Yikes! Our tiny manufacturing sector makes us rich but ugly

At last, the source of our economic problems has been revealed. Our economy is badly misshapen, making it unlike all the other rich economies. Did you realise that our manufacturing sector is the smallest among all the rich countries?

Worse, our mining sector’s almost five times as big as the average for all the advanced economies and our agriculture sector’s twice the normal size.

Do you realise what an ugly freak this must make us look to all the other rich people in the world? We’re like the millionaire who made his pile as a rag and bone man with a horse and cart. Yuck.

It’s something about which we should be deeply ashamed and very worried, apparently.

How do I know this? It’s all explained in an open letter signed by about 70 academics who, because they’re banging on about economic matters, have been taken to be economists. But they don’t sound like any economist I know.

Indeed, they devote most of their letter to explaining why some of the most fundamental principles of economics are not only wrong, wrong, wrong, but sooo yesterday.

They condemn “outdated ‘comparative advantage’ theories of trade and development – according to which, countries should automatically specialise in products predetermined by natural resource endowments” which theories, they assure us, “have been abandoned” by other rich countries.

Rather, “there is new recognition that competitiveness is deliberately created and shaped, through proactive policy interventions that push both private and public actors to do more than market forces alone could attain”.

Get it? When you’re trying to make a living in a market economy, it’s a mistake to worry about what you’re good at, or to think you’ll sell something you’ve got that they don’t. No, with the right policies, governments can make you “competitive” without any of that.

You may think we’ve done pretty well among the other rich countries but, in truth, we’ve been getting it all wrong. When those Europeans were sailing round the South Pacific looking for an island they could take from its local inhabitants, their big mistake was to pick Australia.

They thought our island would have a lot of good farmland. And surely somewhere in all that space there must be some gold or other valuable minerals. But this turned us into hewers of wood and drawers of water.

Worse, some of us became the lowest of the low, digging stuff out of the ground and shipping it off somewhere. We turned our country into a quarry. And there’s only one thing lower than running a quarry: providing “services” to other people. You know, being a cleaner or chambermaid or waiter.

All of which tempted us away from the one honest, noble way to earn a living: making things. And if only our island hadn’t been good for farming and mining, making things would have been the only way left to make a living.

Really? As the independent economist Saul Eslake has said, this isn’t economics, it’s the fetishising of manufacturing. It’s the one worthy occupation. All the rest are rubbish.

Now, I’m sure the open letter-signers would protest that they’re only arguing for a big manufacturing sector, they’re not saying we shouldn’t have farmers, miners or servants.

Trouble is, as Eslake points out, all the parts of an economy can’t add to more than 100 per cent of gross domestic product or total employment. If some parts’ shares are bigger than others, the other bits’ shares must be smaller.

When you think about it, this is just an application of the economists’ most fundamental principle: opportunity cost. You can’t have everything you want, so make sure what you pick is what you most want.

To anyone who’s been around a while, it’s clear the letter-signers are on the left. Nothing wrong with that. At its best, the left cares about a good deal for the bottom, not just the top. But for some strange reason, a lot of those on the left see themselves as linked to manufacturing by an umbilical cord.

The joke is, few if any of the letter-signers would ever have worked in manufacturing – or ever want to. (My own career in BHP’s Newcastle coke ovens lasted two days before I scuttled back to the comfort of a chartered accountants’ office.)

Academics, more than anyone, should understand that the future lies in services, not manufacturing. The good jobs come from what you know, not what you can make.

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Australia's future to be made under Treasury's watchful eye

The Albanese government’s Future Made in Australia has had a rapturous reception from some, but a suspicious reception from others (including me). In a little-noticed speech last week, however, one of our former top econocrats gave the plan a tick.

Rod Sims, former chair of the Australian Competition and Consumer Commission, and now chair of Professor Ross Garnaut’s brainchild, the Superpower Institute, has been reassured by the plan’s “national interest framework”, prepared by Treasury and issued with the budget.

But first, the budget announced that the government would “invest” – largely by way of tax concessions – $22.7 billion in the plan over the next decade.

Treasury’s framework will be included in the planned Future Made in Australia Act. It will “clearly articulate” how the government will identify those industries that will get help under the act, to “impose rigour on government’s decision-making on significant public investments, particularly those used to incentivise private investment at scale,” according to Treasury.

