Roy Green on the urgency of the industry task ahead

As a result of the massive fiscal stimulus applied during the Covid-19 crisis, together with close to net zero immigration, Australia has effectively achieved full employment for the first time in fifty years. This is a welcome result of the former Coalition Government’s Damascene conversion to Keynesian demand management, after years of denying its efficacy.

Apart from handing over an eye-watering $30 billion in Jobkeeper payments to companies that didn’t need the money, and forgetting to include a claw-back provision, the Coalition could at least credibly claim that they had risen to the challenge when it mattered. And they were supported in doing so by the Labor opposition, which responded similarly to the global financial crisis.

However, we should not delude ourselves that this stimulus-driven boost to employment is an indication of a high-performing economy as it is unlikely to be sustainable in the absence of measures to address longstanding supply-side issues, in particular the lack of investment in research, innovation and skills. It may be just another ‘sugar hit’, underwritten by the latest commodity price spike.

Already, in a return to market orthodoxy, the Reserve Bank has ignored these issues and asked us to believe that the current inflationary surge can only be controlled through interest rate increases, risking a slide into recession, when the evidence suggests that the major causal factors are on the cost side of the equation.

The idea that this inflation reflects a wage-price spiral has rightly been dismissed by ACTU Secretary Sally McManus as a “Boomer fantasy”.

Bloated corporate profits facilitated by monopoly pricing, the decline of union bargaining power and the ‘financialisation’ of Australia’s economy are a more significant part of the inflation story this time around.

This has been highlighted by an Australia Institute analysis of ABS data showing that wages account for only 0.6 per cent of the 4.1 per cent increase in prices so far this financial year.

Beyond our shores, the European Central Bank also found that ‘profits have recently been a key contributor to total domestic inflation’.
And related research by the US Federal Reserve has shown that when an industry is concentrated, the costs they pass onto consumers ‘become about 25 percentage points greater’.

However, even these sizeable profits, mostly at the expense of the labour share of the economy and joined now by the ‘windfall’ super-profits of gas exporters, will also likewise evaporate along with investment if demand is choked off by restrictive monetary policy. Clearly the drivers of long-term growth and jobs must be found elsewhere.

Why industry policy?

What is clearly missing in Australia, by contrast with most other advanced economies, is a coherent and purposeful approach to industry policy.

This important part of a modern social democratic government’s policy armoury has been relegated to the margins of public debate in recent years by the ideologically driven scramble to privatise public infrastructure assets, outsource services and (selectively) deregulate product and labour markets.

The problem is that instead of productivity-enhancing competition and improved consumer welfare, Australia has ended up with innovation-stifling market concentration and ‘market failure’ in key areas of our economic infrastructure, particularly transport and energy.

A particularly egregious example is New South Wales ports privatisation which boosted the sale price of Sydney’s Port Botany by placing an anti-competitive restriction on the Port of Newcastle.

This 50-year restriction effectively prevents the Port of Newcastle from developing a commercially viable container terminal, which would contribute to diversification of the Hunter region at a critical moment of energy transition, improve NSW freight and port efficiency and decongest roads and rail in Sydney.

This, and other examples, show how the neoliberal agenda has run into the sand, even subverting its own professed belief in competition policy.

In addition, the pandemic itself has highlighted deficiencies in service provision as the focus switched to public health, including aged care, disability services and childcare, with the increasingly apparent lack of resilience in local supply chains also a cause for concern.

Ironically, the most fervent advocates of private provision use the same arguments as those who claimed Soviet communism was fine in theory but just misapplied in practice.

Industry policy also has its theoreticians, indeed very formidable contributors over at least two centuries, but it is distinguished by grounding its models in real-world evidence.

A major goal of contemporary policy is to identify the current and potential areas of competitive advantage in an economy and enable industry to build on these through a coordinated approach to investment in the technologies and skills of the future, including management skills.

