Australia as an industrial superpower? Well, yes …
The Albanese government’s Future Made in Australia project is one of the most misunderstood and misrepresented policies of recent times. It may also be the most important.
Nobody knows how the economy works. It is too vast, too complex and it has 8.1 billion moving parts.
Covens of macroeconomists around the world try to develop models that show how the economy, or parts of it, function at a particular time. But within a very few decades, the whole mad contraption reaches an unexpected tipping-point and economic orthodoxies, which seemed to work for quite a while, no longer do.
It takes several years for orthodox economists to (first) realise that times have changed and (second) try to work out a new explanation for what’s going on.
Economics is more resistant to change than economies are. Today, even governments are moving more quickly.
Around the leading developed nations, massive and unorthodox policy shifts are under way. In the United States, Europe, Japan, Korea and elsewhere, enormous amounts of public money are being poured into essential industries – mostly in advanced information technology, critical minerals, renewables and other green industries. This investment involves a powerful trend to bring must-have enterprises into being and to keep the benefits onshore, rather than outsourcing them to unreliable countries like China.
But these programs contradict ruling economic doctrines. They are undoubtedly protectionist, they involve governments in “picking winners”, they represent a rejection of globalist fundamentalism, and they will have an impact on the allocation of resources.
They are also essential. But to understand what’s going on, we need to look at how economies can suddenly and unexpectedly flip – as the world economy did a only few years ago.
Sudden, profound, unexpected
If there’s a single point where we can find the fracture between one economic era and the next, it was probably 27 February, 2007.
On that day, share prices in the US and China plummeted in response to an unexpected slump in house prices. Alan Greenspan, not long retired as chairman of the Federal Reserve, predicted a recession. And soaring rates of delinquencies in sub-prime home loans forced Freddie Mac, the US government-sponsored mortgage lender, to stop its binge on issuing dodgy loans.
Few, of course, did. Economists are good at telling us what has already happened, but terrible at telling us what to expect in the future. As JK Galbraith famously put it: the only function of economic forecasting is to make astrology look respectable.
Economic eras are defined by the seismic events that mark their births and deaths. The Great Depression in the 1930s ended a time of devotion to the free market and government austerity, and spawned the Keynesian era of activist governments, the welfare state, full employment and declining inequality.
That era died in the confusion of stagflation in the 1970s, when the prescriptions of Maynard Keynes no longer seemed to work. In previous times, high unemployment and stagnating economies would have been met with fiscal stimulus – but that was no longer possible when inflation was already too high.
Stagflation was finally killed by cripplingly high interest rates that sent the world economy into deep recession and threw millions out of work, but which – after immense pain – worked. Those harsh times suited the swing back to the pre-Depression economics of Ronald Reagan and Margaret Thatcher. Government was the problem and the market was the solution – to almost everything.
The new way became known as the Washington Consensus because that’s where many of the key hardliners – the International Monetary Fund prominent among them – were located.
Taxes were slashed, but budget deficits soared because cutting spending is harder than cutting taxes. An orgy of privatisation lasted for over 30 years as public assets were sold off. The profit motive, according to the new orthodoxy, would make almost everything more efficient and responsive. The list seemed endless: trains, trams, electricity, telecommunications, mines, water and sewerage systems, postal services, banks, insurers were all auctioned off.
But public services were impoverished: public hospitals became overcrowded, schools starved of funds and government employees sacked, their functions contracted out to private consultancy firms.
Economic output – gross domestic product – continued to increase but at a slower rate than during the Keynesian decades. More importantly, an outsized share of those gains went to people who were already rich. Throughout much of the developed world, the top 10% prospered (and the top 1% prospered mightily) but middle- and working-class people often found their incomes and wealth stagnating or going backwards. Inequality is now producing serious social and economic difficulties.
When eras change, many fundamental assumptions about how the economy works no longer give the right answers. Always, macroeconomists develop models that appear to fit the times in which they live; but when those time change and the models no longer work, they remain wedded to the old, familiar conventions.
The human cost of outdated theories
The changed era which now confronts us confounds, once again, formulas that not long ago were seen as universal laws. Take, for instance, theories about the relationship between inflation and unemployment.
