A characteristic feature of economic booms is that those caught up in the excitement believe they will go on forever. Australia’s recent mining boom is no exception.  Following the pattern of resource-based economies, a commodity price hike increased our terms of trade without any special effort on our part – adding 15 per cent to our national income over a six year period while the rest of the world languished in recession.

Did I say the rest of the world? Some countries performed much better than others, and I’m not just referring to the obvious example of China and emerging markets. The advanced economies which recovered most strongly from the global financial crisis – Germany, Sweden, Switzerland – also have the most competitive manufacturing sectors. How can this be when manufacturing is supposed to be in terminal decline?

I’ll come back to this question in a moment, but first let’s revisit Australia’s boom, which ended in predictable symmetry with the way it began – a commodity price collapse. This precipitated the biggest reversal of our terms of trade in five decades with immediate impact on our national income.  Is it any wonder this government and the last have found achieving budget balance let alone a surplus to be the ‘labour of Sisyphus’?

We must come to terms with the painful reality that Australia has squandered a once in a generation chance to reposition its economy for sustainable growth. The question is not whether it could have been different, as we know in retrospect it could, but what policy lessons can be learned for the future? It is often said that Australians are better at responding to adversity than prosperity. Now is our chance to prove it – we have left ourselves no choice but to do so.

The Dutch had to learn these lessons the hard way in the 1970s when a currency spike associated with North Sea gas made their manufacturing sector uncompetitive. The phenomenon was given a name – the ‘Dutch disease’.  The British did no better, in fact arguably worse, when in the 1980s they cheerfully frittered away the proceeds of their oil bonanza in tax cuts and a consumption boom, rather than a long term investment strategy. It has taken more than a decade for the UK to rebalance its economy, with a renewed focus on manufacturing.  

Only the Norwegians understood the lessons of these dismal but instructive experiences. They took a public stake in their oil assets and imposed not a 20 or 40 per cent but a 76 per cent resource rent tax. They also established a sovereign wealth fund to quarantine exchange rate effects and invest in their research and innovation infrastructure. Clearly, these measures will enhance Norway’s capacity to diversify its industrial structure as the oil price plummets.

Likewise, Australia’s challenge is to identify new sources of growth, based not just on our comparative advantage in raw materials, subject as they are to diminishing returns, but on the ‘competitive advantage’ conferred by knowledge and ingenuity. This will mean rethinking our approach to manufacturing, with the prospect of increasing returns in high value segments of the world market.

But we face three additional hurdles which compound this challenge.

First, while the dollar would normally have fallen with the terms of trade, it refused to do so until recently, and even now may be overvalued. The effect has been to make it harder for trade-exposed non-mining activities to plug the gap left by mining. As a result, the large scale job losses in manufacturing over the last five years are attributable more to import competition than the labour-displacing technological change which has characterised manufacturing historically.

The second, related hurdle is the deterioration of Australia’s productivity performance since the 1990s, masked as it was by the terms of trade. This deterioration not only subtracts from current and future growth, but exacerbates our competitiveness problem. As a high cost economy, Australia must undertake a fundamental shift from domestically focused mass production – a legacy of tariff protection – to more flexible and specialised activities in global markets and value chains. The Europeans call this ‘smart specialisation’.

The third hurdle can only be described in Paul Keating’s memorable phrase as policy indolence. Just at a time when governments around the world are recognising that the way out of secular stagnation, unemployment and environmental degradation is through productivity-enhancing investment in innovation and skills, the Australian Government is reducing its contribution to this vital strategic objective.

This is all the more extraordinary when we cast our minds back to the 2008 review of the national innovation system, which lamented that we didn’t have much of one. Australia ranks poorly for business-university collaboration, not because of market failure but ‘systems failure’. And we still do, as the present Industry Minister has publicly acknowledged.

How can manufacturing help us to reimagine our future? In becoming more globalised, knowledge-intensive and interdependent with service design, robotics and digitisation, manufacturing matters more than ever for advanced economies. This is firstly because it drives innovation and technological change, and secondly because it contributes to the external trade balance.

On the first point, manufacturing accounts for a quarter of Australia’s private sector R&D expenditure. And even more is spent on ‘non-R&D’ innovation, such as new business models, systems integration and high performance work and management practices, with diffusion effects throughout the economy.

Second, without a manufacturing base, Australia would need to import more consumer and capital goods, reinforcing our chronic inability to run a positive trade balance. Additional borrowing to do so together with the repatriation of resource profits would expose serious vulnerabilities in our external position. Before the global financial crisis, conventional wisdom viewed the current account deficit as irrelevant. Since then, economic opinion has switched as financial markets savaged countries excessively dependent on foreign borrowings.  

