Is the price of no manufacturing worth paying?

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Via Ian Verrender at the ABC:

Everything old is new again.

As the world plans a recovery from the economic devastation caused by the coronavirus, long discarded and previously discredited ideas and ideologies suddenly are getting a fresh airing.

For a start, there’s been a complete reversal in thinking when it comes to the role of government in managing the economy.

Where in the crisis of just a decade ago, central banks pretty much took the running on saving the financial system and the global economy, this time around it is governments pumping in extraordinary amounts of money.

Social welfare and safety nets, temporary although they may be, are not the strategies most closely associated with Coalition governments who have led the charge for minimal government, if not always in practice, for the past half century.

Given interest rates are at zero, or barely above it, in much of the developed world, many governments were forced to once and for all junk the austerity mantra that has so dominated our thinking. Deficits, it seems, just don’t matter anymore.

But that’s not all. There’s now a push to wind back some of the hard fought “advances” foisted upon nations by the free market philosophy that prevailed throughout the west.

For decades, free trade has ruled. Instead of producing everything, there’s been a consensus that nations should produce the things they’re good at. You sell that offshore and buy in the stuff you need.

But in February, when China suddenly shut down, and the world couldn’t buy what it needed — everything from pharmaceuticals to electronic components and packaging — a grassroots push to be more self-reliant gripped the globe.

Our very own National COVID-19 Coordination Commission, in a move reminiscent of post-war command economies, wants to reboot Australian heavy manufacturing powered by cheap and abundant gas.

Can it be done? The answer to that is a resounding yes. But it would come at enormous cost — if not to the taxpayer, then consumers.

Why we dumped protection

For more than 50 years, we’ve watched our manufacturing sector wither on the vine. It hasn’t been an accident. In the post-war era, our flourishing manufacturing base was built upon protection.

The first was a natural protection in that we were a long way from our then traditional trading partner Britain. And in an era of relatively stable exchange rates, it was economical to make your own things.

The second was trade protection. Tariffs, subsidies and import quotas cushioned our industries from the winds of change blowing through the global economy.

But by the time Japan became an export powerhouse in the 1960s, producing top quality goods at much lower prices, it became increasingly difficult to justify paying top dollar for sub-standard local product.

The Whitlam Government was the first to move and took an axe to the cosy protectionism that shielded big business and unions from global competition and innovation, slashing tariffs 25 per cent in one hit.

a graph showing Average effective rates of assistance to manufacturing in Australia from 1968 to 1997
Average effective rates of assistance to manufacturing in Australia.

From then on, protection levels systematically were cut — as this graph shows — until the late 1990s when they were virtually non-existent.

How the mining boom hit manufacturing for six

It wasn’t the removal of protection that ran a bulldozer over our manufacturing base. It was the dollar, or more specifically, the mining boom.

Way back in the mid-1970s, Australian National University economist Bob Gregory put forth the idea that a boom in the resource sector could effectively squeeze out other sectors of the economy. In other areas of the world it was known by other names such as Dutch Disease.

From 2000 on, Professor Gregory’s thesis turned from textbook to real world playbook. As China transformed itself and built cities on a scale previously unknown, its insatiable demand for raw materials sparked an unprecedented Australian resources boom.

As billions of dollars in new investment poured into building new mines, our dollar soared through parity with the greenback, eventually peaking at around $US1.10.

That made our exports expensive on the global stage while imports were amazingly cheap.

Try competing against that as a local manufacturer.

For all the complaints from business leaders about overpaid Australian workers, it was the soaring currency and the vast lift in real estate values that priced us out of the global manufacturing ballpark.

This table, with random year pay rates shows how the currency inflated labour costs. At the turn of the century, Australian labour costs were the cheapest in the developed world. By 2012, when the mining boom and the currency were at their zenith, they were the most expensive.

US-Australia exchange rate and labour costs relative to the US, Europe and Japan in 1996, 2001, 2005, 2012 and 2015
The Australian dollar inflated labour costs.(Australia Institute, Conference Board, Reserve Bank Of Australia)

When General Motors, Ford and Toyota all decided to quit the country, it was primarily because the local currency had priced the domestic industry out of business.