Throughout the neoliberal era of the past half-century, it was almost universally assumed that the unemployment rate had to be no lower than about 5%. If it went below that, households would have too much money to spend and inflation would take off. According to these then-new assumptions, full employment in the pre-1970s sense – in Australia, that was an unemployment rate of around 2% – could not happen. The fact that it did happen for quite a long time was brushed aside.
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According to a 2021 working paper from the Australian Treasury, the estimate of the NAIRU was revised down from 5%, where it had been for many years, to 4.5%. According to one of the core assumptions driving Australia’s monetary policy, if unemployment went below 4.5%, wages would rise, inflation would take off and interest rate would have to rise.
In the 1970s, there was a real wage-price spiral, and that led to the NAIRU being adopted as central bank orthodoxy. But as Matt Grudnoff, an economist at the Australia Institute, has pointed out, “despite there being little real-world evidence that the NAIRU even exists, it has been embraced by the RBA for decades.”
For quite a while now, the unemployment rate has been falling – and so has inflation. That’s not supposed to happen. The unemployment rate is now at 3.9%, so pushing it up to 4.5% would put 89,000 people out of work.
Here’s another way of looking at it. Since the pandemic, the employed proportion of the population has not increased – but inflation took off. There is little evidence here of a causal relationship between prices and jobs.
Outdated economic theories are dangerous. But the people who follow and enforce those theories seldom pay the price of their failure. Their jobs are secure.
New times, old ideas
Three unmistakeable elements largely define the new economic era: the faltering of globalisation, climate change and artificial intelligence. All are potentially devastating.
Governments, including ours, have belatedly begun to move on climate change. On the other two, serious action is only now being contemplated.
Globalisation was the mantra and the driver of the neoliberal free-market era. Trade barriers tumbled, protectionism became a dirty word and capital was allowed to flow unimpeded around the world. In trade policy, the ruling idea was that each country should limit itself to the things it was good at, and import the rest from those that could do it better and cheaper.
So China became what Britain had been in the 19th century: the workshop of the world. Manufacturing in most of the developed world was ravaged. Currency speculators became very rich indeed.
Despite such lessons as these, the canon of unimpeded globalisation remained – until the need for a more nuanced approach became inescapable. And China’s record as a unreliable trade partner and a commercial bully is alarming western leaders.
Catching up
Jim Chalmers, unlike the econocrats in the Treasury and the Reserve Bank, realised quite a while ago that a new era had begun and many of the old nostrums were no longer useful.
Over a year ago, he wrote this:
“Outside of specific reforms to strengthen financial regulation, it is very hard to think of any similar set of changes in the way a budget is put together and an economy is managed that truly reflects the lessons of that crisis, 15 years later.
“This matters a great deal. Being a good policymaker begins with having the right information and mental models for how the world works – that always precedes any particular decisions or actions … And since 2008, the mental models for most economic decision‑making have been unchanged.
“Over time [the Washington consensus] became a caricature for ever more simplistic and uniform policy prescriptions for “more market, not less”. This school of thought assumed that markets would typically self‑correct before disaster struck …
“One reason we became more vulnerable to economic uncertainty and upheaval by 2020 is that for much of the past decade leaders failed to do the thinking that would have given us a new plan in the intervening years.”
In her 2012 book, The Entrepreneurial State, she traces the habits of venture capitalists. These are the people who are prepared to take big risks with emerging enterprises in the hope that some will pay off later in a big way.
“For every ten [venture capital investments],” said Kerry Packer, “three or four will fall over, three or four will do okay, and one will shoot the lights out.”
But venture capitalists are in the game to make money, not to advance the national interest. So, like any sensible investor, they pick their moments to buy and sell. Too early, and they encounter risks they don’t like.
The earlier an investment is made, the riskier it is. The situation for Britain is typical throughout the world: the chances of loss in the earliest stages – funding of research, and company start-up – are over 50%.
As private investors would prefer not to lose their money, they avoid those high-risk, early stages and invest instead when the outcome is much less uncertain. Here, again, are the findings of an independent British study.