It is increasingly recognised that accelerating deindustrialisation results in countries going backwards technologically with a diminished capacity for innovation. Other industries cannot substitute for this loss in capacity.

While the resources sector increased its R&D spending to match manufacturing, this has mostly been directed at tax minimisation rather than technology maximisation. Also sales of locally made equipment to the resources sector amount to just 2 per cent of total annual manufacturing sales. The mining boom was never going to save or substitute for a robust manufacturing sector.  

Without manufacturing, we face the prospect of losing science and engineering expertise that has taken generations to nurture in research and production. Manufacturing directly employs one in five engineers in Australia, and many more indirectly. These skills are not only critical to new growth industries but are core infrastructure skills on which every modern economy depends.  

Many people initially trained in manufacturing move to other industries. Where will the engineers, technicians, maintenance fitters and machinists come from to install and maintain our telecommunications, power stations, water plants, transport and defence systems? The resources sector does not train for these skills, but ‘buys them in’.

How long will the taxpayer fund research in solar energy, aerospace, microelectronics, advanced materials, nanotechnology and biotechnology when the industries that use these high level skills to innovate and make new products have disappeared? The Productivity Commission has already questioned public support for science and engineering when the benefits of resulting knowledge accrue to other nations.

Recent experience should be sufficient to dispel the myth that advanced economies can offshore their manufacturing base and retain high value design and marketing. Asian firms that started as cheap no-name makers of western-designed and branded products have quickly become global manufacturing leaders.

Manufacturing is changing the world and is itself changing as the prime source of transformational products and services. Australia’s commodity boom was an opportunity to build this transformational capacity, not to let it slip away in the name of a ‘black box’ economic model. Now we must do so in less favourable circumstances.

Despite over two decades of trade liberalisation, Australia has a predominance of low to medium tech manufacturing, in steel, non-ferrous processing, building products, basic chemicals and food processing. These are the areas most threatened by international competition, especially from emerging economies.

On the other hand, we scarcely register in high tech manufacturing, despite some notable success stories. Around the world, ‘micromultinationals’ are superseding vertically integrated corporations through niche production in global networks and value chains. This is the future of manufacturing, but also the largest component of Australia’s trade deficit.

The alternative is manufacturing decline. Some economists would argue that this is not a problem at all but ‘structural change’ which results in a re-allocation of labour and capital, leaving us all better off. The main deficiency of this approach is that it confines itself to asking how a fixed quantity of resources can be efficiently allocated. Consequently, it sees industry assistance as a zero-sum game, with some firms benefiting at the expense of other producers and consumers, with no net economic gain.

By contrast, influenced by the work of Joseph Schumpeter, other economists are beginning to model capitalism as a ‘dynamic system’, where change is the only constant. It is increasingly understood that because innovation is risky and expensive, and information is costly to acquire and use, government has a role in reducing risk and encouraging the uptake of new technologies and skills. This is the role of the ‘entrepreneurial state’.

The former Labor government commendably brought innovation to the forefront of industry policy. This included support not only for R&D and entrepreneurial start-ups in high tech manufacturing but also the development of innovation capability in low and medium tech firms. After a shaky start, and a barrage of policy advice from business groups, the Coalition government has begun to craft similar measures, albeit with minimal funding.

The centrepiece of the government’s approach is five new ‘Growth Centres’, including one for advanced manufacturing, which will be designed to encourage business- university collaboration. These have been allocated around $190 million, compared with almost $3 billion for the UK Catapult Centres, on which they are modelled.

In my view, a shared vision of future manufacturing in Australia should have three main elements. First, it should intensify the engagement of industry with research institutions, given the importance of public research in our innovation system. Second, it should further enhance the ‘absorptive capacity’ of manufacturing firms, along with more effective public procurement, so they are better placed to participate in global markets and value chains.

Finally, there should be a renewed emphasis on management and workplace innovation as the key to a competitive, knowledge-based economy. Our own recent analysis of Australian manufacturing management showed that the area where managers most lag world best practice is ‘instilling a talent mindset’.

The point is that there is no shortage of talent and creativity in Australia, as many examples attest, including among our successful manufacturers. The real deficit in our economy lies in the performance of our innovation system, the imagination of our policy-makers and the capacity of our managers to nurture talent and deploy it to full potential.


*Professor Roy Green is Dean of the UTS Business School, University of Technology Sydney. He chaired the CSIRO Manufacturing Sector Advisory Council, the NSW Manufacturing Council and the former Australian Government’s Innovative Regions Centre. He was also a member of the Prime Minister’s Manufacturing Taskforce.

This presentation originally appeared on Ockam’s Razor, ABC, February 22 2015. Reproduced with the author's permission.

Image: http://newsroom.uts.edu.au/news/2011/07/re-thinking-research

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