ECONOMIC AFFAIRS: by Colin TeeseNews Weekly
The lessons of the past we so quickly forget
, February 16, 2008
Today, Australian manufacturing industry is dying on its feet. However, this was not always so. A former senior trade negotiator Colin Teese explains the background to successful trade and industry policies of an earlier time, and considers why Australia came to drift so far off track.In discussing manufacturing industry policy it is impossible to ignore trade policy - the two go together. They are as inseparable as partners in a successful marriage. However, in the present political climate, neither side of politics has made any genuine effort to understand trade and industry policy, even less to understand the connection between the two.
Their preference is to connect with current ideological fashions as they apply to trade and industry.
Until Labor came to office in 1972 Australia had pursued credible and appropriately integrated trade and industry policies going back to the beginnings of the Tariff Board in 1922.Economic development
For the next half century we pursued trade policies reflecting not merely the reality of our state of economic development, but also our position as a dominion - first in the British Empire and later in the British Commonwealth of Nations. These same policies enabled us to ride out the Great Depression of the 1930s, endure the isolation of the war years, and weather the trials of currency crises in the immediate post-war years.
They also put us into a position to enjoy the growth and prosperity of the 1950s and '60s of the last century.
The centrepiece of our trade and industry policy from the 1930s was the UK/Australia Trade Agreement. Under this arrangement we agreed to apply lower border taxes (called tariffs) against imports from Empire and British Commonwealth sources. In return, our exports (importantly, of agricultural products) were afforded the same advantage in the markets of our Empire and Commonwealth trading partners.
Meanwhile, we had begun the serious business of developing manufacturing industry under a protection umbrella administered by the Commonwealth Government-appointed Tariff Board. The underlying assumption was that the emerging Australian manufacturing industry (then in its infancy) would be afforded the ability to develop with the assistance of compensating border taxes on imports.
It was widely accepted that new and emerging industries, especially in small markets, could not compete without assistance against larger well-established offshore enterprises.
Nothing in our industry policy, it should be noted, was incompatible with the Empire trade arrangement of which we were part. In terms of that agreement, we did not offer (or expect from others) the absolute right of market at zero tariff. What we guaranteed, and asked in return, was a lower rate of duty on our exports into the markets of our Empire trading partners than they applied to non-Empire trading partners.
The arrangement was identified, correctly, both inside the British Empire and beyond, as a system of imperial tariff preferences. Importantly, especially after World War II, it was deeply resented by our non-Empire trading partners - most notably by the US and continental Europe.
The industry protection side of the policy was enormously important and beneficial during World War II. For obvious reasons our capacity to import what our manufacturing industries did not or could make here was immediately and significantly curtailed. We were obliged to make most of what we needed.
Thanks to the activities of the Tariff Board, we entered the war years with a fledgling manufacturing industry quite capable of rapidly expanding the quantity and scope of its local production. Without this advantage, our ability to survive and make our contribution to the conduct of the war would have been seriously impaired.
After the war both trade and industry policy was of necessity, though temporarily compelled to follow a slightly divergent course. At that time the US dollar was the currency of international trade. Because of a shortage of US dollars in the British Empire currency bloc of which Australia was part, we were compelled to introduce a system of import quotas. Without them, we could not have contained the flow of imports to levels our dollar reserves could finance. Equally important, quotas allowed us to channel imports into the goods we most essentially needed.Rebuilding
Import quotas were, however, not part of our industry protection policy; their sole purpose was to safeguard our dollar reserves. Over time, and with the parallel development of a system of multilateral trading rules in the General Agreement on Tariffs and Trade (GATT), Australia was able to rebuild its store of foreign currency and dismantle its import quota regime.
We reverted to the system of tariffs on imports, calculated on the basis of industry by industry assessment by the Tariff Board. Not all industries were deemed worthy of protection. Appropriate protection was recommended only for what were judged to be "economic and efficient" Australian industries.
As to trade, and despite our membership of GATT, we continued, until 1972, to participate in what had by then become a British Commonwealth tariff preference scheme; but at this time Britain entered the European Economic Community (now the European Union).
Our policy of protecting efficient Australian manufacturing against what would have been crippling competition remained as a central part of our trade and industry policy. And that policy, in turn, was an essential part of our post-war development program.
Within that policy framework it was common ground in both the main political parties that agricultural exports would generate essential foreign exchange. Equally, the parties agreed that Australia's post-war domestic economy needed to be based on manufacturing industry and population growth.
