues that impact on Australia’s international competitiveness and jobs generation capability. [It] aims to bring fresh analysis, rigorous research and a more innovative perspective to the complex issues of economic and industry policy’ (Charles: i). Such an initiative is certainly to be welcomed.

The Marceau Report, after surveying the industrial characteristics of Western economies, relates Australian industry to that environment. The final section looks at policy implications for Australia. The bibliography is long, with a bias toward ‘new growth’ and strategic trade theories that have been developed to counter the liberal view of economic development and justify interventionist industrial policy. The theories are presented without an evaluation of the considerable literature that suggests that their hypotheses only apply to special cases (strategic trade theory) or are not proven (‘new growth’ theory). The report consists of a detailed compendium of well known information about Australia and the OECD countries, attractively arranged to support the interventionist case. The data presented could have been equally used to demonstrate the importance of basic economy-wide policies in industrial development and the redundancy of intervention. Interviews with managers, as in the MTIA-EIU report, support the basic themes of the need for government intervention, but do not shed any light on the role of managers in making business efficient and
internationally competitive. Is this what business schools are teaching? High technology, globalisation, networking, commitment to training, human resource management, policy integration and co-operation buzzwords permeate the text and dominate the conclusions, but in terms of analysis the report falls far short of the Business
Foundation’s aims.

Another Australian Business Foundation volume, the Charles report, looked at the experience of about 30 successful Australian and multinational companies operating in Australia. Unlike its companions it runs to less than 100 pages, but it makes interesting and cheerful reading. The case studies presented clearly indicate that entrepreneurship and good management are alive and well in Australia. They embrace a variety of quality products and production practices, show effective research expenditures, discuss the hiring and management of high quality staff and have effective marketing practices and an international outlook. Rapidly growing firms know that the Australian population is not large enough for efficient production, so the case studies include a high proportion of exporters. The Charles report sharply contradicts the conclusions of the Mortimer, Goldsworthy, MTIA and Marceau volumes, indicating that capable entrepreneurs and managers do not need interventionist government assistance even in a less than perfect economic environment. The study suggests that if the reform of basic policies continues, more entrepreneurs and managers will join the elite group of those who are achieving high private returns, increasing employment and contributing to high social returns without incurring social costs.

The Australian Business Foundation’s next step might be to test hypotheses about why the average Australian firms – their Boards and their managements – lag so far behind those that excel. To be useful, such a study would have to go beyond the arrangement of facts to demonstrate prejudices and beyond case histories. In a scholarly fashion it would have to test hypotheses about such determinants of business incompetence as Australia’s long history of protection and industry policy intervention. It is encouraging that the Australian Business Foundation has the funds for such work.

Whither industry policy now?

The 8th December 1997 industry policy statement reflected the Mortimer report and supporting business pressures. The Government pointed to the key importance of improving underlying economic co-ordinates, notably low inflation and interest rates, but the efforts of the government-business teams and business contributions had to be recognised and were stated in the technology- and investment-speak of the reports. Industry policy funding is, however, to remain roughly at present levels. The work of the Productivity Commission, though not expressed so as to capture the public interest, has clearly also had an impact on policy. The principal new initiative is the export zone for Newcastle, where the State and Commonwealth Governments have to pick up the social costs of large scale business failure and, under Australian rules of the game, even contribute to the rescue of shareholders’ funds. Otherwise changes are largely cosmetic, continuing current programs. Unfortunately this has precluded a shift of public flows from industry subsidies to such infrastructure as improvements in basic education for that 20 per cent or so of the school population now being prepared for long term unemployment.

Who benefits from industry policy?

Firms – managers, workers and shareholders – are the driving force behind the clamour for ‘industry policy.’ In the past, in the shelter of protection, they were able to make substantial gains from going to Canberra with their begging bowls. In the current international environment, however, seeking handouts rather than efficiency is not likely to work over time. The experience of the 1990s suggests that, despite handouts, returns to shareholders and employment will be eroded unless firms become competitive. The most highly protected industries have lost the most workers, and the same fate looms ahead for motor vehicle, textile, clothing, footwear and other protected firms if they take advantage of protection rather than speed up their efforts to improve efficiency and competitiveness. In tight international markets, remaining tariffs and expenditures of $4 billion a year are a burden on exporters and undercut employment.

The unequivocal and now perhaps the principal beneficiaries created by industry policy are the public servants who administer it. Still assured of relatively secure tenure and well superannuated, public servants’ remuneration and power depends on the size of their staff and hence on the administrative tasks that they can create. In addition to core positions in government departments, public enterprises such as Austrade and Australinvest provide high level employment and incomes and a two way street for business executives temporarily lacking niches in the private sector.

A new career has opened up for public servants in consulting positions that use the detailed knowledge of the programs that they have created to help businesses gain access to subsidies. The Export Marketing Development Grants scheme provides a handsome living for former staff. The same applies to small business, research and development and other grants and tax exemptions. Not surprisingly, such consultants form a well-informed, highly articulate lobby group for interventionist industry policy.

It has always been somewhat of a mystery that Labor politicians strongly support implicit and explicit subsidies for capital investment that reduce the relative cost of capital and thus encourage the substitution of capital for labour, reducing potential employment. Labor support for expenditures on industry policy is politically much stronger than its support for the improvement of educational opportunities for children from low-income
families.

The consequences of the adoption of industry policies in East Asia are not only having an impact on their living standards and growth prospects, but will lead to export problems in Australia. Australian management needs to respond quickly and efficiently to the opportunities opened up by the devaluation of the Australian dollar to intensify its efforts to compete, domestically and within existing and a broader range of export markets. Most business commentators assume that such an effort is not likely to take place, so Australian growth will be reduced as a result of East Asian problems. Among the many pages reviewed, the Charles report is alone in contributing to this critical challenge. Only the decisions made by managements and in boardrooms in the next few months can make a difference to the response of Australian business to the East Asian crisis.

References

Australian Business Foundation, August 1997, The High Road or the Low Road? Alternatives for Australia’s Future: a report on Australia’s industrial structure for the Australian Business Foundation Limited (Marceau report).

_________September 1997, Winning Companies and Jobs: how high growth and knowledge intensive industries create jobs (Charles report).

Department of Industry, Science and Tourism 1997, Going for Growth: business programs for investment, innovation and export (Mortimer report), Commonwealth of Australia, Canberra.

Department of Industry, Science and Tourism, Information Industries Task Force 1997, The Global Information Economy: the way ahead (Goldsworthy Report), Commonwealth of Australia, Canberra.

Economist Intelligence Unit (EIU) for the Metal Trades Industry Association of Australia, August 1997, Make or Break: 7 steps to make Australia rich again (MTIA-EIU Report).
 

Helen Hughes is Emeritus Professor of Economics at the Australian National University. 

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