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Originally written in August 2011 - it might have been yesterday - so little has changed.

 

 

Manufacturing viability is back in the news.

The loss of manufacturing jobs in the steel industry has been a rallying point for unions and employers' groups. The trigger was the announcement of the closure of the No 6 blast furnace at the BlueScope plant at Port Kembla.  This furnace is well into its present campaign and would have eventually required a very costly reline to keep operating.  The company says the loss of export sales does not justify its continued operation. The  remaining No 5 blast furnace underwent a major reline in 2009.  The immediate impact of the closure will be a halving of iron production; and correspondingly of downstream steel manufacture. BlueScope will also close the aging strip-rolling facility at Western Port in Victoria, originally designed to meet the automotive demand in Victoria and South Australia.

800 jobs will go at Port Kembla, 200 at Western Port and another 400 from local contractors.  The other Australian steelmaker OneSteel also recently announced a workforce reduction of 400 jobs.

This announcement has reignited the 20th Century free trade versus protectionist economic and political debate. Labor backbenchers and the Greens want a Parliamentary enquiry. The Prime Minister who reportedly initially agreed has now, perhaps smelling trouble, demurred.

No doubt 'Sir Humphrey' lurks not far back in the shadows.  It is now a generally accepted tenant of economics that selective protection, applying to a single industry sector or business, is economically distorting and results in sub-optimal economic performance; a poor allocation of productive resources and a distorted distribution of wealth.

On the other hand, the economic impact of a theoretically non-distorting, universally applied, import tariff (applied to all imports without exception) can be more efficiently achieved by a downward revaluation of the currency. This lowers the price of all exports, making them more competitive; and raises the price of all imports, lowering their competitiveness.  As many developing countries have found currency manipulation is also a more flexible instrument as it provides no tax revenue on which government may later become dependent.

The opposite also applies.  A higher dollar strips away any residual protection making local trade exposed economic activity, of all kinds, less profitable, with more pressure to cut costs and be competitive; to improve productivity.

The present high value of Australia's floating currency is not due to domestic manipulation but is a reflection of our overall trade competitiveness and attractiveness to foreign investors.  Thus the dollar is high because some sectors of the economy are presently very successful in overseas markets; some of which, like China and India, are manipulating the value of their currency. In others 'quantitative easing' is effectively degrading their currency, achieving a similar outcome. In the Euro zone various mendicant States are pulling down the value of the currency making more efficient countries like Germany more competitive.

As our exporters are collectively more successful the relative value of the Australian dollar rises, partially offsetting their improving international competitiveness.  Those that fail to keep up in the competitiveness stakes lose out to other Australian exporters that are more successful.

Individual exporters inevitably see their international sales in the light of foreign competition.  But in effect Australian exporters are not just competing with overseas firms but with each other for a piece of the export action. 

On the import side of the equation increased export revenue needs to be matched by increased imports of goods and services or corresponding capital outflows.  Lower cost imports improve the overall material wealth of Australians.  Capital outflows attract overseas dividends and profits; also enhancing Australian wealth.

This causes Australian businesses to cut back in areas that are becoming uncompetitive and unprofitable.  Investment is inevitably redirected to areas that are not so trade exposed; or to business activity that enjoys a competitive edge that can match that of the most successful exporters. This includes some areas of manufacturing that can be identified in the Appendix to this article.  The lower cost of imported machinery, technology and other factors of production gives some more innovative manufacturers greater scope to improve their products and production methods. 

At the present time this restructuring has not resulted in declining business profitability nor higher rates of unemployment overall; although there may be regional effects when large businesses reduce employment.  Indeed Australia is enjoying historically low rates of unemployment, to the point of skills shortage, posing a wage inflation risk.  As a result Australia has high interest rates by present world standards and ample scope to reduce these should economic stimulus be required.

But if it is accepted that the impact on trade exposed manufacturing is going too far and causing the loss of core technologies and skills, the debate should not be around tariffs but around the present undue competitiveness of the mining sector.  This is because it is mining that is increasingly commanding a much larger slice of the export cake; forcing out marginal manufacturing; agriculture; and services such as inward tourism. 

