Trade and Industry

1. INTRODUCTION ⁽¹⁾

Almost all Western governments -- including Australia's -- have become deeply involved in "industry policy" in the last fifty years, and many are coming to regret it.  Any active industry policy by definition involves a government in attempting to stem or divert market forces, a task that can be likened to folding up a bean-bag:  apparent success in one area is always accompanied by bulging out of control in others.  Active industry policies always involve diversion of resources to favoured industries, either to encourage their development or to delay their decline.

In Australia, there have been two main strands to industry policy:  first, protection by import barriers and bounties, and second, intervention in domestic markets through the tax system (investment allowances etc.) and directly by regulation (e.g. aviation).  The cost and long-term effects of protection are now apparent;  they are discussed in section 3 and an appropriate policy recommended.  The question of uncertainty and industry policy is discussed in section 2.  Finally, section 4 includes various other recommendations relating to trade and industry.

2. THE PROPER OBJECTIVE OF INDUSTRY POLICY

Government intervention in markets in pursuit of an industry policy is always on one or both of two grounds:  either government thinks it can do better than the market would on its own, or it is having to intervene in an attempt to fix problems resulting from previous intervention.  The underlying motive has often been short-term electoral advantage.  It has long been known that it is simply impossible for government or any other single agency to obtain and comprehend all the information about individuals' needs and preferences that markets automatically integrate into prices.  It follows that any intervention in markets is blindfold fumbling and likely to have unwanted consequences. ⁽²⁾

Consequently we propose as the objective of industry policy no more than the maintenance of an environment favourable to entrepreneurship, innovation, and the development of internationally-competitive industries.  The most important single, contribution government can make is to minimise the uncertainty created by its policies and actions.  Business can adjust to virtually any regime except one subject to continual unpredictable change, although business activity and economic growth are of course very much affected by matters such as the level and incidence of taxation, interest rates, industrial relations and labour costs, and so on.  Policies in these areas are presented in other chapters.

Whether or not investments are made depends on investors' perceptions of risks and expectations of returns after inflation and after tax.  The experience of 1984 and 1985 shows that after a decade of slow growth in demand and low profitability and rates of return, economic recovery and high current profits alone do not bring about significantly increased investment:  there must also be an expectation of sustained profitability.  The more uncertainty there is about conditions in the future, the higher the perceived risk in any project, the higher the rate of return demanded for a project to be embarked upon, and the fewer the projects that make the grade;  investors transfer their attention to share dealing, takeovers and the short-term money market.

Governments can neither control nor predict the future, but they can avoid creating a climate of needless uncertainty for investors. ⁽³⁾  Reducing uncertainty requires the adoption and maintenance of stable and mutually consistent policies and an absolute minimum of ad hoc intervention.  As far as monetary policy is concerned, this means steady moderate growth of monetary aggregates;  for fiscal policy, it means regaining control of government expenditure and eliminating the structural deficits of the last decade or so.  Recent experience shows that while expansionary monetary and fiscal policies stimulate consumption, this is not necessarily followed by additional investment (as was traditionally assumed).  Rather, the expansionary measures raised consumption more than investment, increased imports more than local production, and had to be abandoned in the face of balance of payments difficulties and accelerating inflation.

Other chapters in this volume have been written with these considerations in mind.  Control of government expenditure and rapid elimination of budget deficits will reduce pressure on interest rates, thus lowering business's borrowing costs and increasing rates of return.  Stable monetary policy and lower inflation will do the same.  Increased absolute and relative wage flexibility will allow profitable and expanding industries to bid for labour, while moderating labour costs in less profitable areas.  The policy recommended in the Tax Reform chapter will minimise the uncertainty associated with the major changes to the tax system which are desirable.  In addition, as people get used to financial deregulation, entrepreneurs will make it simpler for even small businesses to reduce uncertainty by hedging directly or indirectly in futures or options.

The proposals below apply the same principles to reducing protection.  Do not forget that the aim is not to maintain a stable industry structure but to provide stable rules for a dynamic structure.  A stable industry is a static one whose products will soon be obsolete and unwanted.