This will require well-designed interventionist measures not only to correct market failure, but to shape the markets in which industry operates so that agreed missions and priorities can be translated into action at the enterprise level.

The role of industry policy is not necessarily to ‘pick winners’, let alone prescribe outcomes, but to create the conditions for winners to pick themselves in globally connected innovation ‘ecosystems’.

By contrast with the previous government’s record of neglect in this area, symbolised by the constantly revolving door of portfolio ministers, Labor has committed to an ambitious set of industry and innovation programs, primarily focused on the revival and reinvention of Australia’s shrunken manufacturing capability.

While the policy direction is clear, there is inevitably much work still to be done on detailed implementation.

The appointment of Ed Husic as Minister for Industry and Science has been well received by business, universities and other stakeholders, as he is known for his strong commitment to science, technology and innovation.

Mr Husic will be assisted by Tim Ayres, who combines the responsibilities of manufacturing and trade, and he has also foreshadowed much closer cooperation between his department and that of Education Minister, Jason Clare.

Professor Roy Green

From the outset, Mr Husic has indicated his intention to take an inclusive approach to the work of the Industry and Science portfolio, drawing on a wide range of ideas from across the community, and even across the political spectrum:

“We have to create a sense of purpose, a national purpose. We got a sense of that through the pandemic. In terms of saving the lives of not just fellow Australians, but people across the world… What the pandemic did at the time [was demonstrate that] when we needed things we couldn’t get them,” Mr Husic said during an address to Science and Technology Australia’s annual Science Meets Parliament dinner.

“How do we address that? How do we rebuild manufacturing capability across industry sectors?

“With the application of technology, we’ll either see makers or see takers. What side of the equation do we want to be on? We want to be the maker…So, there is a lot to do. I want to be able to work with you,” he said.

“But I also need your guidance and advice. And the other thing I promised to do is bring… my great impatience, my great stubbornness, I will use that for your benefit. But you’ve got to charge me up…”

While expectations have been raised by the election of a new reform government in Canberra, we cannot expect everything to get done at once. As Prime Minister Anthony Albanese has emphasised, this is a marathon not a sprint.

But an important first step will be to review and reassess the existing array of programs, many of them sub-scale, and to start building institutional capability for the delivery of a more strategic, future-focused approach.

Clearly, there are many lessons to consider from around the world, as countries recognise that post-Covid recovery and reconstruction will require doubling down on measures to create a more competitive and dynamic knowledge-based economy.

This will be the key test for Australia too in addressing the challenges of sluggish productivity, wage stagnation and energy transition, let alone the transformation of our outdated industrial structure.

Outdated industrial structure

Let’s reflect for a moment on where we are. Unlike the Norwegians, with a 76 per cent resource rent tax and the world’s biggest sovereign wealth fund to underpin the future diversification of their economy, we failed to take advantage of our once-in-a-generation commodity boom.

The revenues left over from rich pickings by foreign shareholders fuelled short-term consumption, not the much-needed longer term investment in the industries and technologies of the future.

Manufacturing as a share of Gross Domestic Product (GDP) fell from around 30 per cent in the 1960s and 70s to 12 per cent in 2000 after the Hawke-Keating tariff reforms.

This was not unexpected, but more complex manufacturing exports then actually showed signs of rebounding as Australia participated in the worldwide transition from large-scale vertically integrated mass production to smaller, more specialised firms making their way in global markets and value chains.

This repositioning of the Australian economy was interrupted not just by the global financial crisis, but more dramatically by the increase in commodity prices that powered up our income from the rest of the world, mainly China, and in turn boosted our terms of trade and currency exchange rate. As we now know in hindsight, this left us with more problems than it solved.

Essentially, the windfall gains from higher commodity prices masked a structural deterioration in our productivity performance as a high dollar made much of our trade-exposed manufacturing uncompetitive.

This phenomenon, which became known as the ‘Dutch disease,’ was previously experienced by the Netherlands with the discovery of North Sea gas in the 1960s.