Longer timeframes between putting money into a venture and getting any profit out have blown out, making private venture investment increasingly less attractive.
A study by the consultancy group KPMG explained what was happening. “2023 was a particularly difficult year for VC investment globally given the significant economic challenges, geopolitical tensions and conflicts, and ongoing concerns related to the valuations of VC-backed companies,” the consultancy said.
The essential role of government
The message for public policy is clearer than ever: if Australia identifies certain areas of innovation that are critical to the national interest, governments will have to step in.
That, of course, is what governments have been doing all along. Despite the mantras of not picking winners and allowing the market to take care of itself, governments have always funded early-stage research and development. Private companies have then benefited from that taxpayer-funded work and made vast profits – but little or nothing has flowed back to government.
For examples, Mazzucato points to Apple and the pharmaceutical industry. Almost all the basic research that went into the iPhone and other innovative Apple products was conducted either by government agencies or by public-funded institutes. Steve Jobs was an innovator, but he didn’t deserve all the credit he took.
The pharmaceutical companies have increasingly stepped away from early-stage drug development, in favour of buying up new products from small outfits and conducting the large-scale clinical trials before bringing them to market. But the basic research on which this industry relies is overwhelmingly by governments, in the US but also in Europe, Britain, Australia and around the world.
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| The National Institutes of Health ... giving money away |
Without the huge and ongoing contribution from governments, behemoths like Pfizer, Merck Sharpe and Doehme, Glaxo Smithkline, Gilead, Roche and the rest would be very different outfits.
These companies are making a immense amount on the back of research they get, essentially, for nothing. Pfizer has lamented a fall in revenue for 2023: with declining COVID vaccine sales it was only $US58.5 billion ($A91 billion), down from $US100.3 billion ($A156 billion) the year before.
What about some return on investment?
The conventional justification is that governments get money back in taxation. But do they? These companies are adept at minimising and avoiding tax, setting offshore subsidiaries in tax havens and employing thousands of tax lawyers and lobbyists to get around the rules.
Testimony to the US Senate from a researcher at the Council of Foreign Relations showed the big American drug companies paid an effective tax rate of around 10%.
There are many other, more direct, government subsidies for firms that are identified as R&D oriented. These include further tax breaks, grants and loans. Of the three, loans are the least objectionable because, at least, the government will be paid back (unless, of course, the business goes bust). With the other two, the money is just given away with only the chimera of some tax money some time in the future.
Rather than giving cash away, it would often be in the public’s interest to use the same money to buy equity in an enterprise. Professor Mazzucato points to Tesla as an example.
But Tesla shares soared, finally reaching a peak of $US407 a share in 2021. Even today, and despite the company’s travails under its unpredictable boss, Tesla is at $US142 a share at the time of writing. And with 3.176 billion on issue, that puts it market valuation at $US451 billion ($A698 billion).
Elon Musk, largely on the back of that government loan, is now the third-richest person in the world, with a current personal fortune estimated by Forbes magazine at $US176.3 billion. That’s $273 billion in Australian dollars.
A minority stake in that company could have funded a great deal of public investment in future research and development.
“The prospect of the state owning a stake in a private corporation may be anathema to many parts of the capitalist world,” Mazzucato wrote, “but given that governments are already investing in the private sector, they may as well earn a return on those investments … The returns could be used to fund future innovation.”
What are Jim and Albo up to?
In 1926, Maynard Keynes wrote about “those decisions which are made by no one if the state does not make them.
“The important thing for government is not to do things which individuals are doing already, and to do them a little better or a little worse; but to do those things which at present are not done at all.”
That is at the heart of the new global policies of innovation funding, including A Future Made in Australia. If something really needs to be done, and only the government will do it, what’s the choice?
At first glance, the flagged initiative looks promising but vague. We don’t yet know what we’re being offered, but there are some clues.
Anthony Albanese and Jim Chalmers clearly understand what many in the economics trade do not: that the world is not only in the process of changing, but has already changed almost beyond recognition.
That’s the real message behind Albanese’s speech, A World Made in Australia. That speech, which foreshadowed much more than a shift in industry policy, was widely reported and equally widely misrepresented.