3. TARIFFS AND OTHER PROTECTION

3.1 INTRODUCTION

Tariffs and other import barriers are the most important features of Australian industry policy.  Their history is bound up with that of wages and employment policy.  In the early years, the tariff was used to increase the price of imported goods to protect the domestic competitive position of Australian manufacturers paying the high wages set by the arbitration system.  After the second world war, the tariff was used to encourage the growth of import-replacing domestic manufacturing. ⁽⁴⁾

The result of these policies is a manufacturing sector which has concentrated on selling in small, protected domestic markets, and is largely fragmented and inefficient by world standards.  Manufacturers have become accustomed to seeking assistance from government when they run into difficulty -- or even before. ⁽⁵⁾  The cost is borne by Australian exporters, who have to take world prices for their products but pay Australian prices for most of their inputs including labour, and by all Australian consumers, who pay excessive prices for many manufactured goods.  The worst consequences of the policy are the textiles, clothing and footwear (TCF) industries and the car industry, which have been awarded extremely high levels of tariff and quota protection over the years.  The high levels of assistance have locked substantial quantities of Australian labour and capital into activities which are increasingly unsuited to the Australian economic environment.  In spite of increases in protection over the years, employment in the most highly protected industries has been declining (along with most manufacturing employment in developed countries).

There is no doubt that the average Australian would be better off under free trade than with the present, protected industry structure.  This is one of the few things on which most economists agree (see boxes "The Case for Free Trade" and "False Arguments against Free Trade").

3.2 FREE TRADE AND ECONOMIC GROWTH

Freer trade would lead to faster economic growth:

• Cuts in protection would reduce the price of traded -- imported and import-competing -- goods to consumers and to local industries.
• All industries will benefit from lower-priced traded inputs.
• Exporters in particular would benefit from a lower domestic cost structure (e.g. farmers, who pay for protection of local manufacturers of farm machinery).
• Changed incentives and costs will offer new, highly productive opportunities to the dynamic entrepreneurs who now find takeover and property deals more attractive.
• Economic resources (workers, capital, technology, etc.) would move from protected industries which use them inefficiently to the new, promising areas of economic activity.
• Similarly, firms would direct their efforts towards innovative products and processes rather than towards lobbying for protection for obsolescent ones.
• Every time it has been tried in the past, free trade has produced economic growth, usually faster than its enthusiasts predicted.

The Case for Free Trade In every country it always is and must be the interest of the great body of the people to buy whatever they want of those who sell it cheapest.  The proposition is so very manifest that it seems ridiculous to take any pains to prove it;  nor could it ever have been called in question had not the interested sophistry of merchants and manufacturers confounded the common sense of mankind.  Their interest is, in this respect, directly opposite to that of the great body of the people. Adam Smith, The Wealth of Nations. Modern economists disagree about many things, but almost all of them agree that import barriers are against the interests of most of the people. Tariffs tax imports, quotas restrict their supply.  The effect of both is to raise the price of imports and enable domestic producers of competing goods to charge more.  Ordinary consumers end up paying this "tax", which for some goods in Australia is well over 100 per cent.  The most highly protected products are footwear, clothing, textiles and cars.  As poor people spend a larger proportion of their income on these things the distributional effect of protection is highly regressive. The expensive products of some protected industries are inputs for other industries, which therefore must also charge high prices.  The effect is spread throughout the economy, to all consumer prices. When protected industries become unprofitable they go to the government for increased protection, which they have usually received.  This enables them to tolerate inefficient work practices and to concede higher wages than they otherwise could.  Thus protected industries attract resources away from other sectors of the economy where they would be used more efficiently. "Comparative wage justice" means that the high wages spread through the workforce into unprotected industries, reducing their profitability and thus investment in them, and thus further diminishing their share of resources.  The expensive products of some protected industries are inputs for other industries, which therefore must also charge high prices.  The effect is spread throughout the economy, to all consumer prices. Even more seriously, protection reduces the incentive to innovate:  firms and employees come to expect that they will always be able to continue what they are doing.  Why invent a new or better product or process when it is simpler to lobby the government for a higher tariff? Protected industries and protected societies soon stagnate;  but lowering the barriers to trade and commerce always leads to a period of exceptional growth and innovation:  e.g. first Britain and then Germany in the 19th century;  West Germany in the early 1950s;  France and Spain in the 1960s. A final argument in this incomplete list is the foreign affairs one:  it is not possible to be on genuinely friendly and relaxed terms with our Asian neighbours if we close our markets to their products.  Australian protectionism also undermines our credibility when we demand that other nations not discriminate against our primary products.

Faster economic growth is essential for the survival of the Government and the long-term stability of Australia.  The natural growth in the workforce as the population increases, plus increasing productivity (output per employed person) with technological change, mean that economic growth of the order of three per cent per year is needed simply to maintain present levels of unemployment and present average living standards.  Only faster growth will permit reductions in unemployment and/or higher real incomes, and there is no doubt that people want both. ⁽⁶⁾

Reducing protection will cause some adjustment problems.  These would be severe if tariffs were cut without notice.  But if tariffs and other import barriers are lowered gradually over several years in a pre-announced programme, investors will be able to make their plans accordingly, and new investment and employment opportunities will appear at least as fast as the old ones are lost.

