The deindustrialisation of the Australian economy

It will be argued that the manufacturing sector acts as the main catalyst for sustained, cumulative growth.

While manufacturing has been declining, both in terms of value-added and employment, its high technology segment (i.e, computers, electronics, aerospace and pharmaceuticals, etc) has expanded in most countries. Indeed, an integrated manufacturing-services sector has emerged as one of the most dynamic growth poles in the more advanced economies and has generated the fastest growing exports.

Like most OECD countries, Australia has experienced a shift away from traditional manufacturing and towards service industries. However, the evidence also suggests that there has been an unfavourable bias towards the low value-added and low skilled services like tourism and hospitality. The impact of the high Australian dollar also suggests that Australia’s manufacturing sector has been “hollowed out” as a result of the “Dutch disease.”

I. Negative Deindustrialisation

Rowthorn and Wells distinguish between positive and negative deindustrialisation.

Positive deindustrialisation is defined as the normal result of sustained economic growth in a fully employed and highly developed economy. Productivity growth in the manufacturing sector is quite rapid and sustainable, which means that employment in this sector tends to decline relative to services. Most of the new jobs are generated in the “knowledge-intensive” services that are linked to the productive sector. In order to maintain a rise in output at the same rate, in the two broad sectors would require a continuous shift in the pattern of employment.

This form of deindustrialisation is not primarily caused by a shift in demand from industry to services, but is mainly due to the productive dynamism of industry and the high rates of productivity growth made possible by technical advances. The rise in the level of incomes has increased the demand for services relative to goods. Hence, the prices of goods have fallen relative to the prices of services, and employment growth in services has exceeded the growth of employment in industry. This decline can be explained by the “productivity price paradox” in which the relative price of the outputs of industries with higher productivity declines against those industries with lower productivity. Therefore even if manufacturing increases its volume of output, its share of GDP may decline relative to services, which exhibits a lower rate of productivity growth.

Negative deindustrialisation, on the other hand, is a pathological condition and is symptomatic of industrial decline. It will be argued that Australia is an example of negative deindustrialisation. Since most of the labour shed in manufacturing is reabsorbed into low wage services, the economy is characterised by high levels of precarious, casualised and low productivity service employment (e.g., tourism, hospitality, etc). At the same time, the long-term decline in capital formation and expenditure on physical and social infrastructure has reinforced these structural features of retrenchment.

Australia’s industrial anatomy has inherited dualistic features in which industrial enclaves are dominated by foreign owned subsidiaries of Transnational Corporations (TNCs) and are usually surrounded by a cluster of smaller, local enterprises, which service these foreign subsidiaries.

A deficiency of local investment has induced a type of “dependent industrialisation” characterised by a dual industrial structure, which has been highly dependent on government support.

In other words, the phase of industrialisation was essentially governed by the inflow of foreign investment. This type of industrial bifurcation has inhibited the development of vertically integrated sectors, while the smaller domestic firms have found it increasingly difficult to compete with the large TNCs based in countries possessing large technological bases and greater power in world markets.

These relatively weak vertically integrated linkages suggest that the Australian economy lacks structural cohesion. This is most evident in the absence of a well-developed capital goods sector. As a relatively small, open economy, Australia continues to rely on the importation of high technology capital goods. In the more integrated, relatively closed industrial economies, which enjoy the benefits of a large domestic market, the impact of an increase in private investment is most favourable to domestic growth, if it increases the demand for domestically produced capital goods.

However, Australia does not enjoy these characteristics; the economy is neither fully integrated in the sense of having developed linkages within and between sectors, nor does it exhibit a large domestic market. On the contrary, most industries are highly integrated into the world economy, while most capital and intermediate goods are imported. The Australian economy is therefore quite vulnerable to external shocks that are transmitted through the balance of payments.

II. Trade In Manufacturing

In the 16 leading OECD countries, manufactured exports account for 56 per cent of total exports on average. In stark contrast, manufactured goods in Australia only account for 18 per cent of total exports.

Almost two thirds of Australia’s merchandise trade still consists of primary products; a ratio comparable with middle income developing economies like Argentina, Brazil and Mexico. Indeed, over 70 per cent of what is officially classified as manufactured exports, constitutes semi-processed raw materials.

In terms of exports and research and development (R & D) intensity, the following general conclusions can be drawn in the recent Australian experience:

1.    The high concentration of R & D activity is in the manufacturing sector. However, Australia has experienced a very sharp “hollowing out” of the manufacturing base over the past 30 years. As the manufacturing     trade deficit increases, Australia could encounter quite serious structural problems, since the high-tech sectors within manufacturing are knowledge intensive and represent the fastest growing segment of world merchandise trade;

2.    R & D activity tends to be highly concentrated in the largest domestic firms and foreign subsidiaries; and

3.    Within manufacturing, the industries, which are in the medium to high R & D categories exhibit very large trade deficits.

Australia continues to be highly dependent on commodity exports. As a result, the terms of trade will not be favourable in the long term. Commodity exports adjust more to changes in world income than to prices, and are relatively price inelastic. As an international price-taker, Australia is quite vulnerable to the cyclical fluctuations of commodity prices that have played a determinant role in the balance of payments and the behaviour of the exchange rate.

