A CASE STUDY IN ECONOMIC RATIONALISM: THE INDUSTRY POLICY OF THE BUSINESS COUNCIL

OF AUSTRALIA

by STEPHEN ANTHONY *

Industry policy is typically described by members of the economic mainstream as instruments designed to affect the general mechanisms of resource allocation and production on the actual allocation of resources among productive sectors of the economy. The natural progression of such a viewpoint is that industrial efficiency must be put before growth and employment, which is borne out by the advocatory policies supportive to this end amongst the vast majority of economists in Australia. From both major political parties, public sector and university economists, media commentators, business leaders, policy institutes and even the ACTU executive, the same non-interventionist and neutral approach to the market is the norm.

It is almost disturbing how little resistance has met the “freeing up” of the Australian economy, beginning with deregulation of the money market between 1983-5; then, from 1986, the winding down of industry plans and increased emphasis on microeconomic reform and negligible tariff levels in the real goods and services sector; and, currently, the major drive to do away with centralised wage fixing in favour of enterprise bargaining in the labour market. Ten years in our history which have seen a substantial erosion in the general standard of living and eradication of institutions which were designed to alleviate some of the inequities of our society in favour of increasing competitive pressures and the variability of international markets. The question is, what are these reforms and future changes likely to achieve?

The economic policy of the Business Council of Australia (BCA) is repre- sentative of the mainstream view of economics. The BCA is a political coalition of the managing directors of Australia’s largest 85 companies which seeks to give the policy position of big business a public forum. Like all political bodies, it has both formal and implicit objectives stemming from its heterogeneous membership, which drive its policy recommendations. The formal position of the BCA on the issue of industry policy may now be examined.

* Australian Taxation Office. The views expressed in this paper are those of the author and do not necessarily reflect the views of his employer. Thanks to Phillip Norman, Rodney Maddock and Nils Olekahns for their invaluable suggestions.

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1. The industry policy of the Business Council of Australia A strategy for industry is outlined by the BCA which entails the adoption

of generalised supportive measures by government across all sectors of the economy. It is aimed at raising capital investment, employment and profit- ability and the removal of unnecessary impediments to business activity, as well as raising total factor productivity in business (BCA, 199213). All policy tools are classified within two broad headings: general industry policy, designed to enhance the functioning of markets, and selective industry policy, aimed at improving public infrastructure for firms (BCA, 1986).

Industry policy is seen as a component in a macroeconomic approach, with the objectives of lower inflation, higher levels of GDP growth per capita, and improvements in Australia’s balance of payments position. Government is seen by the BCA to provide explicit, uniform, and consistent policy directives in a long-run planning horizon. It plays a non-interventionist role, only correcting market failure for the duration of that failure (BCA, 1991a). Finally, government enterprises should be restricted to the provision of public goods (BCA, 1991a).

In concrete terms at the macroeconomic level, the BCA supports a more contractionary fiscal policy by Federal and State Governments (BCA, 1991a). This would have the objectives of reducing the overall size of government and social welfare expenditure, dampening inflation and raising national savings. It supports a loosening of monetary policy to enable lower interest rates and a depreciated exchange rate (BCA, 1992b). Improvements in the level of capital investment are to be encouraged by lower interest rates, accelerated depreciation allowances and maintaining the 150% deduction for R & D. Also, more clearly stated environmental guidelines and increased public infrastructure spending are proposed.

A number of microeconomic reforms are also suggested by the BCA to increase the efficiency and hence competitiveness of the Australian economy. They include regulatory, constitutional, and electoral reforms on the part of State and Federal Governments to achieve the net result of lower factor input costs for business. This will also be the aim of removing taxes on business input costs and a wider and more consistent role of indirect taxation (BCA, 1993).

Government business enterprises and public authorities will be targeted to raise performance levels through privatisation. This emphasis is also adopted in the labour market, where enterprise agreements based on fixed labour contracts outside the centralised wage-fixing system would be employed. A high premium would be placed on education and training to develop the skill level of the labour force (BCA, 1993).

2. Foundations of the BCA model The economic reasoning which underpins the BCA analysis is the

neoclassical theory of production and the theory of comparative advantage. This was comprehensively outlined in the BCA’s vision for Australia’s industrial development, Developing Australia’s National Cornpetitivness, in 1991.

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Neoclassical production theory sets out to demonstrate that, if factor inputs (labour, capital) are combined in optimum quantities using the best available technology, the producer is operating efficiently so that community welfare is being maximised. The theory relies on the following three principal assumptions (Stdwell, 1984): Resource Allocation

The principal economic problem facing society is the proper allocation of scarce resources, land, labour and capital, across a seemingly inexhaustible variety of productive uses.

