Keynote Address to MTIA National Forum – Canberra October 19th 1992

It is an honour to be invited as keynote speaker for the MTIA National Forum. Though I am largely Japan based, I have reason to know something of MTIA’s efforts in recent years to make a balanced contribution to the industry debate in Australia. The line-up of speakers for this Forum reflects a continuing emphasis on balance.

Such balance is badly needed. A harsh ideological note, on both sides, has entered the debate in recent years. When this happens everyone loses, as we saw in the debate over Vietnam twenty years ago.

Let’s begin with the obvious. Australia must do something about its unemployment problem, youth unemployment in particular. Let me also say something else that also should be obvious, namely that a genuine difference of opinion exists over what to do about the problem.

To date the debate has been greatly confused because there are in fact two very different debates, and they tend to be rolled into one. One debate is over the social consequences of unemployment – the ‘wets’ versus the ‘drys’. The other debate is over the economic policies needed to cure unemployment – the rationalists versus the anti-rationalists. We can begin with the social consequences debate.

The ‘wets’ argue in effect that sustained unemployment, youth unemployment especially, is socially and morally unacceptable, and that if necessary societies should pay a large economic cost to get rid of this curse. Some rather unkindly would call this the sheltered workshop approach.

The ‘drys’ are less concerned about the social cost of unemployment. Some see it as an inevitable part of needed economic transitions. Some even see it as beneficial, as a lubricant to these transitions, or as a tool for the of lowering real wage levels and the changing of worker and trade union attitudes. Certainly they do not want to get involved with sheltered workshops.

In the context of Australia one can see a logic in the ‘dry’ position. Something drastic had to be done and still has to be done to reform labour markets. But is prolonged unemployment the only way? Prolonged youth unemployment could easily be counter-productive, if younger people lose interest in work and skills. New Zealand has pioneered labour market reform techniques worth studying, though admittedly it needed the pressure of unemployment to have some of the techniques implemented.

In Japan, where a need to improve worker and trade union attitudes barely exists, there is not even a hint of a wet versus dry debate. It is taken for granted that unemployment should always be kept at the lowest possible level. Unemployment causes a waste of productive ability and a harmful reduction in final demand. It means social demoralisation, the weakening of communities,and in some cases the loss of traditional cultures. In Japan unemployment above the three percent level would be seen as close to a national tragedy. Eleven percent is out of the question since the government would pay any economic cost – dangerous fiscal expansion, absurdly low interest rates, heavy protectionism and even sheltered workshops to prevent it.

Even when there is overall labour shortage, Japan tolerates a wide range of economic abuse- inefficiency in the distribution sector, heavy protection for agriculture and protection for some areas of manufacturing – simply to prevent localised unemployment. Japan makes the judgement that whatever economic damage these policies may cause is more than compensated for by the social gains from close to full employment.

At times Japan seems to go too far in the anti-unemployment direction; indeed, sometimes the main aim of economic activity seems to be the creation of employment rather than GNP. But if we are to judge by results I think we have to concede that they have done quite well, both in the creation of a stable, well-run society and in the creation of GNP. Maybe there is something in the sheltered workshop approach, Japanese style, after all.

In particular we have to admire Japan’s emphasis on guaranteeing youth employment. Not just the economy but the entire society seems to operate on the premise that young people leaving school or university must be given jobs. Older, part-time and seasonal workers take the brunt of cutbacks during economic downturns.

True, the Japanese tradition of seniority pay and lifetime employment help greatly here. In other words, it is not just a social responsibility to employ the young. It is also in the economic interest of individual firms to keep a constant flow of younger people entering employment ranks. The longer-term view of most Japanese enterprises also makes it very much in the interest of the firm to spend heavily on training these young people (government is only marginally involved).

But underlying all this is an ethos that says young people are the lifeblood of both the society and the enterprise, and that it is an economic and a social crime to ignore them. One wishes something of this ethos could penetrate the cold, dry halls of Western economic thinking.

In particular there is something strange about the way Western governments will bend every nerve to wipe out the slightest hint of alleged discriminations, be they sex, race, physical or age based, in the workplace, but they feel much less obligation to provide workplaces, especially for young people. Unemployment concentrated on younger people, surely, is the worst form of discrimination.