Given all this, why do governments find it so very difficult to reduce protection?

3.3 THE DIFFICULTY OF CUTTING PROTECTION

3.3.1 Example:  Textiles, Clothing and Footwear

Almost all economists, many politicians, and many people in other industries agree that Australia would be better off with much lower protection for the TCF industries.  After years of inquiry and consultation, the Industries Assistance Commission reported on the industries, and recommended a very cautious programme starting in 1989 that would by 1996 leave a 50 per cent tariff on TCF products, and bounties and other measures resulting in effective protection for a range of clothing and footwear products of about 100 per cent.

Cautious though it was, this programme was too much for the ALP caucus, and at the time of writing the Hawke Government had proposed a programme that would reduce nominal tariffs to 60 per cent by 1996, incorporating a wide and expensive range of other assistance measures.  It also makes a nonsense of itself by including a guarantee that tariff reductions will stop if TCF production falls by more than 15 per cent before 1996.  The timidity of the TCF decision contrasts with the Hawke Government's more economically rational decisions on protection of chemical and electronic industries.

3.3.2 The Reason

The reason, of course, is politicians' fear of losing elections:  the most highly protected industries are the ones with the greatest lobbying power.  Among the relevant points:

• To grant protection to an industry is also to grant it influence.  Protection increases employment in the protected industry (at the expense of a greater number of jobs elsewhere) and thus enables it to affect more people's lives and votes.
• The existing jobs that are threatened by cutting protection are much more visible than the jobs which will be created if protection is cut.  The workers have votes, the employers and union leaders have good contacts in the political parties.
• Heavily-protected industries have factories in some marginal electorates.
• The industries are the main source of employment in some country towns.  Factory closures could have a severe effect on some towns.

False Arguments against Free Trade These are some of the arguments traditionally used by TCF and other highly-protected industries. "Jobs will be lost."  Not on balance.  Employment in some currently highly-protected industries will decline (as it has been doing despite protection), but more jobs will be created in other industries which will benefit from lower prices for their inputs.  For instance, there are roughly five times as many people employed refuelling, maintaining and selling motor vehicles -- activities which will benefit from cheaper motor vehicles -- as there are making them.  The number of jobs at risk is anyway quite small when put in the national economic context of new workers, labour turnover, retirements, etc. "Employees can't cope with change."  The statistics show that employees in protected industries are much like others.  Labour turnover is if anything higher than in manufacturing generally, and (especially in TCF) there is a lot of movement by employees into and out of the industry.  The changes in employment in protected industries that will result from the proposed cuts will be at rates comparable with their ordinary labour turnover. "Don't cut protection while unemployment is high."  This is to say that we must not act to improve economic performance while the economy is performing poorly.  The Labour Market chapter shows that big reductions in unemployment can only be achieved by major improvements in the functioning of the labour market, and that increased competition in product markets provides a strong incentive to reduce labour market rigidities.  The implication is that without cutting protection (thus increasing competition), it will be much more difficult, perhaps impossible, to achieve large, lasting reduction of unemployment. "Don't cut protection while the balance of trade is bad."  Import barriers do discourage imports, and encourage domestic production, of some goods:  but the people, materials and capital tied up in this production could otherwise be doing something else -- such as producing for export or making goods for domestic consumption which did not require as much protection.  It is perverse to want to waste opportunities in this way. "Don't cut protection while world trade is in such a mess."  This is flat-earth economics and impossible to refute briefly.  The following points are relevant: The question is not the state of world trade, it is whether Australia would gain from lowering its import barriers. Australian exporters are price-takers in most markets.  Cutting protection will help them compete on price;  maintaining it does not assist them in the face of other countries' import barriers and subsidised exports.

As Bert Kelly wrote:

It's a simple matter for a Member of Parliament to thunder eloquently and angrily if an industry in his electorate is not getting enough tariff protection;  he will be able to point an angry finger at the Minister and with a sob in his voice will talk about the poor unemployed people being flung onto the scrap-heap and so on.

If he is a smart sod, he will arrange for his local television station to come down to the factory on a cold morning and show the closed factory gate with a woman in an apron with three barefooted children at foot.  She will wipe her eyes and ask with a faltering voice:  "How can a government do such a cruel thing?"  And then she will burst into tears. ⁽⁷⁾

If the MP does not run with the sob story, then a union leader or factory owner will.  When import protection is at stake, unions and employers in the protected industry form an unholy alliance.