Rather than reintroduced import tariffs or other protection; there is a good case for a more effective resource rent tax to reduce the export competitiveness of the mining sector.  Unlike tariffs this avoids breaching our international trade agreements and commitments. It also has potential to improve overall fiscal performance; and if appropriately applied to guard against 'high grading' to preserve marginally more resources for future generations.

This very good economic performance does not stop the political advocates of protection from launching into vitriolic attacks on academic and public service economists;  or most recently on the Reserve Bank. 

So how did we reach the present accepted economic wisdom in Australia?

 

The 20th Century economic debate

 

For much of our history NSW (then Australia) has been extraordinarily vulnerable to climate and agricultural trade cycles.

 

 

Phil Ruthven IBIS: ‘The chart shows Australia’s economic progress over 140 years... ‘The volatility was enormous both before and during the Industrial Age (1865-1964) largely due to weather. Agriculture remained over 15% of our GDP for most of that period…  ‘a 25% fall or more in output would slice 4% off the economy by itself - with a domino effect through the food & fibre input-output chain - causing a recession. We had 27 such years or one every 3-4 years...’

 

During the 20th century Australian governments experimented with the full spectrum of government interventions to develop manufacturing; both to reduce our dependency on agriculture and to increase Australia’s military resilience.  To grow and protect manufacturing Australia applied, then abandoned: selective tariffs; publicly owned businesses; and enforced government purchasing preferences. 

Until the start of the 20th century the political differences in pre-federation Australia were polarised around the issue of ‘free trade’ verses protection (NSW versus Victoria).

The electoral success of the Australian Labor Party (in 1910), following the Marxist social analysis in the mid 19th century and English Fabianism, led to a new polarisation around worker’s rights and the socialist alternative to capitalism; retaining a strong protectionist sentiment.  With the split in the Labor party, at the start of the ‘Great Depression’, a new ‘United Australia Party’ (in government from1932 -1941) formed around Lyons and Labor splinter groups, together with elements of the older establishment parties; both free traders and protectionists.

Thus by the middle of the century, both major parties had elements combining the older protectionist movements, as well as elements supporting socialism and public ownership. Protection and government owned enterprise became an accepted reality on both sides of politics; reinforced by two world wars.

By the mid 1960’s, under the protection of import tariffs and direct government involvement in economic production, manufacturing in Australia had grown to become the largest and most productive sector in the economy, long supplanting agriculture, services and mining.

But at the end of the Menzies/ McEwen era, in the late 1960’s, it was apparent that much of this manufacturing and government enterprise was inefficient and unable to compete internationally. With the new Universities, post-war academic sentiment was swinging towards Neo-Keynesian (eg Samuelson) or Monetarist (eg Friedman) economics and the intellectual climate changed. 

Free trade and free market arguments prevailed, in both major political parties, and the progressive withdrawal of protection followed, along with the disposal of government owned businesses and local buying requirements.

In 1967 the first minerals boom and a large increase in foreign investment lead to the dollar’s decoupling (un-pegging) from the pound sterling. Its strong upward revaluation followed.  Together with the Federal Government’s determination to dismantle protection, this contributed to rapid economic restructuring.

 

The relative decline in manufacturing

 

These changes saw a long decline in relative importance of manufacturing, both as an employer and as contributor to total value added (GDP).  This impact was felt first in NSW, the largest and then the most industrialised State. The impact was later, but perhaps more severe, in Victoria and SA, where remnants of protection continued for textiles clothing and footwear (TCF); the automotive industry; and some special cases (like Kodak in Victoria) until recently.

In Australia, throughout this period of manufacturing decline there was an ongoing debate as to the wisdom and prudence of ‘living in the present’ with no concern for the probable future; where, it was believed, the capability to make things might be necessary; particularly in the context of national defence. There was also a lingering cultural belief that Australia needed to ‘populate or perish’; that it was necessary (or feasible) to out-populate our expected enemies; those jealous of our ‘abundant wealth’.   Labour-intensive manufacturing was promoted an essential part of this imperative; as at that time a significant number of manufacturing locations still employed many thousands of people; and the TCF industry was a very large employer of immigrant women.

