Why the fuss about the manufacturing industry?

The decision by BlueScope Steel to shed 1000 jobs, and the more recent release of ABS labour force data showing a loss of 40 000 manufacturing jobs in the last three months, have understandably re-ignited debate about trade and industry policy.

Can our manufacturing sector survive when it is threatened by high exchange rates? Have we really benefited from free trade policies pursued by successive governments, Labor and Coalition?

Without downplaying the impact of these job losses on those involved, and on the Wollongong community, it is useful to put them into some perspective.

Our labour force is constantly churning: every month about 40 000 full-time employees become unemployed, and a roughly equal number of unemployed gain full-time employment. Of course this process is not painless: for many it involves the anxiety of a period of joblessness, the devaluation of skills and the wrench and expense of re-location.

Also, our loss of manufacturing employment is not a recent development. Both in terms of its share of the economy (percentage of GDP) and share of employment, manufacturing has been steadily declining over many years. In 1984 manufacturing accounted for 17 percent of employment and 14 percent of GDP. By now, it counts for about 8 percent of employment and 9 percent of GDP.

The rapid decline in employment almost certainly results from increasing capital intensity, as labour-intensive activities such as light metal fabrication and clothing manufacturing have shifted offshore, prompted by the wind-down of tariff and related assistance. Also, this decline is probably over-stated, because many manufacturing firms over that period have contracted out some of their activities, such as payroll management and transport, thus leading to different statistical classifications.

These figures are about manufacturing's share of the economy. But what may come as a surprise is that in absolute terms, manufacturing was on a growth trajectory until around the turn of the century – a period of vigorous tariff reductions – and has held its own since.

So, the detached observer may ask, why the fuss? And why are we particularly concerned about manufacturing?

Kevin Rudd gave us part of the answer, when, in his election campaign, he said "I don't want to get to a stage where this country doesn't make anything anymore." Ever since the industrial revolution got underway, manufacturing has been symbolic of modernization. In a process that was not always benign, industrialization was the path from feudalism to capitalism, and it aided the rise of a prosperous middle-class.

This process was particularly important to the labour movement, because factories were concentrated sources of union members. Also, the idea of making something, of working with physical materials, rather than sitting in an office shuffling paper or pixels on a screen, is one we hold dear. Just ask any home handyperson, amateur chef, or enthusiast who restores an old car.

Yet, in thinking about manufacturing as the only sector that makes things, we may be too influenced by statistical classifications. Our construction sector, for example, is about making things – houses, skyscrapers, bridges – and, being so dependent on the whims of fiscal and monetary policies, has a much rougher ride than manufacturing. That sector takes the relatively simple commodities of manufacturing such as steel and cement and transforms them into high value-added structures.

Nor is making things the only ways we use high-level skills – think of surgeons, pilots and computer scientists. We too readily accept the "flipping hamburgers" portrayal of the service sector.

More importantly, we tend to forget that manufacturing involves a spectrum of employment, from some of the highest skills through to some of the most deadly jobs imaginable.

In my own time as an engineer in a factory I remember a press line where each worker would take a blank sheet of steel from a bin, insert it in a press, and drop the formed part in another bin, a process repeated 6300 times a day.

The high-skill manufacturing jobs are in research, design, plant engineering, production control, modifying machinery, and special one-off or short-run production, to name a few areas. Rather than thinking about "manufacturing" as a generic category, we should be thinking about types of activities – occupations rather than industries. Many of these jobs can be located in Australia, while operations such as labour-intensive assembly can be performed in other countries.

Another distraction in the current debate is our political tendency to think of import protection whenever we hear the word "industry policy." Such a mental association makes it easy to deride industry policy, because as economists of both left and right persuasion point out, tariffs and import quotas are very expensive ways to support industries.

They operate as largely unseen taxes, they entrench complacency and reward rent-seeking over innovation, their costs fall most heavily on those with least political power or capacity to pay, and, they are indiscriminate in that they support not only good jobs but also mind numbing assembly line jobs.

In dismissing the idea of tariff protection however, it is a mistake to dismiss industry policy. There is much governments can do without breaking WTO rules or violating the principles of sound economic management. There are certain public goods needed by manufacturing but which will be under-supplied in unregulated markets. These include research, education, and transport and communications infrastructure.

Some such services, such as our annual billion dollars of budgetary assistance for research and development, assistance to adjust to carbon pricing and other measures can be targeted to specific industries. While other public goods, such as education and transport are more diffuse in their benefits, and, for bureaucratic reasons, do not show up under the heading of "industry policy."

Nor should we dismiss the idea of "picking winners." It is true that governments don't have a great record in picking winners. Winners emerge, however. Sometimes there are simple natural explanations, such as our expertise in mining technologies. More often they turn up almost at random: Who could have guessed, for example, that we would develop a world market in catamaran ferries? Governments can give limited but important support to such emergent winners, and, above all, can make sure that they don't kill them when they do emerge – as has largely happened to our photovoltaic industry.

More generally, we can do something about our investment climate. There is ample awareness of the competitive disadvantage resulting from a high exchange rate. So far no serious commentator is urging us to turn the policy clock back to the days of a managed exchange rate: The price of a fixed rate is a loss of control of money supply and of interest rates.

But we do need to acknowledge that the volatility in our exchange rates makes for an extremely difficult business environment – quoting for export, estimating the costs of imported equipment, and making long-term plans for location of facilities. Some short-term trades can be hedged, but only at high cost.

Our currency is hostage to sentiment and the speculative carry trade. Our dollar has become the fifth most traded currency in the world. It rises when people are feeling optimistic about the Chinese economy, or when speculators believe we may raise interest rates to combat inflation. Counter-intuitively, it falls when there are jitters about the US economy and people seek the "safety" of US bonds. Whenever a European politician mentions the word "Greece" our exchange rate is moved in a random process unconnected to underlying economic conditions.

There are measures we can take to reduce this volatility, such as a small tax, say 0.1 percent, on all foreign exchange transactions – enough to dampen speculation, but not significant enough to discourage genuine import, export or real investment transactions.

Variations on this idea (a "Tobin tax") include higher rates, which would be rebated for genuine trades. Those who operate in the financial markets may not like such regulation, but we need to remember that the purpose of the finance sector is to serve the real economy. The events of the last two years should be enough to remind us of the consequences when the finance sector develops a life of its own, displacing its role as a service to the real economy.

Similarly, we need to think through our tax systems, to consider whether they adequately support long-term investment of the sort that is required in manufacturing. Do our depreciation rates adequately reflect the rapid changes in industry technologies, for example? The 1999 changes in capital gains tax, which abolished indexation but halved the rate, were highly favourable to short-term speculators, but because they tax nominal rather than real capital gains, they are relatively discouraging of long-term investment.

Such measures, if implemented, will not halt industry change. Structural change is a feature of a dynamic economy, and there is every indication that the pressures for structural change will persist.

What we now know as "developing countries" will become sources of increasingly sophisticated products, exploiting scale economies for huge domestic markets. Depletion of certain fossil fuels and over-exploitation of water resources will change factor input prices, and however the world eventually adjusts to carbon-induced climate change – taxes, tradeable permits or regulation – there will be challenges and opportunities for manufacturing industries. There will always be rich pickings for firms that can anticipate these challenges and develop new products and processes, where we can compete on the basis of responsiveness and innovation.