So, Sims is reassured by the knowledge that the framework – and Treasury – will ensure that “sound economics has been applied”. “In my view, [the plan] represents a growth and productivity opportunity every bit as bold as seen under previous governments,” he says.

Some of those giving the plan a rapturous reception believed it was “a welcome return to activist industry policy and making more things and value-adding in Australia,” Sims says. But “despite what has been said for political reasons, this is not the logic driving [the plan] as described by Treasury”.

Sims says we don’t need to revisit old and tired debates about protectionism. But as it happens, he notes, making more things in Australia will be an outcome of the plan.

Some said the plan represented the end of “neoliberalism” and a return to interventionist thinking. “It is not that either,” he says. “[The plan] relies on sound economics, and any change in economic thinking is a return to the application of sound economics.”

The way I’d put it is that to intervene or not to intervene is not the question. A moment’s thought reveals that governments have always intervened in the economy. (One of the most incorrigible interveners is a crowd called the Reserve Bank, which keeps fiddling with the interest rates paid and received in the private sector.)

No, as we’ll see, the right question is usually whether the intervention is adequately justified by “market failure” – whether, left to its own devices, the market will deliver the ideal outcomes that economic theory promises.

Others have approved of the plan because it’s about encouraging some local production in necessary supply chains. Sims admits there’s an element of this, as local battery and solar panel manufacture are mentioned, but they are a small part of the program.

Similarly, some move to make supply chains less at risk of disruption may be involved, but it’s not the driving logic of the plan.

Yet others have said the plan is copying the United States and its (misleadingly named) Inflation Reduction Act. “This is incorrect,” Sims says. The Americans’ act “spreads money widely, whereas [the plan] is targeted to Australia’s circumstances”.

The US act “also has many destructive features that we will not copy, such as its protectionist approach.”

But, to be fair to the sceptics, he adds, “the policy’s introduction was poorly handled. It was linked to making solar panel modules, when they can be purchased much more cheaply from China, and then there was the announcement of $1 billion for quantum computing.”

“It helps neither global mitigation [of climate change] nor Australian development to force manufacture here, if the final products are produced most cost-effectively elsewhere.”

So, if the plan isn’t mainly about protectionism, what’s its main purpose? Achieving the net zero transition and turning Australia into a renewable energy superpower.

Treasury’s national interest framework says the net zero transition and “heightened geostrategic competition” (code for the rivalry between the US and China) are transforming the global economy.

“These factors are changing the value of countries’ natural endowments, disrupting trade patterns, creating new markets, requiring heightened adaptability and rewarding innovation,” the framework says.

“Australia’s comparative advantages, capabilities and trade partnerships mean that these global shifts present profound opportunity for Australian workers and businesses.” We can foster new, globally competitive industries that will boost our economic prosperity and resilience, while supporting decarbonisation.

In considering the prudent basis for government investment in new industries, the framework will consider the following factors: Australia’s grounds for expecting lasting competitiveness in the global market; the role the new industry will play in securing an orderly path to net zero and building our economic resilience and security; whether the industry will build key capabilities; and whether the barriers to private investment can be resolved through public investment in a way that delivers “compelling public value”.

So, that’s quite a few hurdles you have to jump before the government starts giving you tax breaks. And proposals will be divided between two streams: the net zero transformation stream and the economic resilience and security stream. We can only hope that a lot more of the money goes to the former stream than the latter.

To justify government intervention, the framework requires evidence of “market failure” such as “negative externalities” that arise because the new clean industry is competing against fossil fuel-powered industries which, in the absence of a price on carbon, haven’t been required to bear the cost to the community of the greenhouse gases they emit.

Another case of market failure are the “positive externalities” that arise when the first firms in a new industry aren’t rewarded for the losses they incur while learning how the new technology works, to the benefit of all the firms that follow them.

Politicians being politicians, I doubt whether Treasury’s policing of its national interest framework will ensure none of the $22.7 billion is wasted. But we now have stronger grounds for hoping that Treasury’s oversight will keep the crazy decisions to a minimum.

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Is a Future Made in Australia a good or bad idea? Maybe a bit of both

What exactly is a Future Made in Australia? You can read the long speech Anthony Albanese made about it and still not be sure. My guess is it’s a slogan designed by spin doctors to mean whatever you’d like it to mean.