Wages were exorbitant on a global basis and we could no longer compete on export markets.

It wasn’t just cars. Manufacturing employed 1.1 million people in 2000. By 2016, there were just 860,000.

But since then, with the dollar further weakening, that has grown to around 920,000.

The gas mistake that cost us dearly

The head of the Government’s COVID-19 Coordination Commission Nev Power and Andrew Liveris, who is examining a rebuild of heavy manufacturing, are pushing for a gas-led recovery.

Australia is the world’s biggest gas exporter. But Australian manufacturers have been paying more for domestic gas than many of our export customers because of a debacle that saw an $80 billion waste of money on east coast export terminals that have incurred huge write-downs in value.

They’re now exporting our cheap and efficiently produced gas, leaving the east coast short, with the only alternative to develop new, but far more expensive, fields.

Former prime minister Malcolm Turnbull, then-treasurer Scott Morrison and then-resources minister Josh Frydenberg attempted to fix the mess three years ago, threatening the industry with a “big stick”. But there’s no easy fix.

The latest and perhaps most bizarre solution has been to reimport the Australian gas that has been shipped to North Asia. It’s an expensive solution because the gas has been liquified at enormous cost and has to be turned back into gas, again a costly exercise.

Another idea floated is to build a series of pipelines from Western Australia to help solve the mess on the east coast, again at hideous costs.

Heavy industry or hi-tech?

Perhaps Australia’s manufacturing solution relies on a more hi-tech future. Some of our more successful companies, such as CSL and Cochlear, have developed world-beating medical technologies that are now sold around the globe.

The lack of protection has forced them to be innovative and hungry. Even our remaining heavy manufacturing industries have adapted to the new regime, although they quite rightly have been agitating for government intervention in the gas market debacle.

Recreating the manufacturing base we once had would require a large dose of protection. And that doesn’t come cheap. Just ask US President Donald Trump. His quest to Make America Great Again has backfired spectacularly.

Research from the US Federal Reserve has shown his tariffs on Chinese components and materials have damaged US competitiveness and jobs primarily because they act as a tax on Americans.

US manufacturing slowed dramatically last year, before the pandemic hit, falling seven out of 11 months with an annualised 3.3 per cent drop in the second quarter. US companies paid $US46 billion in tariffs.

The Federal Government has baulked at the idea of introducing tariffs to support domestic operations.

But unless it can offer new entrants a guarantee that the dollar won’t rise during the next resources boom and can deliver cheap land on which to build new factories, there’s little chance of a resurgence in heavy industry here.

When it comes to a cheap and reliable energy, the only short-term solution would be to make east coast gas exporters reserve a portion of the existing cheap gas for domestic use.

Longer term, a focus on large-scale and low-cost renewable energy infrastructure and energy storage would be a better option than building a trans-national gas pipeline.

Another option would be to promote innovation with research and development incentives. It’s been done before with varying success.

The most over-used cliche in the business world is “going forward”. As annoying as it is, it beats the hell out of looking backward.

All true. But what the article does not describe is the price paid in lost sovereignty to a vicious autocracy in China if you do not sustain some industry. It was worth a try to bring China into the global trading system to liberalise it. But that has failed.

This is not an externality to ignore. It is a direct cost of outsourcing your manufacturing, exposing you to:

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  • Economic coercion. The kind that demands your borders remain open as it spreads a virus to you and sucks out your PPE all at once.
  • Political coercion. The kind that destroys your democracy by bribing elites, backdoor deals and silencing critics.
  • Strategic coercion. The kind that demands you abandon democratic principles and allies and exposes you to gunboat diplomacy.

Do we really want to pay that price for more cheap China crap? I would not have thought so.

This description is also a false binary. There will be other cheap jurisdictions within the US alliance network where global supply chains can relocate away from China. But identifying the critical and strategic areas of production for repatriation to allow the government of the day to support them also makes sense.

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Without that, it won’t happen at all and sovereignty will remain in doubt.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.