Next came the UK with North Sea oil in the 1980s, where deindustrialisation induced by the Thatcher government was accelerated as in Australia by a consumption boom at the expense of productive investment.

Only Norway has seemed able to learn from these episodes, and is now well placed to grow high wage, high productivity jobs through investment in carbon-neutral industries.

As the trade deficit in Elaborated Transformed Manufactures (ETMs) doubled in Australia to $180 billion over the last two decades, the manufacturing share of GDP fell further to 6 per cent, with associated job losses across design and engineering.

According to a recent Australia Institute report A Fair Share for Australian Manufacturing, this makes us one of the least self-sufficient economies in the OECD. However, for some leading economists, it was apparently not a cause for concern.

These economists consoled themselves with the idea that Australia might actually be better off as a ‘post-industrial’ society, without reflecting on the destructive volatility of the commodity price cycle.

Moreover, the advent of a services economy still requires us to ask how Australians selling each other residential housing, financial derivatives and piccolo lattes will generate sufficient export revenue to pay for expensive imported consumer goods.

Sovereign capability

The narrowing of Australia’s trade and industrial structure is reflected both in our precipitous decline in global competitiveness rankings, and in the Harvard Atlas of Economic Complexity which measures the diversity and research intensity of our exports. Here we have dropped from a ranking of 55 in the 1990s, which was disturbing enough, to 87 out of 133 countries.

Even Canada, another resource-rich economy, at a ranking of 39 has understood the need for energy transition and diversification of its export mix into knowledge-based products and services.

How long can Australia maintain its first-world lifestyle with a hollowed-out third-world industrial structure? Nothing is guaranteed as Argentina found to its cost over the last century.

Australia’s vulnerability to external shocks was highlighted in the Covid-19 pandemic, when the absence of what we now call ‘sovereign capability’ in a number of basic medical and personal protection products became a matter of life and death.

And yet once again, as already noted, domestic consumption was safeguarded, this time by an unprecedented fiscal stimulus, defying previous shibboleths about the dangers of debt and deficits.

And again, the need for productivity-boosting investment in technological change and innovation was overlooked, against the background of another commodity price spike. This was despite the contribution such investment would make to more sustainable, net-zero emissions growth, with the prospect of reducing our debt in the longer term.

Instead, as a result of this policy neglect, combined business and government expenditure on Research & Development (R&D) as a proportion of Gross Domestic Product (GDP) has slumped to 1.79 per cent, compared with 2.2 per cent eight years ago and 2.4 per cent on average for the OECD.

Some countries such as Israel, Finland, Korea and Switzerland are increasing their R&D spend to four and even five per cent of GDP.

Paradoxically, given the rundown of public funding for higher education, universities have taken on the heavy lifting in research and innovation, mainly through access to increased international student revenues.

The problem here is not only that these revenues have taken a hit from Covid-19, but the research is not always in the areas where it can have most beneficial impact. And while there are exemplars, nor is it translated as effectively as it could be into economic and social value.

Given that the latest Intergenerational Report projects annual productivity growth of 1.5 per cent for the next 20 years as a necessary minimum to maintain living standards, we must look to the policy levers that will assist in achieving that target, from current levels averaging around 0.6 per cent.

These levers must be designed to build our capability and performance in science, technology and innovation, and to increase enterprise ‘absorptive capacity.’

However, not only have these levers been inadequate or entirely missing in Australia, they have scarcely featured in public discussion, with the media more preoccupied with house prices and interest rates.

We may be cautiously optimistic that this is about to change with the new government, given its commitment to long overdue industrial transformation.

National innovation system

Most successful advanced economies are committed to the concept of a ‘national innovation system,’ especially as part of post-Covid recovery.

They see this approach as an essential part of industry policy and the development of an inclusive and dynamic knowledge-driven economy. Yet in Australia we are faced not just with market failure in research and innovation but with ‘system failure.’