Diminishing Returns to Scale In production (consumption) the addition of an extra unit of factor input

(final product) yields a smaller proportional output (consumer satisfaction). Here technology and tastes are exogeneous.

Substitutability All factors (products) are substitutes in production (consumption). These conditions, combined with the assumption that firms maximise

short-run profits and individuals maximise utility, will yield (under certain circumstances) maximum economic efficiency and output.

The theory of comparative advantage, which is a natural extension of neoclassical production theory, states that when a country can produce a particular commodity more efficiently than other nations in the absence of protection, it is said to have a comparative advantage in the production of that commodity and should devote resources to its production. At the firm level, comparative advantage is determined by natural resources, skills, location, demand conditions and firm and market structure (BCA, 1991b).

How the industry policy of the BCA is supposed to achieve its microlmacroeconomic objectives may now be considered.

3. The mechanism for achieving the objectives of BCA industry policy The industries in which a nation specialises are determined by an

individualistic search for market niches by competitive firms (Porter, 1990). Driven by a desire to capture economic resources for their owners, and given the complexity of factors which determine competitive advantage, the individual firm will invest and innovate as a response to competitive pressures. The end result is a pricelproduct differential between the local firm and overseas suppliers of a particular good or service which gives the domestic firm a competitive advantage in a particular market.

Once one or more firms capture a share of a particular market through competitive advantage, monopoly profits can be captured, at least in the short run. These profits are ploughed back as investment into further rounds of product innovation which enable the development of competitive advantage in other goods or services and a further round of monopoly profits. Ancillary firms develop and supply the new firms’ or industries’ needs.

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So investment, profits, employment, and GDP per capita growth rise. Also, as exports expand, the balance of payments improves. This is all achieved as a response to a complex of factors related to the specificity of knowledge and competence attained by the individual entrepreneurial firm. All a government need do is set policy in a consistent manner and allow the market to function competitively.

4. Evidence supporting the BCA vision of a more competitive economy The BCA has presented a detailed empirical case to support its initiatives.

Employing the ORANI model, a computable general equilibrium model of neoclassical origin, it has estimated that economic gains that Australia could make by lifting average productivity levels of firms in manufacturing and services to:

the productivity levels achieved at the time by best performing firms within particular Australian industries combined with half the gains the Industry Commission has quantified from public sector and protection reform (a low-road scenario);

the productivity levels achieved at the time by the best performing companies in the OECD economies generally combined with full implementation of the Industry Commission package (a high-road scenario). Both programs assume a 10% difference between average and Australian

best productivity levels in industry, and a further 15% differential between Australian and world best practice. Further, the achievement of the micro- economic reforms is assumed to take ten years.

The low-road scenario would add $12 billion a year to GDF', raise employ- ment by 0.6% (or 39,000 jobs) and improve the balance of trade by 0.5%. Sectoral outputs in the agricultural, mining, manufacturing, and services sectors would rise by 2.8%, 32.6%, 2.7% and 4.4% respectively. The high- road scenario would add to GDP by $43 million each year (the equivalent of three years of high economic growth), and 78,000 jobs would be created as employment expands by 1.1%. There would be a 0.46% improvement in the balance of trade and a marginal lowering of inflation. Sectoral outputs in the agricultural, mining, manufacturing, and services sectors would rise by 5.51%, 37.34%, 10.9% and 10.84%.

The general findings of the BCAlIndustries Commission concerning the benefits of microeconomic reform and lower tariff levels are in line with the gain to GDP of $20 billion estimated by Garnaut (1988). Both perceive benefits accruing to industries exporting processed raw materials and exports, traditional mineral and agricultural output and exports of high- quality services. There is no room for elaborately kansformed manufacturing industries in either strategy. The problems inherent to this kind of industrial policy may now be considered.

5. Some problems with the BCA proposals From the preceding discussion, the Industries Commission, on the basis

of ORANI, predicts major gains for mining sector output, increased downstream processing of raw materials (i.e. wheat and wool), and an

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expanded role for the service sector. This being the case, according to the ACTU, Australia will lose its market share in elaborately transformed manufactures which constitute 40% to 60% of the growth in world trade (ACTU, 1990). The achievement of either “low” or “high” road scenarios would only improve the balance of payments by 0.5 of a percentage point as Australia would be left an importer of high-value-added goods which are not subject to fluctuating terms of trade.