Population growth, through the encouragement of migrants, was at the centre of our post-World War II strategy. And if this was to be politically and socially acceptable, the incoming migrants needed to have jobs. Only an expanding manufacturing industry base could provide the necessary job opportunities.Full employment
For this we needed to attract foreign capital and business to invest in productive capacity in Australia. And we could not expect to attract investment in new industries - attached to a policy of full employment at Australian pay rates - without protecting the new enterprises from import competition.
The fulfilment of our post-war economic and social aims rested, as never before, upon fully integrated trade and industry policies.
The focus of the incoming manufacturing industries - at least in the beginning - would be on the domestic market, rather than export. And so they did. Internal economic growth would be supplied by manufacturing industry growth; export income would come mainly from agricultural products. Foreign currency needs, beyond from what we earned from agriculture, would be funded by capital inflow financing new manufacturing capacity.
(Compare this with what we do now: borrow offshore to fund consumption, rather that new productive investment).
These policies continued until Gough Whitlam's Labor Government in 1973 began unilaterally hacking into tariffs - on the advice of some of its influential supporters ideologically committed to free trade and market deregulation, and therefore hostile to the idea of industry protection.
But, you may well ask, how did all this happen?
Events played a big role. Some of these we could have anticipated but did not; others we simply could not have predicted, though we might have better handled our reaction to them. Taken together, these circumstances combined to open the door through which ideologically committed economists eagerly passed through. By the time Labor again took office in 1983, under Bob Hawke and Paul Keating, the free market philosophy had gained control.
So what were the events?
First was the movement away from fixed currency relativities towards the end of the 1960s. For nearly 30 years after the war, international trade among the market economies was conducted on the basis of each country maintaining its currency in more or less fixed value compared to the US dollar.
The dominant US currency underwrote international trade flows. But the strains placed on the US economy by the Vietnam War had made that impossible by the late 1960s, all the more so because of the inflationary pressures building up in that country by virtue of the funding of the war. This was done, not by increasing taxes, but by printing money.
As a result, the market economies were forced to untie their currencies from the US dollar. Left floating, currencies tended to shift in value according to export and import flows. Without fixed currency relativities, tariffs could not serve a protective function.
As a nation's currency rises in value relative to those of its trading partners, the goods it exports obviously cost more to offshore buyers. And imports become cheaper because the currency buys more.
Thus, as a nation's currency increases in value, that increase effectively reduces the protection afforded local industry, regardless of tariffs. Conversely, if the value of the currency falls, so industry protection increases.
Because of the special nature of our tariff and trade policies, we were unable to react quickly enough to the new circumstances.
Matters were made worse by the fact that the transition hardly affected most of our major trading partners, who had long given up on the idea of tariffs for protective purposes. Right from the start, they had been busily negotiating away tariffs in the trade-bargaining opportunities provided by the GATT. This was not because of any commitment to free trade; while dismantling tariffs they continued protecting their industries when and as necessary.
They adopted so-called non-tariff barriers, in many ways a more comfortable protective device. Without going into the detail of them, it is enough to recognise that they are under-the-table measures. Tariffs, by comparison, are there for all to see in official documents.
Non-tariff barriers allow the users to preach trade liberalisation by pointing to their willingness to bargain away tariffs, without reference to their equally effective non-tariff protection.
You may well ask why we did not follow the example of the big market economies and embrace the non-tariff barrier option.
The truth is ours was a complicated economy. All of the big players were actively cutting deals in GATT to lower their industrial tariffs. If their industries ran into trouble, why worry? Non-tariff barriers would be invoked to control unwanted imports.
The problem for us was that all the deals on tariffs related only to manufactured goods. Non-tariff measures were firmly in place to keep out imported agricultural produce.
This did not help us. We were still building our manufacturing industries, all of which would be hurt by lowering tariffs, and we had no history of applying non-tariff barriers. So cross-bargaining on manufacturing tariffs was not an option for us.
What we wanted was market access for our agricultural exports into the totally protected markets of North America and Europe. And these were not open to negotiation - at any price.
That there were contradictions in our policy approach is obvious, and the free market ideologues, who had the ear of the incoming Labor government in 1983, were able to take full advantage of it. They gained control of the trade and industry policy agendas.
Their solution to the problem was at once a simplification and an overreaction. We have been paying the penalty for it ever since.
The position of the ideologues (which corresponded with prevailing economic orthodoxy) was that any government intervention in the operation of market economies was bad. Industry protection featherbedded industries and encouraged inefficiencies for which consumers and local business paid.Compensation
Border protection should be dismantled. Industries which could not survive should go under. As to the employment and other consequences, the market would sort out the problems. New industries which were denied the opportunity to set up under protection would develop, and these would provide compensating new investment and employment opportunities.
The same was true, they argued, for the finance industry. Money flows should be decontrolled. Furthermore, it was insisted, government agencies should not run any enterprises.