3.4 FREE TRADE:  THE PROBLEM

The problem, then, is to persuade enough people that a steady reduction in import barriers, to make Australia a free-trade nation over several years, will help the nation, not harm it, and especially to persuade enough politicians that it is not guaranteed electoral suicide.  People must think not only about the weeping woman at the factory gate, but about the job opportunities and standard of living that she and her husband and children might have in five or ten or twenty years' time.  This is not easy.  Various economists and journalists have been trying for years, the best known, perhaps, being the Modest Farmer and his friend Eccles.  A serious attempt was made in the 1980 book Australia at the Crossroads. ⁽⁸⁾  This chapter is of course another.  In it, we assume that the Government -- or at least the reforming core of Ministers and backbenchers -- accepts the arguments for free trade presented here and elsewhere and wants to bring it about.

For present purposes we can divide politicians, regardless of party, into four groups:  (a) those who believe that industry protection is beneficial;  (b) those who do not believe in anything except retaining their seat and, if possible, office;  (c) those who think cutting tariffs is a good thing but not if it costs an election;  and (d) those who are confident of the benefits of free trade.  Members of group (a) have to be persuaded that protection is now harming Australia and Australians.  If this can be achieved, they will move into groups (c) or (d).  Members of groups (b) and (c) have to be persuaded that free trade can be made electorally attractive.

There are a very few electorates where election outcomes or ALP preselection outcomes may be determined by the workforce of a protected industry.  The support of members for these constituencies may have to be bought by the offer of special assistance packages to help displaced workers or, if necessary, by offers of ambassadorships or other ways out of politics.

It ought to be possible to mobilise a large constituency for free trade.  Freer trade offers early, visible benefits to anyone who buys clothes, shoes, linen, furnishings, or cars -- that is, to the whole population.  There will also be early, visible benefits to exporters and their employees, to importers and their employees, and to employers and employees in unprotected industries (through cheaper inputs).  The trouble is that these benefits are more diffuse and less visible than the threat to identifiable jobs in identifiable places from reduced protection;  so the incentive to lobby is less strong.  If the Government plays its cards right, the weaker incentive should be more than counterbalanced by the stronger arguments and greater numbers.

The Government should make the popularisation of free trade a major, immediate goal.

Ministers and backbenchers should miss no opportunity, public or private, to put the arguments for free trade and against protection.  As we do in this chapter, they should occupy high moral ground by speaking not of cutting protection or reducing assistance, but of free trade.  They should concentrate their efforts on the groups identified above as standing to gain directly from free trade.  They should concentrate especially on encouraging these groups to use their lobbying power to persuade other MPs of the desirability and potential popularity of free trade.  This can be done in public and in private.

There are group (d) parliamentarians in all major parties and on both front benches.  Any realistic protection reduction programme will take longer than the life of one Parliament, so the programme is almost certain to become an election issue.  Support for the programme from opposition group (d) members will be valuable even if it is confined to the privacy of the opposition party room or caucus.  Public bipartisan support would be even better.  In 1986, the Federal Opposition showed considerable self-denial in the general interest by not opposing the Hawke Government's cautious reductions in protection, when it could have bought vested interest support by doing so.  In so doing it demonstrated the beginnings of tacit bipartisan support for freer trade, if not of an informal agreement between the economic rationalists of both sides.

3.5 FREE TRADE:  THE PROGRAMME

The case in which it may sometimes by a matter of deliberation, how far, or in what manner, it is proper to restore the free importation of foreign goods, after it has been for some time interrupted, is, when particular manufactures, by means of high tariffs or prohibitions upon all foreign goods which can come into competition with them, have been so far extended as to employ a great multitude of hands.  Humanity may in this case require that the freedom of trade should be restored only by slow gradations, and with a good deal of reserve and circumspection.  Were those high duties and prohibitions taken away all at once, cheaper foreign goods of the same kind might be poured so fast into the home market, as to deprive all at once many thousands of our people of their ordinary employment and means of subsistence.  The disorder which this would occasion might no doubt be very considerable. ⁽⁹⁾

The words are Adam Smith's, summing up the problem and incidentally demonstrating that market economists do not have hearts of stone.  Unfortunately, when it comes to restoring the free importation of some foreign goods to Australia, the gradations tend to be less slow than imperceptible.  What Smith is warning against is sudden action like the Whitlam Government's 25 per cent tariff cut:  the right thing done in the wrong way. ⁽¹⁰⁾  Any unexpected major change in the economic environment is likely to occasion disorder and harm business confidence, as explained above, and where possible governments should avoid them.

In the context of freeing trade, three points are especially relevant.