“This decade marks a fundamental shift in the way nations are structuring their economies – a change every bit as significant as the industrial revolution or the information revolution – and more rapid and wide-ranging than both,” Albanese said.
“Domestic economic policy settings are being re-shaped by a new set of global economic imperatives. And domestic economic priorities are re-shaping trade policy.”
This announcement should not have come as a surprise. Major programs are already under way, as Albanese told Sarah Ferguson on 7.30:
“We've already set out, of course, a range of investments. Critical minerals, $4 billion. The Hydrogen Headstart program, $2 billion. Solar Sunshot, $1 billion. The National Reconstruction Fund is a $15 billion program. So there are a range of funds that we've created, and programs that we’ve started, or kick-started, ones as well that will develop.”
The critical factor is how all this money is going to be spent. Albanese attempted to make that clear on 7.30, identifying two critical criteria for investment:
“One is where Australia has a comparative advantage,” he said.
“The second is where our national sovereignty matters. So for example, we've invested in the creation of mRNA vaccines here. That is, because we identified during the global pandemic, the problem, if we don't have the resilience by having our own pharmaceutical industry here. That's an example of protecting our national sovereignty.”
Albanese picked up on observations by Mariana Mazzucato, who, among many others, identified the difference between value creation and value extraction. Value creation is adding something to the economy that it did not have before. Extracting value involves monopolizing something you did not create in order to be the only entity that benefits from it.
Typically, Australian researchers and inventors, usually backed by public money, have created something valuable that did not exist before. There are many examples: including wi-fi, the cervical cancer vaccine, solar panel technology, Google Maps, spray-on skin, the black-box flight recorder, cardiac pacemakers, ultrasound scanners, inflatable aircraft escape slides.
Almost without exception, those inventions have been taken over by foreign companies who have made enormous profits from them, with little or no benefit flowing back to Australia.
“There hasn't been enough investment in value adding,” Albanese said.
“There's been an investment in extraction, but not investment in value adding … because that's how you create jobs and that's how you also protect our national sovereignty, by making sure that we remain a country that makes things here.”
It was, perhaps, an unfortunate line. It raises painful memories of enormous amounts of government money being poured into dead and dying industries, most notably commercial shipbuilding and vehicle manufacturing. And much of the criticism has come from the misunderstanding that the Future Made in Australia policy will follow that old, discredited model that gave all industry policy a bad name.
That seems unlikely. As Ross Garnaut has documented, Australia has massive competitive advantages in emerging industries of global significance. Most relate to climate change and the shift away from fossil fuels to a world powered by sun and wind.
The end of Australia’s long bonanza on coal and gas is within sight, so the revenue and jobs that those industries produced will have to be replaced.
The key problem facing any Australian steel industry has been that the sources of the two main raw materials – iron ore and coal – are so far apart. A century ago, it made sense for BHP to establish steelworks at Whyalla (near the iron ore) and Port Kembla (near the coal) and transport the raw materials between them by ship. But with the development of vast iron ore deposits in the Pilbara, and of coal in central Queensland, it made more commercial sense to ship the bulk raw product overseas without adding value, or much employment, within Australia.
But now, the sources of cheap renewable energy and of metal ores are in the same places.
“Australia is the economically efficient place to turn mineral ores into metals in the zero-emissions world economy,” wrote economist Ross Garnaut in his 2021 book Reset. “This makes the economic advantage for using Australia’s natural endowments in industry much larger for renewable energy than for coal or gas.”
Aluminium smelters, which now have an uncertain future with high coal prices and carbon pricing, would be viable with cheap, abundant power from sun and wind.
Australia, Garnaut says, could become a renewable energy superpower, not primarily by exporting power in the form of green hydrogen or direct transmission – which he regards as largely uneconomic – but by establishing our own onshore industrial capacity to utilise the developing technologies of a new economy.
None of this is likely to happen without government involvement, both in regulation and investment. History shows us that there will be other, less risky, ways for the owners of capital to make their money. Major private investment will come along only when the path has been laid out by others.
The Future Made in Australia, one of the most important but misunderstood policies of recent times, is not the whole answer. It is, though, a pretty good start.