Mainstream economists are unenthusiastic about industrial policy, which is in crude terms seen as the government seeking to pick winners. But the Treasury department – the bastion of economic orthodoxy – has embraced the “Future Made in Australia” policy set out by the Albanese government with its objective of “maximising the economic and industrial benefits of the move to net zero and securing Australia’s place in a changing global economic and strategic landscape.”
Why the apostacy?
First, the apparent success of countries which have relied on industrial policy to speed their development – notably South Korea, Hong Kong, Taiwan, Singapore and China.
Second, markets are often imperfect, with distortions, lack of competition and deficient information. The challenge of climate change gives this special relevance: the failure to price-in the wide-ranging externalities.
How can Australia draw on the experience of others and develop a framework which minimises the downside of industrial policy?
Third, a substantial part of the economy does not operate in the environment where market prices determine what is produced, who gets to consume it, and where competition imposes efficiency on production. Regulation and institutions insulate some sectors from the market. Public goods (defence, education, hospitals) are largely outside the discipline of the market. National security is difficult to price (recall John F. Kennedy’s “we shall pay any price…”). China’s rise sharpens the security issue.
Fourth, everyone else is doing it. US President Joe Biden’s Inflation Reduction Act is just the most recent instance in a long history of US industrial policies. When America is eating Australia’s lunch, subsidising industries to lure away investment in areas where Australia has comparative advantage, economic theory has no neat answer. We might be left as “hewers of wood and drawers of water”.
Treasurer Jim Chalmers promises to set a high bar for industry assistance, to “focus on only the most critical risks – to avoid a costly mindset of trying to eliminate all risks”. In this, he has the backing not only of the Secretary of Treasury, but the Director-General of National Intelligence.
How can Australia draw on the experience of others and develop a framework which minimises the downside of industrial policy?
This experience varies hugely and offers conflicting lessons. In America, Solyndra (solar panels) failed, but Tesla EVs succeeded. The “warp-speed” development of Covid mRNA vaccines was a triumph. The “active program management” of the Defence Advanced Research Projects Agency produced the internet and GPS. But elsewhere “picking winners” has often failed. China created a car industry from scratch, but Malaysia’s Proton failed.
Let’s clear away some of the false promises of industrial policy: that it boosts employment, creates “good” jobs, and provides resilient supply.
Since the Second World War, Australia has had full employment, with only temporary cyclical shifts in unemployment. Workers move location, occupation or salary, but any jobs created in the new industry will be filled by someone previously employed elsewhere. Overall, no new jobs.
Would it create “good jobs”, which in popular perception, means blue-collar manufacturing jobs? Manufacturing makes up only 5% of GDP, and for good reason – Australia’s comparative advantage lies elsewhere, in mining, agriculture, education and tourism.
Australia is tightly integrated with the global economy because it does not have the scale to produce the full range of products wanted. Prioritising supply-security would, in the words of Treasury boss Steven Kennedy, “simply undermine our key economic strengths and leave us less, not more able, to exercise strategic weight”.
What are the criteria for successful industrial policy?
Australia also has a plethora of other government programs which are, in effect, industry policy but remain outside the framework.
Perhaps the strongest lesson which comes from this varied experience is that the favoured industry, when mature, should be able to compete in global markets. This was a key element in South Korea’s success. Manufacturing usually requires scale, which can come from a large domestic market or successful exportation.
This priority weeds out the poor performers: the usual problem is not so much “picking winners”, but a reluctance to discard losers. Time-limited support helps here. Incentives, including the “bottom line”, are powerful. Private-sector firms are more likely to succeed.
As usual, detail matters, and implementation is the key. How are the incentives given? Tariffs are the least likely to succeed, and incentives which reward demonstrated success (tax breaks) offer the best prospect of relating costs of subsidies to society’s benefits. Competition, applied through open tenders, provides useful incentives and some protection against private interests capturing the policy for self-advantage. Targeted foreign direct investment policy, encouraging the transfer of foreign technology, has worked well for China.
How does the Future Made in Australia policy rate against these criteria? The zero-carbon transition stream is required to pass the competitive advantage test. The success of hydrogen, “green” metals (steel and aluminium) and low-carbon fuels is not assured, but the incentives are in place and the policy sets out Australia’s likely advantage in cheaper electricity. The supply-side resilience stream has a lower bar, but should still be required to meet the lesser test of opportunity cost.
The Future Made in Australia lacks detailed content, but it is a framework for a rational and considered industry policy. However, Australia also has a plethora of other government programs which are, in effect, industry policy but remain outside the framework. This includes the National Reconstruction Fund and the various programs administered by Export Finance Australia. Far larger and more consequential is the Defence department’s Integrated Investment Program, which includes the domestic construction of the AUKUS nuclear-powered submarines. These are also “suitable cases for treatment”, within the same set of efficiency criteria.
If Australia truly wants to achieve a “whole-of-nation” approach to integrating economics and security, the task has only just begun.