Except for a few sensitive manufacturing industries (notably cars and textiles), which, politically, could not be immediately sacrificed, the ideologues had their way. As anticipated, many industries disappeared very quickly, displacing their employees who were left to find their way into the unemployment offices.
Of course, new industries did not spring up. Most of the unemployed never found useful employment and became a charge on welfare. Unemployed workers can't pay tax and so government revenues shrank, as did revenue collections from border taxes on imports.
Suddenly, governments found themselves with budget shortfalls as revenue collections could not support all the demands upon them.
Whereas previously it was possible for governments to incur and service debt for wider public benefit, with a shrinking revenue base this now became more difficult. The pressure came on our governments, both state and Commonwealth, to sell off publicly-owned enterprises to release themselves from debt-servicing obligations.
These developments were not confined to Australia; they were taking place throughout the English-speaking world where the new economic orthodoxy had most influence.
Here in Australia the Commonwealth Bank was the first to go - along with Telecom and Qantas. The latter did not matter much, but no sensible reason could be advanced for selling the bank, or for that matter Telecom, other than a short-term cash gain for the government.
Next followed - especially in Victoria - the sale of power generation and supply enterprises along with the public transport system, also the building of toll roads.
This is not the place for further discussion of the outcome of these choices - or for that matter those relating to the finance industry. But, in general, they have not been good.
What about manufacturing industry? Dismantling of protection generated an immediate and permanent rise in unemployment (genuinely measured), which persists even today. And manufacturing, as a share of total national output, has been in decline ever since - for obvious reasons.
With no protection at home, those who wanted to survive were compelled to move offshore in search of cheaper operating costs. As to new foreign investment in manufacturing, why would any company invest in productive capacity here? If Australia operates no border impediment to imports, why not save investment funds for markets which retain import barriers?
The only investment we can attract is essentially in resource development, for obvious reasons.
That the new arrangements have allowed us access to cheaper goods is, of course, beyond question - and inflation has been kept low. But why?
These developments have coincided with the emergence of China. In effect, China, for the last couple of decades, has been exporting deflation, not merely to Australia, but to the rest of the world. Cheap Chinese goods have helped the world manage inflation.
It is said that we now have a more competitive economy. But have we? At first we could identify a large increase in productivity. This was immediately attributed to the "reform" of industry and trade policy. But we now know those productivity gains came mostly from technology advances - especially computer technology. In fact, productivity per hour worked per worker in Australia has been falling back in recent years and is very poor.
Much of this is due to the fact that companies cannot afford to invest for productivity gains. In our competitive economy margins of profit are insufficient to sustain future investment. Some businesses have told government inquiries that competition has shrunk their margins to the point where they cannot afford to train apprentices.
Manufacturing industry is dying on its feet in Australia. We are down from about 18 per cent of total output to 11 per cent, and because of changes in the way of counting manufactures the 11 per cent figure is probably an overstatement.
We once could boast a number of important industries which count if a nation is to consider itself in the first rank. Of those only the motor vehicle industry remains - and this is holding on by a thread, down from 30 per cent of the market to 19 per cent in the last seven years, and still falling.
The question we must all be wondering is whether the Kevin Rudd Labor Government is up to the job of turning this around. Certainly, it can't succeed unless it can break free of ideologically-based advice. The early signs are not encouraging.
Yet there is some reason for hope, if only because the situation is now more desperate than it has ever been.
The Rudd Government may not be more concerned than was the Coalition over our manufacturing sector, but it may not much longer be able to ignore the ever increasing level of our foreign indebtedness. That has been the unacknowledged consequence of misguided trade and industry liberalisation policies.
It is one thing to congratulate ourselves on being able to import cheaper goods from overseas. What is not usually admitted is that with our policies there is nothing (not even food) we can't import cheaper than we can make it.
The question is: how do we pay for it? What we have been doing for the past 20 or so years is borrowing offshore to make up the shortfall - borrowing not, as we have done in the past, to invest in new productive capacity, but to consume.
On Mr Rudd's watch this particularly unwelcome chicken may come home to roost. And he can't look to free trade or deregulation solutions to his problem. Of course, he could try to export more; but the gap is too wide to be bridged by export alone - especially as we have dismantled so many of the industries that could have helped. He will have to stem the flow of imports by reducing our consumption (hardly possible) or by getting us to manufacture more of what we consume.
Perhaps, after all, the future lies behind us waiting to be re-discovered.- Colin Teese is a former deputy secretary of the Department of Trade. This article is based on a talk he gave on February 2 to the National Civic Council's annual national conference, held at Melbourne University.