Another stream of concern was that ‘infant’, particularly ‘hi tech’ industries needed initial support to become established, after which assistance might be wound back; and latterly that certain industries, like automotive manufacturing, are essential to preserving a reservoir of industrial skills and capabilities.

Against this it was argued that governments are not skilled, and have a very poor track record, at ‘picking future winners’ and are likely to protect industries that have no long term commercial merit (like steam train, typewriter, radio valve or large scale vinyl record manufacture); and in doing so enrich some people at the expense of the rest.  It was further argued that such commercial risk is best taken by those who may reap the rewards of success, or suffer by their failure; and that interventions by government ‘socialise risk and privatise profit’.

The strong dollar was said to be ephemeral and to exploit the value of finite natural resources that were being depleted (the Dutch disease) to maintain the buying power of an ever growing consumer market fed by high levels of immigration.

That the value of the dollar is supported by the exploitation of non-renewable resources, and that this will end in disaster, is a similar argument to that on climate change that: 'we are presently exploiting the birthright of future generations and leaving them with a depleted environment'.  

Against this, technological progress makes it very difficult to predict what resources the future may or may not need or find valuable.  Banks and Phillip believed the potential wealth of New South Wales to be in flax and pines (for sails and masts).  They would have seen no value in a nickel or tantalum deposit or even in iron deposits ‘on the other side of the world’.  In an environment of enormous change and seemingly random natural disasters and fluctuations are voters ready to make sacrifices to their living standards now in the interests of speculative outcomes in the medium to distant future?  Will coal, or gold for that matter, still be valuable in another 200 years when we may have fusion energy and/or the ability to synthesise the metals we need?

It was argued that various countries that would become future competitors were accelerating economic development through the deliberate application of economically distorting economic tools, direct intervention in the productive process, aimed at directing productive resources towards selected industrial activity, education and research.  They and others were using currency manipulation to lower the price of exports; increase domestic savings; and increase investment overseas.  This was seen to be particularly effective in Japan, Korea and China in moving from predominantly rural, feudal societies to industrial ones. 

In 1975 the ‘Jackson Green Paper’: ‘Policies for Development of Manufacturing Industry’ (following the Industries Assistance Commission annual report of the previous year) predicted that the industries most likely to be encouraged by the change from protection to free trade would include:

1.                  The Service Sector.
2.                  Manufacturing industry that is land (eg food) or minerals based.
3.                  Manufacturing industries based on skill, innovation or design.
4.                  Industries with a high degree of natural protection by virtue of their bulk, non-durable nature or ability to satisfy specialised local demands.
5.                  Rural industries – particularly exporters.
6.                  Mining industries based on rich deposits.

A prominent and influential member of the ‘Jackson Committee’ was Robert JL (Bob) Hawke – future Prime Minister.

By 1983 political intervention in the relative value of the dollar, partly driven by electoral considerations, had led to growing disquiet about its negative impact on economic restructuring and the dollar was floated (by the Hawke/Keating Government).

 

The synthesis

 

Economists now argue that the end purpose of international trade is to maximise its benefit to the wealth of the country and its citizens.  In the immediate present this is achieved by getting imports a cheap as possible and selling exports for the highest price available.  As already remarked, an artificially low currency achieves a superior economic outcome to global import tariffs and is far superior to selective tariffs, on some imports only.

All such interventions sacrifice this present wealth for some hoped for future gain.

With the exception of one or two dissident voices, on both sides of politics, there is now bipartisan support for free trade and free enterprise.  Australia is now one of the World’s principal advocates of free trade and argues that industries that are not internationally competitive are a burden on national (and collective) wealth.  Most previously government owned trading organisations have been privatised. It is argued that international competition leads to improved efficiency, productivity and is an incentive to innovate.

As predicted by Jackson, Australia has moved to become a service economy.

For example, the largest industry sectors are now Retail trade, Property and business services, and Health and community services.  Manufacturing is now on fourth position.

There is little doubt that Australia’s very strong economic growth performance and relative insulation from international economic downturns is an outcome of its ability to exploit the moment and extract the best available advantage.

