Defending Australia`s manufacturing industry

The Reserve Bank has signalled that interest rates are on hold for the forseeable future. I have no argument with that decision. Global financial volatility is worsening global economic uncertainty. While Australia's overall inflation is predicted to exceed the RBA's target, this is not by such a margin that great damage will be done if the RBA waits for global uncertainties to be resolved.

Instead this article focuses on the debate about a key 'two speed' economy issue – the tendency of the mining boom to squeeze other industries and what, if anything, can be done about this. I take as my case study strategic (defence related) manufacturing, though two of my three points apply to other non-mining activities also.

Opposition leader, Tony Abbott, has been criticized for supposedly lacking interest in economics. Recently he has been labeled a 'protectionist' for suggesting there may be a case for retaining some capacity in what he called 'heavy manufacturing'.

I recently read The Big Fella. The Rise and rise of BHP Billiton, by Peter Thompson and Robery Macklin. Chapter 4 is called 'Man of Steel', about BHP's legendary leader, Essington Lewis.

It tells how in 1938 Robert Menzies, then industry minister, selected Essington Lewis to be chairman of the Commonwealth's advisory panel on industrial organisation. 'Lewis was happy to serve but frustrated by the indecisiveness within the upper echelons of government', a timeless story for leading businessmen who try to work with government. But the pressure of total war produced a different outcome.

In May 1940, when Germany invaded the low countries, 'Menzies grasped the nettle'. Menzies offered to appoint Lewis as director-general of munitions 'with a charter as wide as the seas and as high as the sky', and Lewis accepted. He controlled the production of 'all ordnance, explosives, ammunition, small arms, aircraft and vehicles, and all machinery and tools used in their production'. Lewis sat on the National Defence committee and had the same access to the War Cabinet as the military chiefs of staff, and unimpeded access to the prime minister.

At its height, Lewis's directorate employed 150,000 men and women. 'They built ships, aircraft, landing craft and artillery. They established 213 armament factories and produced millions of rounds of ammunition. They channelled more than 300 million pounds into armament production without a single accusation of corruption or double dealing'.

My question is this. Would Australia be able to mount a similar effort now? 'Not blooming likely, cobber' is the answer. Losing the capacity that was so vital to Australia's ability to defend ourselves during the last great war has been a gradual process, a perhaps unintended consequence of the post-war deregulation that has helped make Australians far richer.

I do not recommend turning back the clock to a protectionist past, and I do not believe that Tony Abbott does either. But putting a massively increased share of our economy into the mining industry while allowing or even encouraging the demise of other industries, does not make sense either. Australia will benefit in many ways if it retains a broad rather than a narrow industrial structure.

There are three things that we can do to encourage the retention of non-mining industry during what seems likely to be the largest mining boom in global history. Step one is to manage fiscal policy so it accommodates the mining boom. Because this government effectively panicked with the onset of the global financial crisis, fiscal policy now is too expansionary and most of the crisis-induced spending was wasteful. With mining investment gathering pace, the budget should be already in surplus, and heading quickly into substantial surplus.

The economy cannot accommodate massive spending on mining as well as wasteful, excessive and unnecessary government spending, and the net result is interest rates higher than they need be, a stronger currency than there need be and the squeeze on non-mining industries that we are now experiencing. This 'crowding out' is a major consequence of inadequate fiscal policy and will continue unless and until a responsible government eliminates the excessive government activity.

A second thing that a responsible government could do, having achieved a substantial budget surplus, to provide some offset to a massive mining boom is to create a sovereign wealth fund, a fund that places almost all of its investments offshore. Currency outflows from such a fund will ameliorate the rise in the value of the Australian dollar while building a war chest of spending power for use when the mining boom subsides or Australia is faced with a serious geopolitical risk. There are limits to such a policy, as Australia's perceived success in economic policy will encourage overseas investment here. One can observe that this is a nice problem to have.