To overcome the youth employment problem, I am not saying Australia could or should emulate every aspect of the Japanese approach. But a system of low starting pay for younger employees combined with rewards for continued service, penalties (high redundancy payouts) for arbitrary sackings, and the bonding of trainees would go some way to make it worthwhile for firms to recruit younger people, keep them, and spend sensible money on their training.

Turning to the rationalist versus anti-rationalist debate, let me say at the outset that I understand where the rationalists come from. In fact I think I was there, at the creation, back in the sixties, with the small band of largely Canberra and ANU based economists genuinely upset by the excessive and politically biassed protectionism of the McEwan years. They were right to protest that protectionism.

Where they have gone wrong is in assuming that this protectionism was and still is responsible for all the ills of the Australia economy. They remind me of the fat man eating a hamburger who was hit not just by one but by two trucks, broke his leg, went to a quack doctor who crudely amputated the leg, ate another a hamburger to console himself, and then developed gangrene. For the rest of his life he blamed those two hamburgers for his amputated leg and the gangrene.

If you think that is stupid wait till you hear the sequel. Later when the disease spread to the rest of the man’s weakened body he went back to the same quack doctor who told him he would be fine if only he stopped eating hamburgers. And he believed it!

1960’s protectionism was only one of the very many reasons for Australia’s economic troubles. And even that protectionism had its rationale, just as hamburgers can sometimes do us more good than harm. Australia had earlier used moderate protectionism to create quite a lean, viable economy. Despite the handicap of a small domestic market it had created a range of mid-tech consumer goods and heavy engineering industries operating at or very close to international competitiveness. True, in the sixties, the protectionism had been overdone to the point where the economy was getting rather bloated. But that was not causing any immediate problem.

The problems, when they arrived, were of a totally different nature. One was the collision with a ‘truck’ called rapidly rising Asian productivity (which, incidentally was a major reason for the muchcriticised protectionism of the sixties). Then in the early 1970’s Australia ran into another ‘truck’ – the minerals boom and a grossly over-valued currency, combined with rapidly rising domestic wage and other costs.

The Australian economy could have survived that second accident in one of three ways. One (with which I was somewhat involved at the time) was to lock foreign purchasers of minerals firmly into Australian supply and processing so that minerals rather than manufacturing became the basis of the Australian economy. The second (with which I was also somewhat involved )was a resources tax aimed at the more profitable resource exporters in order to restrain rising wage costs. The third was to ride the minerals boom for as long as it ran, while taking special measures to protect the more important areas of Australian manufacturing vulnerable to the over-valued dollar in the meantime.

In the event none of these remedies were used. Instead the quacks were called in. One, called resources nationalism, said keep the foreigners out of Australian minerals development. The second, in the form of budding economic rationalism, said resource taxes, discriminatory resource taxes especially, were a distortion of free markets. And the third, equally rationalist, said Australia should use its balance of payment surplus to cut protection across the board for all manufacturing. This produced the 25 percent tariff reduction when the Australian dollar was at a peak of 400 yen (now 85 yen). It was insanity of the highest order.

The result of all this was the loss of both minerals markets and most of Australia’s more efficient manufacturing. To save the day the late Whitlam and early Fraser regimes had no choice but to resort to renewed protectionism to preserve what was left of Australian manufacturing (mostly the more inefficient industries) because the further loss of manufacturing would have caused unacceptable unemployment. Then as the economy went further down hill the rationalists decided that it was this remaining protection that was causing all the problems, ignoring the damage done by those quack doctors and the continuing over-valuation of the dollar. Their prescription for recovery? More amputations, via zero tariffs.

The key problem facing the Australian economy was and remains that of rising Asian productivity relative to that of Australia. We can debate the reasons for this shift at length – Asians getting their act together while Australians let their act fall apart, Asian protectionism or what have you. But the result is the same: in a situation where massive exchange rate adjustment was needed to preserve trade balance, our exchange rate after allowing for relative inflation levels has not fallen as much as it should have. If our dollar had fallen as much as the NZ dollar has, we would probably be reasonably competitive in some manufactures and certainly in the foodstuffs currently threatened by foreign competition. But in the case of Australia, the continuing high level of minerals exports constantly delays the needed exchange rate adjustments.

