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John Quiggin

A call to foster growth

Australian Financial Review

8 December 2005

In a generally strong Australian economy, one sector has been notably weak. The latest survey of manufacturing undertaken by Price Waterhouse for the Australian Industry Group reports that manufacturing activity contracted in November, as it has done for four of the last five months. Employment has also declined, at an accelerating rate in recent years/

The picture is even worse for manufacturing exports. In 2001, Australia’s exports of manufactures totalled over $33 billion. By 2004, they had fallen to $28 billion. In inflation-adjusted terms, the value of manufactured exports is below the level of the late 1990s.

Although the stagnation of exports has affected all areas of manufacturing, the weakness of exports of elaborately transformed manufactures is particularly worthy of note. This component of exports grew rapidly (from a low base) in the early 1990s. The expansion of ETM exports was hailed, at the time, as evidence of the success of the structural adjustment policies associated with tariff reform. Yet the stagnation of ETM exports over the last five years has been largely ignored.

Is this blasé attitude justified? In relative terms, the manufacturing sector has been contracting for decades, and this contraction is a reflection of economic growth, not economic decline. As productivity in the goods-producing sector has risen, incomes have grown correspondingly, producing increased demand for services, where productivity growth has been slower. We can expect (and hope) that the equilibrium share of manufacturing in output and employment will decline over time.

But the Australian economy is a long way from equilibrium, a fact that is evident in the current account deficit, which is still around 6 per cent of GDP, leading to a rapid increase foreign debt. After a period of stability in the 1990s, the ratio of net foreign obligations to GDP has risen steadily over the last five years, and is now around 60 per cent.

Aa recent Treasury report by David Gruen and Amanda Sayegh argues that there is no reason that our present levels of foreign debt should not be sustainable indefinitely into the future. But, even to stabilise foreign debt at the present levels, it will, as Gruen and Sayegh note, be necessary to reduce the current account deficit, to around 3 per cent of GDP.

At our present levels of debt and interest rates around 6 per cent, a sustainable current account balance of 3 per cent of GDP with in turn requires consistent surpluses in the balance of trade in goods and services, averaging around 0.5 per cent of GDP, compared to recent deficits equal to 3 per cent of GDP.

As Gruen and Sayegh observe, the required turnaround is not unreasonable for an economy where exports and imports both average around 20 percent of GDP. Still, it is reasonable to ask where the improvement is going to come from, especially if we rule out traditional stabilisation policies based on cutting domestic demand and thereby generating a policy-driven recession.

Given recent investments, we are likely to see expansion in the volume of coal exports. But the price of coal seems to have peaked, and in the absence of a general inflationary surge, the same is probably true for other commodities. Services may show some growth, but probably not enough to restore equilibrium.

Improvement in the balance of trade in manufactures is required. But what can governments do to promote such an outcome without distorting the economy?

A good start would be to remove policies that actively discriminate against manufacturing,. The most important of these is the concessional treatment of capital gains, which encourages short-run speculative investment in housing. More generally, there are a wide range of government policies that encourage investment in housing (which generates non-traded services) at the expense of traded goods and services.

Going beyond such obvious measures, it may be necessary to reconsider policy options that have been off the agenda for some time. Active intervention in particular industries has long been derided as ‘picking winners’ and there are plenty of cautionary examples of failed policy. On the other hand, there have been successes, notably including the Industry Plans of the 1980s driven by John Button. The characteristic feature of these plans was not reliance on large-scale subsidies or high protection, but the adoption of co-ordinate policies with clear objectives.

If we are to avoid a contraction in domestic demand, the stagnation of manufacturing exports must be replaced by strong expansion. Governments may not be able to drive such an outcome, but they could do more to facilitate it.

John Quiggin is an ARC Federation Fellow in Economics and Political Science at the University of Queensland.

John Quiggin is an Australian Research Council Federation Fellow in Economics and Political Science at the University of Queensland.

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