As well as being underfunded, Australia’s approach is notoriously fragmented and undirected. In 2015, a report which I was commissioned to undertake for a Senate inquiry on ‘Australia’s Innovation System’ found that Commonwealth spending was spread almost randomly over 13 portfolios and 150 budget line items, few of which connected with each other.

This report was momentarily of interest to then Prime Minister Malcolm Turnbull, whose government made use of its recommendations for the short-lived National Innovation and Science Agenda (NISA).

Needless to say, business as usual resumed in due course with more ‘slicing and dicing’ of the budget envelope to create a multiplicity of programs lacking interdependence and critical mass.

Our innovation effort is also undirected in the sense that it lacks a coordinating focus, where national priorities are identified and monitored by evidence-based ‘foresight’ exercises.

Instead, the largest component of funding is the R&D Tax Incentive program, whose guidelines have become more opaque as demand continues to grow to the point where its claim on resources is unsustainable. Other countries make more use of direct targeted programs aligned to their priorities.

How much of this will change over the next three years? The pace of the Coalition’s program announcements picked up remarkably as the election loomed closer, and of course were welcomed by potential recipients. But they continued to suffer from being sub-scale, non-transparent and lacking the institutional structures that would ensure longevity of engagement and impact.

For its part, Labor came to office promising to ‘repurpose’ existing programs and to introduce a new $15 billion National Reconstruction Fund, from which would be drawn grant, loan guarantee and equity support initiatives. This is a substantial commitment, albeit spread over a number of years, which is intended to leverage further co-investment with industry.

The Fund will be based on the model of the Clean Energy Finance Corporation (CEFC) and will focus initially on advanced manufacturing, medical manufacturing and critical technologies, such as artificial intelligence and quantum computing. Other priority areas will include clean energy technologies, defence, transport and value-adding in resources and agriculture.

Although the details of how this Fund is to operate are yet to be announced, it will be reassuring to industry that it builds on proven experience.

Another local model to draw upon in this context is the Innovative Manufacturing Cooperative Research Centre (IMCRC), which also leverages private investment for R&D projects but whose funding winds up at the end of this year.

Public procurement will additionally be deployed to promote local industry participation through a ‘Future Made in Australia Office’, as well as setting aside at least a fifth of federal tenders for small and medium enterprises, possibly along the lines of the US Small Business Innovation Research (SBIR) program. Public procurement is a powerful but underrated tool for driving innovation.

Institutional architecture

Apart from further layers of program funding, it is timely to revisit the institutional arrangements that deliver this funding with a view to devising a more coherent and cost-effective research and innovation system.

This should encompass a number of components, the first being a national coordinating agency, similar to those successfully operating elsewhere, such as Sweden’s Vinnova, the Netherlands TNO and InnovateUK.

In her latest book Mission Economy: A Moonshot Guide to Changing Capitalism, Mariana Mazzucato makes the case for such agencies to establish clear agreed missions, analogous to JFK’s ‘man on the moon.’

These provide a framework for research commercialisation that is not just linear ‘lab to market’ but a multi-faceted interaction, with spinoffs, co-investment and competition all playing a role. The Commonwealth Scientific and Industrial Research Organisation (CSIRO) has already been experimenting with this approach.

In this context, the second component of reform would be to apply a mission-driven approach to support for public research, including ‘blue sky’ research, across all discipline areas with provision for an independent assessment of grant applications.

Moreover, it has become dysfunctional and indeed inappropriate for universities to have to backfill research projects with teaching revenues.

So far, the government has announced an Australian Strategic Research Agency, based on the US Defense Advanced Research Projects Agency (DARPA), to ‘fund pivotal research in breakthrough technologies for national security.’

But we also need a broader commitment to basic research, or there will be nothing to commercialise. Universities Australia estimates that a 1 per cent increase in research funding will generate an additional $24 billion for GDP over a 10-year period.