The result is the antithesis of economic rationality – a situation where even with the recent fall in the dollar every Australian exporter and every Australian producer of import competing goods currently faces a 25 percent impost via the still overvalued exchange rate (using New Zealand as the benchmark). If economic rationalists were as rational as they claim they would give this problem absolute priority.

Unfortunately they manage to bury it under a pile of rationalisations – inflationary fears, interfering with free markets. etc, while they concentrate on the almost totally irrelevant problem of tariffs – the unfortunate hamburger that seemed to start everything off. Reducing tariffs when your currency is over-valued is, of course, a repeat of the insane quack remedy of the early seventies.

Seen from Japan, the Australian obsession over tariff policy is extraordinary. Tariffs are or should be an element of economic policy just as relevant as TAFE training, GST, payroll taxes, income taxes etc. They impose costs while creating gains. The aim is to minimise the former while increasing the latter. In some countries (such as India or much or Latin America) and at some times (such as 1960’s Australia) bad tariff policies mean that the costs exceed the gains. In other countries (Japan, Taiwan, Korea and now Thailand and Malaysia) and at other times (pre-1960’s Australia) skillful tariff policies mean that the gains exceed the costs.

In the minds of Australian rationalists it is all costs and no gains. Look at 1960’s Australia, they say (1960’s Australia was probably doing a lot better than the current Australia, incidentally). Look at India, they insist, averting their eyes from Japan’s past protectionist sins while praising the relatively non- protectionist Japan of today. No one seems to note that every nation at its economic peak – the UK in the late 19th century, the US in the 1950/60s, Germany up till now, and from now on Japan – all suddenly and miraculously embrace free trade as an absolute virtue.

Seen from Asia, Canberra’s fear of devaluation-led inflation seems almost equally obsessive. Many Asian economies – Japan and Korea especially – relied heavily on an under-valued currency to get economic growth underway. Expanded output then allowed them to cope with inflationary pressure.

But the main problem with economic rationalism is the 19th century dogmatism that says resources taken out of inefficient industries manufacturing mainly, in the case of Australia – will automatically find their way into more efficient, internationally – competitive industries. In theory that sounds great. But what happens if there are no internationally competitive industries to absorb those resources, if instead they find their way into massive unemployment, youth unemployment especially?

In the 19th century perhaps the main determinant of economic efficiency was the relative allocation of resources such as labour and capital. Today it is something that can be called the economic base – the fine network of technologies, skilled workers, repair shops, transport links, funds for education, domestic demand etc that keep an economy turning over and expanding. Destroy an industry, even an inefficient industry, and you weaken the economic base to some extent. Weaken the economic base and you make it even harder for efficient industries to emerge. The fact that you may have a lot of unemployed capital and labour on hand is almost irrelevant, even if those 19th century textbooks say otherwise.

On the contrary. In today’s world the need to provide benefits to unemployed labour becomes another burden for the economy. The blind dismantling of existing industries can easily push an entire economy into a downward spiral from which no amount of subsequent devaluation will provide a rescue.

A major rationale for Japanese protectionism was just this: that the more existing industries, even inefficient industries, survived and flourished the easier it would be for new and more efficient industries to emerge. The consumer suffered, and occasionally there were even increased costs for producers. But all that was more than compensated for by later growth.

Some argue Japan went too far in the protectionist direction. Maybe. But Australian laissez-faire can also go too far. An uncompetitive economy has to do something to rescue itself.

Current Canberra policy sees lower tariffs and micro-economic reforms as restoring competitiveness. Obviously the reforms are necessary. But I can’t understand the hope placed on further lowering tariffs. We are told how tariffs increase costs over the entire economy, making Australia less efficient. Even in textbook theory that is only true for tariffs on producer goods. Tariffs on consumer goods are simply a tax on consumers. You do not use Italian cheese or Japanese TVs to produce wheat or steel. True, they can divert resources from unprotected to protected industries. But that is only a problem in a fullemployment economy.