The figures produced by the ORANI model are also subject to much criticism. They assume microeconomic reform is cost free; there is some double counting of benefits; and all benefits are assumed to go to end users. The result is a resources boom into which no environmental constraints are factored (ACTU, 1990). Nearly 25% of the gains from microeconomic reform in the Industries Commission package are obtained by reducing tariffs, while the exact opposite is predicted by the National Institute of Economic and Industry Research (NIEIR). The NIEIRs analysis suggests GDP would be 1.6% lower with zero protection.

The total factor productivity gain of 25 % across all Australian industries [the “high” road) also seems unachievable. This was tacitly admitted recently by the BCA (BCA, 1992). It seems the best we could hope for is an across- the-board rise of about 12 % in ten years, which is in line with the low-road scenario of the BCA (NIEIR, 1991). This, as we have seen, would leave the mining sector with increased output of around 32 %, with negligible improvement in any key economic indicator.

Sir Arvi Parbo recently stated that: The best social welfare policy, I suggest, is the creation of good-quality, well paying, interesting, and stable jobs. This is the bottom line benefit from a strong economy (BCA, 1992, p25). The 39,000 jobs that ten years of productivity increases and micro-

economic reform are said by the BCA to create falls well short of the 1,000,000 existing unemployed. By pushing ahead with a strategy which would only see substantial expansion in the capital-intensive minerals sector and further downstream processing of agricultural output, the BCA would condemn the urban population to massive unemployment. On its own figures, any full-employment objective is unachievable.

The next question to consider is whether the achievement of static efficiency and a lower level of interest rates could induce the dynamic efficiency of accelerating economic growth. As we have noted previously, the realistic scenario of the “low” road strategy would only lead to increased GDP of around $21 billion, the equivalent of one-and-a-half years of expan- sionary output.

There is some empirical support for the BCA proposition that an easing of monetary policy will, through its effect on the exchange rate, raise the level of capital investment, particularly in import-replacing, export- enhancing industries (Kohli & Ryan, 1986; Wood, Lewis & Petridis, 1991). But raising the level of investment in the context of the current recession cannot lead to greater output. If capital in a nation is underutilised because

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of the lack of effective demand, adding further to the net capital stock of the economy can only worsen this position. Also, as we saw in the deregu- lated environment of the late 1980s, investment may also be unproductive. The BCA has no strategy to raise effective demand and will condemn the economy to low levels of private and public investment.

The BCA strategy, in the labour market and in relation to taxation, will see a lower average level of real wages in the economy. On this basis, as is borne out by the experience both before and during the Accord periods, investment will be labour intensive and not capital intensive. Hence, if demand is sufficient to generate increased investment, it will not flow to modernising capital-intensive manufacturing necessary to be competitive in world markets. Neoclassical theory also predicts that public goods will be under-provided by the market. The BCA policy of fiscal restraint over a number of years could see a serious erosion in the quality of public infrastructure and services necessary for the well-being of the population.

6. Is a mainstream industry policy worth pursuing? It does not matter how good the economic analysis is if it is not firmly rooted in an understanding of the social and political . . . context in which it operates (BCA, 1992, p. 17). Because of an almost dogmatic adherence to the creed of efficiency, the

BCA has factored the Australian people and their culture out of all con- sideration. Efficiency before jobs and growth, or no jobs and no growth, which is closer to the truth. We have found that the achievement of static efficiency and significant productivity improvement would achieve negligible benefits, and this is with all the costs of such a policy excluded. Another ten years of economic restructuring will be measured in the social dislocation of the Australian community, with nothing to show for the hardship and wasted potential output that full employment of resources would ensure.

So who would benefit from the strategy of the BCA? The only clear winners are industries in the minerals sector, who would see their combined output rise by around 32%. This benefit would not be achieved from productivity gains within the sector because, for the purposes of the BCA analysis, these industries were already assumed to be achieving world-class productivity levels. However, the gains are the result of public sector and transport reforms which lower the input costs of mineral producers and hence improve their competitive position. It is not surprising that, when the largest ten companies of a nation are predominantly miners or banks, their management should try to lobby Canberra in the direction of a resources boom through the board of the BCA.

For the vast majority of economists who have supported something like the policy position of the BCA, I suggest that some kind of re-think is in order. The existing strategy fails to address the economic needs of the Australian community, whether it be maintaining current living standards, achieving employment expansion, or decent public welfare and infrastructure. It also singularly fails to address the question of manufacturing performance in

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high-technology, value-added industries which will be of increasing importance in the future, if we are to overcome our present difficulties. But, most importantly, it puts the economy before human need.

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