Third, while everyone favours increased industry-university collaboration, Australia lacks the structures to conduct this effectively at scale and over long periods of time. Successful examples around the world, such as the UK Catapult Centres and Manufacturing USA Institutes, are ‘aggregators’ which bring together the full range of stakeholders in innovation ecosystems, including universities, multinational companies, Small to Medium Enterprises (SME) supply chains and CSIRO equivalents.

An important characteristic of such centres is that they are stand-alone physical facilities which have the task of solving problems for industry both in specialised areas of technological change and in the development of core manufacturing capabilities.

Some embryonic examples already exist in Australia, such as the Tonsley Innovation Precinct in South Australia and the Advanced Robotics for Manufacturing (ARM) Hub in Queensland.

Fourth, it has also become evident from local as well as international examples how important ‘place-making’ is for the development of innovation and entrepreneurship precincts.

Many of these will be nurtured and grown by individual states and territories, but there is scope for the Commonwealth to provide logistic support and access to finance on a cooperative basis, especially in Australia’s regions.

However, there are also dangers in these examples. In his book Innovation in Real Places, Dan Breznitz argues that aspiring precinct and industry cluster initiatives would be well advised to start from their own competitive strengths and capabilities, rather than attempting simply to transplant models from elsewhere. While salient lessons may be drawn, they must be adapted to local conditions.

Finally, and perhaps most importantly, a world competitive industry policy framework will only be as successful as the skills that are brought to bear in the development and deployment of new technologies, design and business model innovation.

Again, this is a question not just of funding but the most effective institutional structures for capability-building, including closer integration of university and VET pathways.

The renovation of Australia’s domestic skill base, along with skilled migration, will be critical to productivity improvement at the enterprise level. And there is ample evidence from the 2009 Management Matters in Australia survey, which benchmarked our management practices with those elsewhere, to suggest that involving workforces in the decisions that affect them would also contribute substantially to this improvement.

Harvard economist Dani Rodrik has recently noted that a consensus may be emerging around a new policy approach which he labels ‘productivism’. This ‘emphasises the dissemination of productive economic opportunities throughout all regions and all segments of the labour force.

Unlike neoliberalism, productivism gives governments and civil society a significant role in achieving that goal. It puts less faith in markets, is suspicious of large corporations, and emphasises production and investment over finance, and revitalising local communities over globalisation’.

Net-zero world

Australia’s future will not be determined by any single program or initiative but by a system-wide, policy-driven transformation of our narrow and unsustainable industrial structure.

Nothing less will enable us to diversify our trade mix and escape the path-dependency of our traditional reliance on unprocessed raw material exports.

This is also the message of a recent Grattan Institute report The Next Industrial Revolution: Transforming Australia to flourish in a net-zero world.

Of course, mining and mining-related technologies will remain important to our economy. However, the focus can now shift to the much in demand critical minerals for newly decarbonising industries as well as to capturing entire value chains in areas such as battery manufacturing, green hydrogen production and, ultimately, green steel and green aluminium.

While the government must operate within its funding envelope, there are many programs that could be repurposed to support the transition to a more innovative, net-zero economy.

An obvious example is the Diesel Fuel Tax Rebate, now costing around $7 billion a year, which is over half the entire Commonwealth spend on innovation and an impediment to clean energy transition.

Why not reallocate a third of this funding to projects aimed at making Australia a ‘renewable energy superpower,’ as the Prime Minister has been advocating, a third for moving up the critical minerals and agri-food value chain and a third for high energy users in regional small businesses and farms?

Some large non-tax paying global mining companies may not favour this approach, but everyone else will benefit.

In sum, despite the global challenges of inflation, supply chain disruption and the rapidly changing geopolitics of our region, the new Albanese Labor government finds itself in the best position in a generation to undertake a fundamental and long overdue reshaping of Australia’s economy and society.

As the management theorist Peter Drucker once put it, ‘the best way to predict the future is to create it.’ And create it we must.

Do you know more? Contact James Riley via Email.

Roy Green on the urgency of the industry task ahead

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