Lower tariffs may help reduce some feather-bedding in the economy. But most of that has surely been removed by now. Given (a) the over-valued dollar (b) the weakened manufacturing base (c) the corrosive effect of continued unemployment (d) the continuing protectionism in Asian markets plus rising protectionism in Europe and North America, and (e) the rapidly growing efficiency of the cheap labour Asian economies not to mention the continuing sophistication of the more expensive labour Asian economies, the idea that lower tariffs will turn Australia into an economic world-beater seems fanciful.

Some like to point to the statistics for expanding ETM exports to prove that salvation is round the corner. But some of these exports are distress or facilitation exports, or energy-intensive goods disguised as ETMs. Niche exports are increasing, but the problem with niche exports is that the moment they reach any volume they can easily be taken over by foreigners with better production facilities, protected markets, or cheaper labour. And they will almost certainly be matched by niche imports. (Much of the increase in niche exports in due to the invention of the fax machine, which greatly facilitates trade, but in two directions.)

Apart from national pride, why is Canberra so convinced Australia can and must become the manufacturing Sweden or Switzerland of Asia? Australia already exports and will continue to export enough minerals and farm goods to cover much of its current account debit. All it needs on top of this is something to cover the balance.

One answer is further to expand exports of minerals, farm goods and processed goods, together with increased exports of services such as tourism. But these things are not going to be enough to fill the gap.

Farm goods are losing, not gaining, competitiveness as lower labour cost producers swamp markets. Already we are seeing processing moving out of, not into, Australia thanks to our rigid environmental restrictions and other problems. There is, of course, the hidden agenda of the minerals and farm goods producers, which says in effect that Australia should abandon all non-competitive manufacturing of tradeables, collapse the dollar, and in this way make the export of minerals and farm goods more profitable. But this seems to be a selfdefeating move, since there would have to be massive taxes on exporters’ profits to finance the cost of increased unemployment. And what happens if their exports are still not enough to fill the current account deficit?

In short, Australia is going to have to rely on manufacturing in some way to overcome its current account problem. To date attention has been focussed entirely on increasing manufactured exports. This in turn has led to a debate over whether the government should try to pick and encourage export manufacturing winners – a debate in which I side with the rationalists. The risks and costs of failure are to great.

But there has long been an alternative to manufacturing export expansion, and this is the increased production of import replacement manufactures. The employment and balance of payments effects are exactly the same. And import replacement is very much easier than export expansion.

To break into significant export markets Australian producers would need enormous technological and marketing advantages over rival Asian producers enjoying either cheap labour or a stronger manufacturing base. To compete in import replacement all that is needed is some initial assistance in gaining a reasonable scale of production and sales within Australia. Producers know right from the start the scale and the tastes of the market they are aiming for. They are close to consumers. Even without a technological or managerial lead over competitors they would probably end up supplying a significant share of the Australian market. The Australian balance of payments would improve by that amount.

Today, in a wide range of mid-tech industries Australia could be quite an efficient producer of the consumer goods currently imported in large volume, provided manufacturers could be sure of a sufficiently large share of the Australian market in advance to allow volume production, and provided they could import some parts and materials from largescale overseas producers at marginal cost. To satisfy both conditions, however, Canberra would have to impose strict anti-dumping and possibly other measures to stem the current flow of imports. It would also need to devise some scheme to force would be producers to bid for the right to be allowed to enjoy access to this promised large share of the Australian market.

In a recent book (‘Shutdown: The Failure of Economic Rationalism and How to Rescue Australia’, The Text Publishing Company, Melbourne) I have set out the details on to how Canberra could encourage such a program of import replacement. By my own estimate Australia could at very little cost (and that cost would be borne almost entirely by middle and upper class consumers) have established within two-three years a range of import replacement factories employing upwards of 100,000 people. The current account would be moving substantially into balance.

These employment figures would, of course, improve as the establishment of more import replacement factories made it worthwhile to begin producing more parts and materials in Australia. Within five years Australia would have gone a long way to restoring a manufacturing base, to the point where it might even become a significant exporter of manufactures in its own right.