Free Trade Economics

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 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 are manipulating the value of their currency by State sponsored investment overseas. 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. Thus manufacturing is competing with mining and both with agriculture.

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. 

[In 2011] 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 [as the $A rises]. 

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?

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