27 May 2020
The world, says former International Monetary Fund (IMF) Chief Economist Kenneth Rogoff, may be facing the biggest reversal of economic integration since the disastrous tariff increases and competitive currency devaluations of the 1930s.
What should Australia do if Rogoff’s worst fears are realised?
" Like people, countries generally increase their incomes by specialising in what they do best.”
The answer is clear: if the rest of the world is throwing up trade barriers, Australia should do the opposite. It should tear down its remaining trade barriers.
That might seem counter-intuitive but it is also right. If you want proof of that, you do not have to look any further than Australia’s own economic “miracle”.
The Hawke and Keating government tariff cuts of the 1980s and 1990s were unilateral; the barriers faced by Australia’s exporters were unchanged.
And yet, those tariff cuts brought an acceleration of productivity, exports and national income growth.
Australia’s total exports of goods and services grew at a trend rate of 6.9 per cent in the 10 years to 1994-95, which was almost double the growth rate of the previous 10 years.
Moreover, almost two thirds of the accelerated export growth came from manufactured exports. This was despite the claims that Australian manufacturers would be wiped out if the tariffs were lowered. In fact, by the end of the decade Australian manufactures were earning a quarter of their revenue from exports.
So, what was the trick? Undoubtedly the phased reduction of the tariff wall helped exports because the tariffs had become a tax on exports. When you curb imports, the real exchange rate rises, and exporting becomes less profitable.
But the really big change accelerated by the tariff cuts was an increase in what economists call “allocative efficiency”. More of the economy’s scarce resources were allocated to their most productive uses.
Like people, countries generally increase their incomes by specialising in what they do best. The tariff reductions meant Australia could import the things we were not good at producing while concentrating our resources on doing the things we do well.
Australia, with its small but highly skilled labour force, its large stock of sophisticated plant and equipment, and its abundance of natural resources, has a comparative advantage when it comes to knowledge-intensive and capital-intensive production, especially production based on its natural resources.
Not all manufacturers survived the tariff cuts but the ones that could make good use of Australia’s comparative advantages did. Indeed, even the car industry, which had always been heavily protected, enjoyed a renaissance as it adjusted to increasing import competition.
In that decade of accelerating exports there also was a big increase in manufactured imports. Australia was specialising more in what it did best and productivity growth was building. By the middle of the 1990s, multifactor productivity growth was double its average of the previous 30 years.
The bulk of the benefits of lower tariffs were flowing to the country that cut the tariffs, just as economists said they would.
Of course, the tariff cuts were not the only productivity-boosting reforms in that period but they were a very important part of the Hawke-Keating revolution.
As Prime Minister Hawke told parliament in 1991: “The most powerful spur to greater competitiveness is further tariff reduction”.
The spur to greater allocative efficiency and higher productivity was import competition. Australian manufacturers and their unions had to raise their games to survive.
Who would want to turn that clock back? We tried to build an internationally competitive manufacturing sector behind high tariff walls and failed. Australia’s reward was one of the lowest productivity growth rates in the Organisation for Economic Co-operation and Development (OECD).
Lower productivity means lower real wages and lower living standards.
So, how will the next phase of trade and competition policy play out?
Popular opposition to globalisation is not new and trade barriers have been quietly rising in the advanced economies in response to the weak recovery from the global financial crisis.
Donald Trump’s determination to confront what he sees as the threat to employment from imports and the “offshoring” of US jobs has raised fears of a damaging trade war.
The COVID-19 pandemic has exposed new risks attached to service exports such as tourism and education as well as the advanced economies’ dependence on global supply chains largely centred on China.
That is widely seen as strengthening the case for advanced economies to do more of their own manufacturing.
No doubt there will be a re-evaluation by Australian business and governments of these risks. However, the expansion of subsidised, high-cost manufacturing is a very costly “solution”.
If education and tourism are not quite the money spinners we thought they would be, the economy will automatically adjust to fill the gap. And while that may take time, the result will be more efficient than anything the politicians are likely to conjure up.
As for healthcare equipment and personal protective equipment shortages, perhaps the more sensible solution is for governments to build and maintain adequate reserve supplies. The failure of governments to acquire adequate stockpiles well in advance of the crisis seems extraordinary given their own health experts have been warning about the inevitability of serious pandemics for years.
The choice between strategic stockpiling and investing in manufacturing capacity should be made by the health authorities and financed from the global health budget to create an incentive for the most cost-effective option. The decision should be fully transparent.
As for supply-chain risks more generally, it seems likely the supplier economies will themselves be making some fundamental adjustments.
China will not want to put itself through another shutdown of the scale we have just seen. And, like Australia, the Asian economies that supply the Chinese manufacturing machine are likely to diversify. Their prices, tax regimes, real wages and exchange rates may change in ways that make it less attractive for Australian industry to shift to high-cost home production.
And, of course, if the US and Europe do intervene to expand their manufacturing capacity, that too increases Australia’s future supply options. They will suffer an efficiency cost but their big domestic markets and the available economies of scale should mean their cost penalty is less than ours.
The COVID-19 recession will leave a scar of prolonged unemployment and weakened businesses with very limited capacity to contribute to the recovery in business investment and innovation.
It coincides with a secular decline of global productivity growth and it has caught Australia napping with a long to-do list of unaddressed economic reform.
Together, Australia’s failure to press on with reform and the global productivity slowdown have seen Australia’s productivity growth collapse. That will make it more difficult for governments to both supply high quality healthcare, education and other services and restore their budgets to balance.
The urgent challenge now is to revive productivity growth, not weigh it down with economically inefficient manufacturing. What the economy needs in addition to the government’s current fiscal support is reform of taxation, industrial relations and infrastructure investment.
No doubt the resurgence of business investment will include investment in manufacturing and that will be perfectly fine - if that manufacturing can stand on its own feet.
In the vast majority of cases, it should mean no government involvement at all.
Alan Mitchell is a bluenotes columnist and former economics editor of the Australian Financial Review
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
27 May 2020
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