• Faster economic growth is badly needed.  It cannot be achieved by continuing to shore up obsolescent industries in an inappropriate economic structure, but only by opening new and productive opportunities for Australians' enterprise and innovativeness.  Limited short-term disorder is a price worth paying (and there are ways of helping affected individuals:  see below).
• The long-term choice for Australia is between free trade and growth on the one hand, and, on the other, stagnation as a banana republic or a siege economy, with economic collapse on the Bolivian or Polish model a real possibility.  The longer the move to free trade is delayed, the more disorderly and uncomfortable the transition is likely to be.
• One of the functions of markets is integrating present and future preferences.  If a programme of phased cuts in protection over several years were unexpectedly announced, and believed, it would constitute a major change in the rules for business.  But it would only be one change:  although the rates of protection would alter say every six months for the next five years, the programme would be known from the start, people would make plans accordingly, and markets would signal this through the price mechanism.  If such a programme were expected before its announcement, markets would already have begun to allow for it.  Dislocation would be minimised.

The unfortunate corollary of the last point is that if people do not believe that the programme will be carried through, markets will not make allowance for it and dislocation will be severe.  Hence the importance of gaining public acceptance of the need for free trade, and of any measure of bipartisan support that can be achieved.

Traditional attempts to cut protection have been on an industry-by-industry basis, have relied heavily on economic projections of employment in the industry in the future under various protection regimes, and have been complicated and slow.  The concentration on particular industries or groups of industries has enabled them to say "Why pick on us?", and to make best use of media coverage and lobbying to retain their privileges.  The process takes a long time and is often unsuccessful (e.g. successive schemes for TCF and cars).

Another argument against industry-by-industry schemes is that in settling the details of each scheme government is by definition having to second-guess the market by deciding what to do about each industry.  It is unlikely to guess right (see section 2);  and the degree of detailed intervention involved makes this an unconvincing way to set about freeing trade.  We therefore propose a single, easy-to-understand, across-the-board free trade programme.

Phase out all protection in ten equal steps over five years, starting six months from the announcement.

This is the programme presented in Australia at the Crossroads, no less valid after six years of snail-like "approaches to general reductions in protection". ⁽¹¹⁾  For such a programme to be successful, it must be believed when it is announced and it must be implemented on schedule.  If it is not believed, investment and other decisions will be delayed ("let's wait and see") or made on incorrect assumptions;  if it is not implemented as announced, people's decisions will be similarly falsified.  To minimise the disorder Adam Smith foresaw, the programme must be adhered to:

To ensure that this preannouncement has public credibility and to fend off lobbying for retention of individual tariffs or quotas, the government makes these tariff cuts binding under the GATT agreement and adopts the simple, clear-cut formula that all tariffs are to be cut by the same percentage of the tariff level prevailing at the starting date of the exercise.  The programme ... is unconditional.  Downturns in export or overall demand or a balance of payments deficit, for example, are ruled out as reasons for delaying the implementation of the programme. ⁽¹²⁾

Some industries (TCF and cars) are protected by import quotas and local content requirements as well as by tariffs.  All these industries have been exhaustively studied by the Industries Assistance Commission, and estimates of the tariff equivalent of the quotas are available.  Import quotas should be phased out as soon as possible, perhaps by abolishing quotas at the time of the first round of tariff cuts, and making appropriate adjustments to the tariff for affected industries.  The IAC's last task can be to advise on this process.  After that, the need for it will be over and it should be abolished.  Bounties and export credit schemes should be phased out over the same period as tariffs.

3.6 NO NEW PROTECTION

It is obvious from the foregoing that there should be no erection of new, or raising of existing, trade barriers.  The only exception should be anti-dumping duties under GATT rules;  even here, the Government should remember that dumping by definition means that foreign manufacturers are selling below cost and thus subsidising Australian consumers.

3.7 FREE TRADE:  POLITICAL WILL-POWER

Of all the policies presented in this volume, the move to free trade is one of the two or three most important, and it is the one which will try the Government's steadfastness most severely.  The reason is that other major initiatives -- labour market deregulation, for instance -- allow flexibility in their implementation, while free trade does not.  In most areas, a bit of delay here or an exemption for a favoured group there are undesirable but do not jeopardise the success of the general policy initiative.  Once the free trade programme has been adopted and announced, however, no concession to an affected industry and no postponement of tariff cuts can be allowed.  If one industry gains concessions from the Government others will be encouraged to try and the Government will find it harder to resist them than if it had not given way.  All industries will begin to doubt whether the Government will really go through with the plan, and investors will not have a known tariff structure on which to base their decisions.  Postponement of cuts will similarly increase uncertainty and deter investors.  Deviation from the announced programme, then, will make the transition to free trade more, not less painful;  and the consequences of deterring investors are likely to include an electorally damaging rise in unemployment.

Another very important reason to stick to the announced programme is one that the Government can use to hold high moral ground while refusing concessions:

Any deviation from the free trade programme will be a breach of faith with all the people who have based their career and investment plans on the programme.

