Why the Government's car plan is a scandal

At the G20 meeting, Prime Minister Kevin Rudd committed Australia not to introduce any trade-distorting measures “within the next twelve months”.

Well, here is a dirty secret: should the government’s new car plan go ahead, the effective rate of protection to the Australian car industry will rise for the first time since the ill-conceived Whitlam plan of 1974.

Is this something the government, which claims to be committed to transparency and to free trade, has disclosed? No, it isn’t. And is an increase in effective assistance consistent with our new G20 obligations? Plainly not.

The facts are these. Starting from levels that were already irrationally high, Gough Whitlam raised effective rates of assistance to the car industry into the stratosphere, reaching more than 250 per cent by the end of the 1970s. Each $1 of value added in the industry therefore attracted (or rather, extracted) a further $2.50 in public support. Malcolm Fraser, as was his wont, fiddled at the edges, but failed to tackle the distortions head-on. That was left to Bob Hawke and John Button, whose plan may have been imperfect but, to their ever-lasting credit, set a path for reducing assistance over time.

Consistent with that plan, the effective rate of assistance to the industry halved by 1990; it halved again by 1995, and then reduced further, to less than a tenth of its 1985 level, by 2006-07.

Reductions in aggregate assistance were not achieved without new costs for consumers and taxpayers. From the first Button plan on, the subsidy packages successive governments provided to the industry squandered millions of dollars. But those governments, no matter how weak their political will, held one principle firm: that the direction of movement towards steadily lower total levels of assistance should be maintained.

It is that principle the Rudd Government has now jettisoned as its plan provides the industry with far more compensation than the producers are losing from lower tariffs.

The Rudd plan is therefore not merely one more episode in Australia’s long battle to rid itself of the protectionist ghost. Rather, it throws in the towel, and under the cover of cutting the tariff, slugs taxpayers and consumers.

The economic costs this involves are far larger than the $6.2 billion the government has committed to spend. Because each dollar raised in taxes distorts economic activity, likely costing the economy between $1-20 and $1-80, merely funding those outlays involves a burden that could reach some $2,000 per household.

To make matters even worse, the subsidies will be provided to bring new capital and labour into the industry. It is our most efficient industries, starting with the primary exporters, that will be worst hit, as resources, including badly needed skilled labour, are diverted from firms that pay their way to those that ride on the public purse. As efficient industries contract, national income will fall.

Moreover, as new labour is attracted to the industry, future adjustment problems are compounded. Today’s economic folly creates tomorrow’s social costs, leaving a poison pill for future governments.

Internationally, the credibility of our commitment to open markets, undistorted by the types of subsidies that so damage Australia’s agricultural exports, will get a battering - as well it should. To do this just as the world economy enters into recession, with a global trade round in tatters and the threat of protectionism in the air, reeks of recklessness.

And what is all this for? According to the Prime Minister, because of the jobs at stake: according to him, 200,000 of them. But even this number is suspect. As both the Productivity Commission and the Bracks review note, the industry employs fewer than 70,000 people. The Victorian government generously estimates that a further 100,000 jobs indirectly depend on the industry. So where are the additional 30,000 jobs the Prime Minister is referring to? Or are they merely thrown in for effect?

But even were the Prime Minister right, according to the Productivity Commission’s modelling, cutting tariffs by half and phasing out current non-tariff assistance would lead to a contraction in car industry employment of only about 3.5 per cent, or less than 2,400 jobs. Is the Prime Minister suggesting that the Commission is wrong by a factor not of 2, nor even of 3, but of 80? If so, wherever is the evidence on which he relies? Or is he merely stating that the industry is important? If so, will all important industries get assistance, in a throw-back to the days of “protection all around”?

As for the Industry Minister, he claims that “automotive manufacturing sits at the core the nation's manufacturing effort, because building a modern car involves almost every advanced technology we use, from microchips to light metals”. But in the great class of sequiturs, this is a non, for the same could be said for everything from flipping burgers (visit a McDonalds) to assembling Playstations. Why would using lots of diverse inputs make an activity more deserving of public support than any other? And will all activities that use lots of inputs get assistance, presumably at the expense of the very input producers on which they rely?

What about the Industry Minister’s claim that other countries also subsidise their car industry? In fact, no developed country provides assistance at a rate anywhere near that which the government has announced. But even were the claim correct, how could it possibly be rational for us to follow the errors of others? Rather, we should draw what benefit we can from the subsidies they provide, and, if those subsidies distort trade, rely on the WTO disputes process to seek redress. If, as we constantly claim, those processes are good enough for others, why aren’t they good enough for us?

Ultimately, it would have been better if the government had simply left the previous arrangements in place. True, the tariff would have been higher, but at least tariffs raise revenues, thus allowing other, more distorting, taxes to be lower, and they are less hypocritical than the meaningless verbiage being used to justify the new plan. Moreover, once the tariff is set, it is market forces that allocate its burden and its benefits. In contrast, the billions the government has set aside will be allocated through processes that seem as lacking in transparency as they are in economic rationality and effective accountability.

Indeed, this is becoming the government’s modus operandi: set up massive slush funds that can be used to strengthen existing constituencies, or even create new constituencies, whose fortunes hinge on its remaining in office. The Building Australia Fund set the pace; the car plan goes to new heights. The government’s refusal to ensure full transparency of these funding decisions - in stark contrast to international best practice - makes the risks of abuse all the greater.

Economists differ about many things, but on one point there is consensus: the quality of public expenditure is every bit as important as its level. It is inevitable, indeed desirable, that a slowing economy will reduce the budget surplus. But there is nothing inevitable or desirable about the extraordinary deterioration now underway in the quality of the government’s spending decisions.

Malcolm Turnbull somewhat cruelly described the government’s first budget as “Morris Iemma comes to Canberra”. It will take better than the car plan to prove him wrong.