As I wrote on Monday, what I hope it means is that the government intends to secure our economic future by ensuring all the income we’re going to lose from the world’s decision to stop buying our exports of fossil fuels is replaced by us using our new-found comparative advantage of being able to produce renewable energy more cheaply than most other countries.

We can produce masses of the stuff but, because it’s expensive to export, we can set up new industries which use the renewable energy to produce green iron, green aluminium and various other green minerals and then sell them to the world.

Because such industries don’t yet exist, the businesses that start them will inevitably make mistakes from which later businesses will learn. So it makes hard-headed economic sense for the government to cover much of the cost of this learning-by-doing “positive externality” – this spillover benefit to the wider economy for which the original businesses will go unrewarded.

If that’s what Albanese means by making our economic future, he deserves all the support and encouragement the rest of us can give him.

But I fear his slick slogan was designed to remind people of the old goal of trying to ensure that as many as possible of the goods we consume are Made in Australia.

This was our aim for about half a century until, in the 1980s, the Labor government of Bob Hawke and Paul Keating rolled back the import duties protecting our inefficient manufacturing industry and opened our economy to the world.

But why would Albo and his smart economists, Jim Chalmers and Chris Bowen, want to reverse the bipartisan policy of the past 40 years and take us back to the future?

Well, some polling produced this week by Essential Report offers some big clues. Asked to what extent they supported or opposed the Future Made in Australia policy, 30 per cent of respondents said neither. I take this to mean most hadn’t heard of it, or weren’t sure what it involved.

But 51 per cent supported the policy, leaving only 19 per cent opposing it. Unsurprisingly, Labor voters were more supportive than Liberal voters. But this is surprising: two-thirds of Greens voters supported it.

Why so much support for the government policy with a snappy name but so little detail? More clues followed. Fully 70 per cent of respondents agreed with the statement that “the pandemic showed we cannot be wholly reliant on global supply chains”.

And 63 per cent agreed that “it was a mistake to allow the Australian car industry to close,” with 43 per cent agreeing that “the days of globalisation, where we just imported cheap goods from overseas are over”.

Against that, however, only 37 per cent agreed that “it is not the government’s job to support Australian businesses that can’t compete overseas,” and only 34 per cent that “the market will make the best decisions and government should stay out of the way.”

Get it? There’s strong support for the goal of self-sufficiency and making as much as we can locally – keeping the jobs and the profits at home, not sending them abroad.

It’s noteworthy, too, that support for Made in Australia is much stronger among those aged 55 and above than among those aged 18 to 34. Believing that a country must make things, not just deliver services is, thankfully, more a hangup of the old.

So, if Albo and his spin doctors see benefit in playing to the Bring Back Manufacturing crowd, it wouldn’t be so surprising.

Just so long as you don’t forget this: keeping the jobs at home seems no more than common sense but, when you think it through, you see it’s a great way to be poorer, not richer.

One of the main ways humans have made themselves richer over the centuries is what economists call “the division of labour” and the rest of us call specialisation.

We can use the same amount of labour to produce more goods and services by having workers specialise in doing what they do best. By now, the process of specialisation – which no doubt has yet further to run – has reached the point of specialisation within specialties.

But obviously, specialisation can’t work without exchange: I sell my stuff to you; you sell your stuff to me. And what makes economic sense for individuals also makes sense for countries. We don’t maximise our material prosperity by stopping specialisation and exchange at the border.

Countries also need to specialise in what they do best, exchanging their surplus production with other countries specialising in what they do best. Economists call this pursuing our “comparative advantage”.

Autarky – the pursuit of national self-sufficiency – seems like a good idea, but one of the most useful things economists do for the community is to explain why, contrary to common sense, self-sufficiency is a great way to be poorer than we need to be.

It’s a dumb idea because it involves wilfully forgoing the benefits of specialisation and the “gains from trade”. When we insist on making items we aren’t good at, those things will cost more that importing the same goods from those countries better at it than we are.

So we end up forcing Australians to buy the inferior and more expensive locally made goods by imposing a special tax or “duty” on the imports. This leaves us less money to spend on other locally made goods and services. So jobs created in the inefficient part of the economy come at the expense of jobs in the efficient part, causing us to be less well-off than we could be. Well done.

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