Evidently intent on exposing his economic illiteracy and ignorance of economic history to the full glare of informed opinion, Haermeyer went on to assert that

We can try and compete with China, India, Brazil and the others on cost but, even if we adopt their standards of living and labour costs, we still wouldn’t have their economies of scale

Competition is not based on labour costs. If it were Ethiopia and Bangladesh would be among the world’s great trading nations instead of being among its most poverty-stricken. Haermeyer is so ignorant of economics that he doesn’t realise that his labour-cost argument rests on the assumption that labour is basically the only factor of production. This means that his argument could only hold up in the absence of capital a structure. (This argument is dealt with in some detail in Labour Market Wars).

Like his colleagueTim Holding, Manufacturing and Export Minister, Haermeyer seems to have developed a value-added fetish. He thinks that

We will have to compete by going for higher-value-added products; things people will pay extra for, things that are different and that those other countries won't do.

As far as comparative advantage and absolute advantage go, you can forget them according to this pair of brilliant economic thinkers. Value-added is what really counts. This pair

…obviously assume that if the TFC industries develop a high value-added structure they must automatically become more profitable. There are absolutely no grounds to support this assumption. Any accountant or economist worthy of the name could have told him, if he had bothered to ask, that profit and loss figures reveal absolutely nothing about any firm’s level of value-added. (Tariff nonsense and ALP stupidity takes aim at the value-added fallacy).

Knowing the sort of operatives that run the Liberal Party they’ll probably start arguing about the very real potential for corruption that ‘industry policies’ give rise to; they’ll probably also try to draw parallels with the Cain-Kirner years.

But it needs to be stressed that this approach would be a grave error. The Liberals would have to tackle industry policy supporters on their own intellectual ground if they are to succeed in publicly discrediting it. This is not likely to happen while the current ‘intellectual’ climate prevails among Party officials and players

It needs to be carefully and continually explained to the public why industry policies –– which is government economic planning of one kind or another –– not only fail but have the unintentional consequences of keeping living standards lower than they would otherwise be.

It was General Peron’s industry policy that wrecked Argentina’s once prosperous economy; it was the industry policies of the Congress Party that kept hundreds of millions of Indians in abject poverty, and its legacy still does; and it is industry policy that contributed to the “Asian meltdown”. In short, industry policy is the problem, not markets. So even in the total absence of any kind of corruption industry policies will still fail.

Proponents of industry policy claim that the state (politicians, bureaucrats and favoured interest groups) can better direct a country’s resources than “blind market forces”. All that is needed, so they think, is for the proper agency operating as part of a “well designed industry policy” to pick potential winners and make, according to a set of guidelines, the appropriate investment decisions.

This is basically how Haermeyer et al. imagines the Ministry of International MITI (Trade and Industry) managed Japan’s post-war success. Haermeyer and Holding’s approach is similar to Lenin’s simple-minded view that book-keeping had advanced to the stage that advanced economies could be managed like the post-office. (State and Revolution, 1917). Then there is Professor Quiggin’s equally naive view that growth is virtually “automatic” so long as there are “well-designed industry policies” and access to technology and capital goods is maintained.

What drives a progressive economy is entrepreneurship. This vitally important fact is completely missing from the so-called industry-policy debate along with a few other trivial things like markets and savings. What is of even great importance is the fact that entrepreneurship does not exist in a vacuum, it the very heart of the market process, which in turn brings us to the nature of the market.

The market is not a datum, as is assumed in standard textbooks: it is an astonishing institution for the continuous collection, coordination, storage and dissemination of knowledge, not in steps but simultaneously. As Hayek has explained, it is the market that has solved the knowledge problem and not bureaucrats, academics or politicians.

The market continuously gathers unimaginable quantities of knowledge and expectations of circumstances unique to each individual actor. It is these circumstances that must be taken into account when decisions concerning production processes, market expectations, etc., have to be made. Much of this knowledge is transitory, largely subjective, localised and entrepreneurial in nature.

It is the kind of knowledge that entrepreneur use in their role to discover profitable opportunities, to switch investment to the production of those goods and services most valued by consumers; to be on the lookout for new products, new techniques, new methods of production to innovate and speculate. As we can see, the market is also a discovery process and a means of experimenting with new products and techniques.

