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August 29th 2011 print

Peter Smith

Three speed economy

To have a government right now outspending its revenue in the middle of a resources boom is economic vandalism.

BlueScope Steel’s announcement of job losses prompted Paul Howes (AWU) to play the well-known strategic protectionist card: “we can’t rely on imported goods in our strategic sectors." He advocated putting pressure on China to allow the Yuan to float (good luck with that one) and a “sectoral support plan” including “tough local content policy”.

What is a tough local content policy? It is a policy to lessen the profitability and competitiveness of other Australian industries by having them pay more for their steel products than would otherwise be the case. Is that sensible and sustainable? Of course it isn’t. Union leaders seldom have a grasp of economics beyond the end of their nose. But Mr Howes is not wrong about everything. He said back in April that he could not support the carbon tax if it cost just one job. Though he has been noticeably shy – no prizes for guessing why – about repeating this very brave ultimatum, it was a fleeting moment of insight. It pointed (albeit incidentally) to the importance of macroeconomic policy in influencing job creation and to how that policy should be configured to support manufacturing (and other non-resource industries) during a resources boom.

A resources boom has two parts. They have quite different implications. The first is a rise in export income as the price of minerals and energy rise. Of itself this does not squeeze the manufacturing sector. The exchange rate will tend to rise but this effect will be offset by lower interest rates as import prices decline and national savings rise (in correspondence with increased profitability in the resources sector). It is the second part of a resources boom that squeezes the manufacturing sector. The second part is increased investment in the expansion of existing mines and the development of new ones to take advantage of increased prices. This requires additional labour and materials and savings to pay for them. Labour and material costs rise, interest rates rise, and the exchange rate rises still further to the extent savings have to be sourced from overseas. The manufacturing sector faces a three-way squeeze.

Government can help – not by putting in place ineffective protectionist measures, which damage non-protected businesses – but by having flexible workplace laws, less red tape and regulation; and, vitally, by getting its fiscal house in order. In particular, it should reduce its claims on labour, on materials, and on national savings, by deeply cutting its own expenditure. To have a government right now outspending its revenue in the middle of a resources boom is economic vandalism. It should be markedly reducing its demand for labour and materials to reduce their price, and saving rather than dissaving to reduce interest rates and the exchange rate.

We hear a lot about the two speed economy. We should hear about a three speed economy; comprising resource industries, non-resource industries, and galloping government. Resource industries make us prosperous and should be supported. Any idea of artificially slowing them down to make room for manufacturing is as preposterous as a team putting shackles on its best player. The way to make room for manufacturing is to reduce the size of government.

Keynesian thinking, which inspired the Rudd/Gillard government into reckless and wasteful spending, is partly responsible for the manufacturing sector’s woes. That thinking is ever around. Its current guise is in advising the government that now is not the time to cut expenditure and move back into surplus. On the contrary, it is most certainly the time, and without delay, to take some of the pressure off the manufacturing sector.

Government spending is costing manufacturing jobs. Mr Howes in his ultimatum pointed to the possibility of the carbon tax costing manufacturing jobs. He was right.

The tax will raise energy costs for all manufacturing businesses in Australia making them even less competitive with Chinese manufacturers; which, in exquisite irony, will benefit from lower-cost power sourced from non-carbon tax-paying Chinese power stations burning Australian coal. This effect would be offset to some extent by lower interest rates, if the government saved all of the revenue. But, in fact, it will engage in a churn and spend most of the revenue. A substantial part will be disbursed to lower income earners. They will spend most of this money (for understandable reasons lower income earners don’t save much). This spending will contribute to keeping interest rates up.

The AWU and the AMWU should protect their members’ jobs, as best they can, by lobbying the government to introduce more flexible workplace laws (sorry that was silly, I will start again), to cut its expenditure and to abandon the carbon tax. This would be far more effective than trying to persuade the Chinese to do something they don’t want to do or to fiddle with protectionist measures which are bound to fail. While at it, they might see their way to opposing additional taxes on mining unless the government saves every extra dollar it doesn’t use to reduce company taxes. Otherwise, again, government spending will make things tougher for manufacturing.

Traditional manufacturing industry in Australia will almost certainly continue its decline in the years ahead no matter what resource prices or governments do. China and some other Asian nations have a comparative advantage in this kind of manufacturing and this advantage will tend to grow as their own domestic markets grow, bringing down their costs of production. There is no point in standing against the tide, as unions so often forlornly try to do. At the same time, there is point in providing a supportive macroeconomic environment in which the government is not crowding the private sector. This lessens the pressure on manufacturing industry and allows more room and time for the structure of the economy to adjust to changing circumstances. 

Peter Smith, a frequent Quadrant Online contributor, is the author of Bad Economics