Every lobby group turned away empty-handed will discourage the others and make it easier for the Government to stick to the programme.  At one discussion during the writing of this chapter, it was suggested that the ideal Minister to implement the programme would be Calvin Coolidge, one of the great monosyllabists of history.

Finally, reformers should remind their more timorous colleagues that the free trade programme may increase electoral risk at the end of the first term, but that the growth and prosperity it will bring in the longer term should guarantee success at the following two elections at least.

3.8 PROBLEMS OF ADJUSTMENT

The free trade programme is spread over five years as a compromise.  A very rapid programme would occasion considerable "disorder" unless equally rapid freeing of other parts of the economy -- including unions' and managers' habits of thought -- were also achieved.  This is too much to hope for.  Although the "disorder" would only be temporary, it is also too much to hope that any Opposition would be able to refrain from exploiting it as an electoral issue by promising to abandon free trade.  A slower programme, on the other hand, risks less "disorder" at any given time but is ruled out for two reasons.  First, a five-year programme should only have to survive one election, instead of two or three, and the longer the programme lasts the less likely it is that people will believe from the beginning that it will be implemented in full.  Second, Australia's economic problems are so serious that we cannot afford to linger.

The amount of "disorder" that will accompany the five-year free trade programme depends to a large extent on the success the Government has had in implementing other Mandate policies, especially those affecting the labour market.  The more flexible the labour market, the easier will be the adjustment to free trade.  Conversely, the increased competition in Australian product markets that comes with freer trade will put pressure on employers, employees and unions to abandon antagonistic attitudes and antiquated practices, making it easier for new businesses to start and old ones to transform themselves.

If the free-trade programme is carried through along with the Mandate policies, no significant increase in unemployment need be expected even in the short term.  Over a few years, economic liberalisation and the attitudes to enterprise and employment encouraged by it will bring about the creation of very large numbers of jobs. ⁽¹³⁾  Nevertheless, employment in parts of the highly-protected industries will decline sharply, and the effects on some one-industry towns will be severe unless other industries start up in those towns.  There are certain to be calls for special adjustment assistance for displaced workers or affected regions.

The arguments against special assistance for displaced workers are that it is not possible to separate out jobs lost because of the free trade programme from jobs that would have been lost through technological change, management incompetence, bad luck, etc.;  that the rate of job loss in affected industries will be comparable with their ordinary labour turnover;  that unemployment benefit is available to everyone anyway;  and that you cannot make an omelette without breaking eggs.  The argument for special assistance is that current employment levels in highly-protected industries are the direct result of government policy endorsed by the community over many years, and that the community therefore has a responsibility to provide some short-term compensation for those temporarily disadvantaged by the move to free trade.  Both arguments are tenable, but provision of some adjustment assistance would reduce the force of the opposition to free trade and with it the chance of the programme not being carried out in full.

The free trade programme should be accompanied by modest adjustment assistance measures.

Assistance measures should meet the following criteria:

• They should be temporary, expiring at most one year after the end of the free trade programme.
• They should speed adjustment, not delay it.
• They should favour places where highly-protected industries now employ large proportions of the workforce.
• They should favour enterprise and innovation.
• They should be cheap and efficient.

Possibilities include such things as:  tax "holidays" for shareholders' profits from new investment in affected areas;  "holidays" from the unemployment benefit work test to encourage workers to retrain or to go into business for themselves (see section 5.2.4 of the Welfare chapter);  and encouragement and assistance for workers to move to places where their labour is in demand.

3.9 OTHER IMPORT BARRIERS

Tariffs and quotas are not the only constraints on competition from imported goods and services, and other barriers are sometimes important.

For example, motor vehicles to be licensed in Australia must conform to the unique requirements of the Australian Design Rules (ADRs).  This restricts the variety of imported cars available, as it is usually uneconomic even to prove ADR compliance when a car would only sell here in small numbers, let alone modify the design for the Australian market.  It is not clear that EC safety standards, or US exhaust emission standards, are inferior to ADRs.  Some ADR requirements are of marginal importance:  one imported car was sold here with no lid to its glove-box because the original catch did not conform to the ADRs.  The IAC has recently examined non-tariff barriers. ⁽¹⁴⁾

The Government should identify major non-tariff barriers against imports to Australia, undertake cost-benefit analyses of the most important ones and abolish those that are not justified.

4. OTHER TRADE AND INDUSTRY POLICIES

4.1 DEPARTMENTAL REORGANISATION

Trade, industry and commerce policy has always been split among several Commonwealth Departments.  The principal ones at the time of writing were Trade, Industry and Commerce, Minerals and Energy, Primary Industry, and Attorney-General's, with help from Prime Minister and Cabinet and Employment and Industrial Relations.