Since the onset of recurrent mining booms during the past decade, there has emerged a direct relationship between the exchange rate and commodity prices. After the floating of the dollar in the early 1980s, the exchange rate has been determined largely by commodity prices, most notably in the key energy exports. The Australian dollar itself has become a tradeable commodity in foreign exchange markets and has been inextricably linked to international commodity prices.

This relationship between international commodity prices and the behaviour of the exchange rate has been enshrined in the “Dutch disease.” Its central proposition is that the emergence of a mining export boom causes an appreciation of the nominal exchange rate. This has had an adverse effect on the competitiveness of Australia’s manufacturing exports during the mining boom of the past decade.

Similarly, with the liberalisation of the Australian economy, the manufacturing sector has encountered quite savage competition from cheap imports. This process of industrial restructuring has been evident in the decline of local investment in manufacturing and the gradual run-down of capital stocks (as a percentage of GDP).

Competition from Japan and later from the East Asian Newly Industrialised Countries (NICs), has gradually displaced domestic manufacturing by cheaper imports. The policies of trade liberalisation have effectively condemned Australia as an exporter of commodities in the global market. The possible onset of adverse terms of trade with the end of the mining boom, will blow out the current account deficit and net foreign debt because of the lack of import substitution in manufactures, most notably in the capital-goods sector.

The openness of the Australian economy has also ensured that within this structural remoulding it has shared the short-term oscillations of the world economy. This boom-bust syndrome has been closely synchronised with international trade cycles.

As Australia has increased its share of manufactured imports and foreign investment over the past two decades, the structural imbalance has worsened. Each business cycle recovery has encountered the balance of payments constraint, which manifests itself in a cumulative increase in the current account deficit. A self-perpetuating cycle of low levels of domestic investment to generate endogenous saving has only increased Australia’s dependence on international capital inflows.

Consequently, Australia’s net foreign debt has gradually increased and now exceeds 60 per cent of GDP. Since the foreign debt is largely denominated in US dollars, the “valuation” effect of a nominal depreciation of the Australian dollar will have the effect of increasing the value of Australia’s private and public debt.

A cursory analysis of the composition of Australia’s foreign debt reveals the following attributes:

1.    75 per cent of the net foreign debt has been incurred by the private sector;

2.    The domestic financial sector has intermediated an increasing amount of the foreign borrowing since financial deregulation in the early 1980s;

3.    60 per cent of Australia’s gross foreign debt is denominated in foreign currencies and about 60 per cent of this is denominated in the US dollar; and

4.    The debt/equity ratio of the foreign debt has risen sharply and has been accompanied by a decline in the maturity of the debt which places greater strains on the ability to service outstanding foreign debt.

In other words, foreigners are financing Australia’s current trade deficit by acquiring domestic assets. Overseas investment in Australia is growing faster than Australian investment abroad, which means that Australia relies more heavily on the importation of capital. Foreign investors acquire a return on their investment that appears in the balance of payments as a negative entry in the net income component of the current account. Over the past 20 years, Australia has become more dependent on the inflow of foreign investment.

This severe external imbalance emerged during the era of the neoliberal ascendancy from the early 1980s onward. The basic theoretical contention of this strategy was that market liberalisation and deregulation would induce an increase in the level of productive investment and economic restructuring through the purgative forces induced by competition.

The whole strategy hinged on the dismantling of national forms of regulation, protectionism and state support for local industries. The fatal flaw of the neo-liberal program, however, was the lack of a coherent structural policy to encourage industrial upgrading and technological reconversion. After three decades of economic “reform,” the evidence suggests that Australia’s export sector resembles that of an upper-middle income developing country. The implications would appear to be quite dire in the long run.

The evidence suggests that the Australian economy has undergone quite profound structural changes over this period, with the shift toward services and the decline of traditional labour-intensive manufacturing. Australia has experienced the classical symptoms of negative deindustrialization. The present policy focus is essentially agnostic towards the current account deficit.

Within the neoclassical literature, the issue is simply ignored as a short-term problem of exchange rate adjustment. On a more fundamental level, however, structural change in the Australian economy over the past two decades has led to quite profound sectoral shifts. The continued dependence on commodity exports means that the terms of trade will not be favourable in the long-term. Furthermore, the pivotal role of manufacturing has been downgraded and neglected over the past three decades.

Although one should acknowledge the shift towards a knowledge-based economy, the myth that this implies a post-industrial society should be debunked.

Indeed, it is the knowledge-intensive sectors of manufacturing that exhibit the fastest growth rates and exports, while manufacturing accounts for over 50 per cent of productivity growth in total private sector output, even though it represents less that 12 per cent of total employment (Toner, 2000, p.24). The expansion of industrial exports would therefore contribute to overcoming the balance of payments constraint on future growth.

This brief analysis re-affirms the pre-eminent role of manufacturing and the capital goods sector as the primary catalyst for growth in the economy as a whole. In contrast to the static, unrealisticassumptions which govern conventional neoclassical accounts, this analysis is based on the “stylized facts” that manufacturing acts as the “engine” of growth in the economy as a whole.

The implications of long-term structural change are far more pervasive and profound than the traditional welfare losses due to static misallocation of resources as a result of monopoly power and tariffs. Unfortunately, the present focus of public policy in Australia is still on the latter while the former has been neglected.