It can also be argued that the last remnants of protection have now been stripped away and manufacturing has reached a more or less stable base and share of the economy consisting of: 'industry that is land (eg food) or minerals based; industries based on skill, innovation or design; and industries with a high degree of natural protection by virtue of their bulk, non-durable nature or ability to satisfy specialised local demands'. 

But manufacturing is still at the mercy of implicit protection (or its opposite).  It can be seen from the earlier discussion that the value of the Australian dollar is now the single greatest determinant of manufacturing viability and growth (or decline) in Australia.  In addition to the implicit protection afforded by a low dollar, and corresponding lack of protection afforded by a high dollar, rapid fluctuations in the value of the dollar and cost of capital militate against businesses that are highly capitalised and need a continuous, relatively stable return on that capital. These fluctuations both affect viability and make it difficult to predict return on investment.

External influences on the dollar’s value include money market speculation, the country’s trade performance and international investment flows.  The principal visible trade drivers of a strong Australian dollar are our mineral and energy exports but agriculture, trade in services and manufacturing itself are important contributors.

The various Governments’ fiscal behaviour has an influence on internal distributions of wealth and on savings, in turn influencing investment, and the longer term dollar valuation.

The remaining (benign) facility to smooth fluctuations and influence the dollar’s value (through money market operations and interest rate manipulation) now rests with the independent Reserve Bank (established in 1960 under Menzies).

While government has substantially withdrawn from direct market manipulation and participation in support of local manufacturing it continues to play a number of important roles that directly or indirectly support or influence manufacturing viability.  These include:

•  labour laws and regulations;
•  regulation of occupational health and safety;
•  regulation of business practice, including accounting standards and competition;
•  regulation of emissions (airborne, water, noise);
•  local planning and zoning;
•  maintenance and expansion of transport infrastructure (roads, rail, ports, airports);
•  ensuring the appropriate availability of electricity, gas, water, and waste disposal;
•  ensuring an adequate information technology and communications infrastructure;
•  participating in international standards;
•  regulations affecting export reputation (eg export meat and dairy);
•  providing support for research and technology development;
•  providing export development services;
•  negotiating international trade agreements and partnerships;
•  ensuring high standards of basic education and literacy;
•  providing and/or supporting skills, trade and advanced education;
•  ensuring a healthy population; and
•  maintaining law and order and the protection of property.

 

Taxation plays an important role providing revenues to support these services and redistributing wealth to steer society in agreed directions.  Such redistributions include present resource taxes and of course progressive income taxation. But any such redistributions are inevitably opposed by those disadvantaged; and governments need to be strong and decisive when making changes.

This has not been the case in recent history.  For example of the 138 'Henry' Tax Review recommendations (a review commissioned by the present Commonwealth Government) hardly any of the substantial recommendations have been implemented; and those few have mostly been watered down.

Important to the present discussion were recommendations 45 to 50 in section C1 — Charging for non-renewable resources.  These have largely been set aside after heavy lobbying by mining  interests and some States.

Also of interest, but completely ignored was recommendation 25 in section A3 — Wealth transfer taxes: 'While no recommendation is made on the possible introduction of a tax on bequests, the Government should promote further study and community discussion of the options'.

Even recommendation 1, setting out the global principles, has been largely ignored:

Revenue raising should be concentrated on four robust and efficient broad-based taxes:

  1. personal income, assessed on a more comprehensive basis;
  2. business income, designed to support economic growth;
  3. rents on natural resources and land; and
  4. private consumption.

Additional specific taxes should exist only where they improve social outcomes or market efficiency through better price signals.

Such taxes would only be used where they are a better means to achieve the desired outcome than other policy instruments.

The rate of tax would be set in accordance with the marginal spillover cost of the activity. User charging should play a complementary role, as a mechanism for signalling the underlying resource cost of publicly provided goods and services.

With both specific taxes and user charges, revenue would be a by-product of the tax or charge, not the reason for it.

Other existing taxes should have no place in the future tax system and over time should be abolished.

 

All taxes need to be simple with clear guidelines and a minimum of exceptions or exemptions. For example under no circumstance should an entity (a person or a business) be taxed and then be compensated for the taxation impost.  I have remarked on the proposed carbon tax in this context elsewhere on this website.

 

 

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