The division of responsibility has come about partly because of the sheer amount of government involvement in economic activity, but it has also led to policies being formed and implemented for one sector without proper consideration of their effects on other sectors or on the community as a whole.  The glaring example of this is the way in which the policy of protecting manufacturing industries policy continued for decades apparently without regard to its effects on agricultural, pastoral and mineral export industries, or indeed to those on ordinary consumers.

The policies recommended in Mandate to Govern are non-interventionist and largely self-regulating, and will greatly reduce the work of the Departments involved.

The Departments of Trade, Industry and Commerce, Minerals and Energy and Primary Industry should be amalgamated into a Department of Trade and Industry.

4.2 THE AUSTRALIAN TRADE COMMISSION

The Australian Trade Commission should be abolished, and some of the money used to hire able businessmen on short-term contracts for the Department of Foreign Affairs.

4.3 MINERAL EXPORT CONTROLS

Remaining controls on mineral exports should be abolished.

4.4 INTERNATIONAL COMMODITY AGREEMENTS

Like most other attempts to manipulate markets, international commodity agreements seldom work for long and encourage misallocation of resources.  Sometimes they end disastrously:  consider the tin market since 1985.

The Government should withdraw Australia from all international commodity agreements.

4.5 THE GENERAL AGREEMENT ON TARIFFS AND TRADE (G.A.T.T.)

In the past, Australia has not contributed adequately to reductions in tariffs negotiated under the multilateral tariff negotiations (MTNs) held under the auspices of GATT.

The free trade programme should be incorporated in Australia's negotiating position in the current round of MTN negotiations.

This will strengthen Australia's position and make it easier to stick to the programme.

4.6 FOREIGN INVESTMENT

The Hawke Government's liberalisation of foreign investment guidelines in July 1986 was a substantial step in the right direction.  It is desirable to go further and abolish all remaining controls on foreign investment and with them the Foreign Investment Review Board (FIRB). ⁽¹⁵⁾  Worries about foreign domination are only justifiable when they concern markets in which a foreign investor could acquire monopoly power, and these are as a rule those in which competition is limited by government-imposed barriers to entry or other regulation.  The opening of product markets to competition that would result from the policies in this chapter will make monopolies much less likely, and the Government should carefully explain this, mentioning the Trade Practices Act and other anti-monopoly provisions.

Remove remaining controls on foreign investment as such and abolish the Foreign Investment Review Board.

4.7 TAKEOVERS

For a takeover to occur two conditions are necessary:  the bidder must value the target company more highly than the market share price indicates, and the existing owners must prefer the offer price to hanging on to their shares.  The price of shares depends on the market's assessment of the company's assets and future profits, and if the bidder reckons they are worth more it must mean that he believes he can make more effective use of the target's resources than present management.  Theory and recent empirical studies agree that takeover activity in Australia has been of significant net benefit. ⁽¹⁶⁾  The mere threat of takeover causes lackadaisical managements to buckle to.  The Government should never interfere ad hoc in particular takeovers.

A review of the existing regulation of takeovers and of the NCSC's role should be instituted, with a view to simplifying the requirements for bids and, by reducing the opportunities for target managements to delay and hamper bids, to increasing the pressure for efficient management.

4.8 COMPETITION POLICY

One of the Government's principal aims should be to ensure competition in product and financial markets, to minimise the opportunity for the exercise of monopoly power by businesses or unions.

4.8.1 Product Markets

In the case of internationally-traded goods, protection of local manufacturers restricts competition on the domestic market.  The protection reduction programme will thus bring about increased competition.  Note that there is likely to be more effective competition in a market with no import barriers and a single, internationally-competitive local producer than in one with a number of local producers protected by tariffs and quotas.  Certainly consumers can expect lower prices.

The Government should strengthen and extend the Trade Practices Act.

The Trade Practices Act should be reviewed to ensure that the provisions which control restrictive trade policies and mergers which reduce competition are adequate.  Regard should be had to the facts that some mergers produce benefits through economies of scale and that with free trade the fact that there is only one local producer does not necessarily mean that there is a monopoly.  The scope of the Act should be progressively extended to include more economic activities, including quasi-commercial public-sector activities and service industries including the professions.

4.8.2 Financial Markets

The Hawke Government has made much progress in deregulating the financial system, building on work initiated by the Fraser Government, and the effects of the increased competition are apparent not only in the business world but in the increasingly sophisticated and flexible ways in which ordinary people manage their savings.  Now is the time to take stock of what has been achieved and what more needs to be done.  The Government should compare the recommendations of the Campbell Report ⁽¹⁷⁾ and the steps actually taken to implement them, so as to identify areas where further or remedial action may be required to remove unwarranted regulation and further to enhance competition in financial markets.

4.9 RESEARCH AND DEVELOPMENT POLICY

The most effective long-term way of ensuring that the private sector undertakes adequate research and development (R&D) is to provide an environment that is conducive to investment and encourages competition and limits barriers to entry of new firms into industries.  A necessary condition is that innovators can expect an adequate return on new investments (bearing in mind the risks involved and so on), and that obsolete investments are not afforded artificially high returns by regulation and protection.

Patents provide a means of improving the return from some innovations by guaranteeing exclusive rights to it for a period, although not all innovations are patentable.  Revision of patent law to reduce the cost and increase the availability and quality of patent protection may encourage innovation and hence R&D.

Review patent law to determine whether there are significant impediments to innovators obtaining adequate returns on their innovations.

Some R&D shows a social rate of return greater than its private rate of return, and there is therefore a case for government subsidies.  This is clearly the case with much basic research.  The trouble is that in practice it is often extremely difficult to identify, let alone measure, such external benefits of R&D.  Further, the distinction between basic and applied research is often blurred.  Consequently it is extremely difficult to determine the appropriate level of government support for R&D, let alone the particular projects that should be subsidised.  The best thing government can do to encourage R&D is to maintain a business environment in which entrepreneurs are confident of long-term policy stability and in which old technologies are not protected.  For people to invest in research which offers chancy and distant returns, they must be confident that if they strike lucky they will be allowed to reap the profits.

Encourage R&D with stable, non-interventionist policies.

The present 150 per cent tax deducibility for R&D expenditure is being exploited as a tax minimisation device.  Tax deductibility for R&D expenditure should be reduced to 100 per cent after a few months' notice.  The existing Grants for Industry Research and Development (GIRD) Scheme should be continued, but should not be extended after it expires in 1991.

The Commonwealth Scientific and Industrial Research Organisation (CSIRO) is a major Australian institution and has a fine record in some areas of research.  It also suffers from the usual public sector problems of perverse incentives and inefficiency.  Government support for CSIRO should continue, but in a way that will impose some commercial discipline.

Government funding for CSIRO should be reduced to half the present real level over six or seven years, and then frozen.

The organisation should be encouraged to supplement its funds from the private sector, by contracts for specific research, by (tax deductible) donations, bequests, etc., and by increasing its commercial exploitation of its work.

---

ENDNOTES

1.  This chapter owes much to Wolfgang Kasper, but opinions expressed in it should not be assumed to be his.

2.  See e.g. L. von Mises, tr. Kahane, Socialism, an Economic and Sociological Analysis, New York, 1936;  F.A. von Hayek, "Socialist Calculation:  the Competitive Solution", Economica, VII, 125.

3.  The Two Airline Policy is an example of government going too far and providing near-certainty to favoured investors by to the exclusion of others.

4.  The evolution of protection policy is summarised in Approaches to General Reductions in Protection, IAC Report No. 301, Canberra, IAC, 1982, pp 14-18.  The political background is well presented in G.A. (Alf) Rattigan, Industry Assistance:  the Inside Story, Carlton, Melbourne University Press, 1986.

5.  The fall in the value of the $A has increased our export opportunities.  At the time of writing, a large investor had recently sought assurances from Government and Opposition that tariff protection for a new venture would be forthcoming if unfavourable currency movements occurred.

6.  Conservationists should note that there is not a straight-line relationship between economic activity and use of natural resources.  In developed countries, the input of raw materials (including energy) per unit of gross product has been falling markedly, especially under the stimulus of the oil shocks.

7.  C.R. (Bert) Kelly, Economics Made Easy, Adelaide, Brolga Books, 1982, p 52.

8.  W. Kasper et al., Australia at the Crossroads, Sydney, Harcourt Brace Jovanovich, 1980.

9.  Adam Smith, The Wealth of Nations.

10.  Even this can be defended:  the choice was tariff cuts, further revaluation, or accelerating an inflation rate that anyway went over 20 per cent.

11.  The IAC's phrase.

12.  Australia at the Crossroads, p 218.

13.  See W. Kasper, The Destruction and Creation of Jobs, AIPP, 1985.

14.  Industries Assistance Commission, Regulatory Impediments to Industry Adjustment, Canberra, AGPS, 1986.

15.  See W. Kasper, Capital Xenophobia, Sydney, Centre for Independent Studies, 1984.

16.  See P. Dodd and R.R. Officer, Corporate Control, Economic Efficiency and Shareholder Justice, Sydney, Centre for Independent Studies, 1986.

17.  Final Report of the Committee of Inquiry into the Australian Financial System, Canberra, AGPS, 1981.