By its very nature the decisive market data is always disparate, subjective, transient, widely dispersed, mainly ephemeral, sometimes extremely detailed but frequently vague. Though entrepreneurship is the heart of the process the price ‘mechanism’ is its nervous system. Paralyse one or the other and you immobilise the whole. This is something Lenin discovered very quickly and that is why he introduced the New Economic Policy in 1921.

It is ludicrous for Haermeyer to assume that any state or national planning agency could perform the function of the market. However, our latter-day would-be planners will argue that this is not their attention: that they only intend to step in where the market has failed. By a curious coincidence these alleged ‘market failures’ are invariably defined as results that our would-be planners disapprove of.

So if the market directs resources to certain products at the expense of products which the likes of Haermeyer thinks should be produced in greater quantities then it is market failure by definition. Never mind that it is what consumers demand. Furthermore, granted that it is not their aim to sovietise the economy they nevertheless do intend, without even realising it, to assume for themselves, or their agencies, the entrepreneurial function. But Professor Coase hit the case of planning with his insight that

…economic planning is imposed on industry, while firms arise voluntarily because they represent a more efficient method of organising production. In a competitive system there is an ‘optimum’ amount of planning. The Firm, the Market and the Law, University of Chicago Press, 1988).

Critics of industry policy would do well to ask Labour Party luminaries and other supporters of industry policy to demonstrate how politicians and bureaucrats spending taxpayers’ money, taking no risks, making no sacrifices can do better than genuine entrepreneurs. Does anyone think that this approach would have created Ford, Boeing, ICI, Sony, Apple, Microsoft, Intel, Compaq, Hewlett Packard, Honda, Panasonic, Pioneer, NEC and a multitude of lesser but still successful companies, not to mention a vast range of inventions? Yet Haermeyer is claiming just that.

Japan’s Ministry MITI used to be frequently held up by Australian interventionists as a showcase for industry policy. But this was the same agency that told Mitsubishi, Toyota and Nissan that the Japanese economy was unsuited to car manufacturing; it tried to stifle Honda’s plans to produce motorcycles because foreign competitors were obviously far too advanced in production techniques, design, marketing, etc; planners from this agency tried to dissuade Sony from acquiring transistor technology and advised it against investing in consumer electronics.

MITI planners reasoned that because established electronics companies were not using transistors it followed that they must be a poor investment and thus a waste of resources. Masaru Ibuka, Sony’s founder, thought otherwise. He successfully defended his entrepreneurial judgement against the MITI planners’ market assessments and went on to lay down the foundations for the wildly successful Japanese consumer electronics industry. (The Sony experience is a neat example of how of planners look at what has already been achieved rather than what can be created). In fact, Japan’s successful glass, paper, and cement industries were virtually ignored by the MITI.

Admirers of the MITI also ignored its failures. At great cost to Japanese taxpayers it favoured the shipbuilding, aerospace and steel industries, scarcely world leaders. And if it had succeeded in aborting, for example, Sony’s entrepreneurial decision to make transistor radios the consumer electronics industry would have been another one of its disappointments. But no one would have known because the industry would not have emerged; at any rate, not in its successful form.

This is another of the dreadful and hidden costs of these interventionist policies: all the forgone opportunities, the firms and industries that were never conceived or were aborted because they did not fit industry policy. This is a heavy price to pay just to satisfy left-wing ideologues like Haermeyer.

At the end of the War Japan was literally devastated. The situation was so dire that many observers considered her a lost cause. It was the foresight and determination, despite some errors of judgement, of Tanzan Ishibashi that put Japan firmly on the road to recovery and prosperity.

In the correct belief that high taxes hinder growth and that savings fuel it, he radically slashed income taxes, abolished taxes on interest and savings and lowered the corporate tax rate; he also insisted that Japan should concentrate its efforts in labour intensive industries, which was no more than saying that comparative advantage should rule, at least at home.

The results were remarkable and by the mid-1950s Japan’s savings ratio had risen to more than 30 per cent. Unfortunately her banking system was pretty poor and so the MITI acted as the principle source of credit for business expansion. But with a vast and expanding pool of savings to allocate and faced by a considerable range of profitable opportunities offering little risk, many created by wartime damage, there was little ‘need’ to try and pick winners. But in that case, it is not unreasonable to assume that a mature financial system would also have made similar investment decisions. As financial markets became more sophisticated the MITI lost its financial leverage, completely losing it by the early 1970s.

The idea that the MITI guided investment and business in Japan is a complete fiction. If the MITI had ever have had the power ascribed to it by the likes of it Australian admirers Japan would now be a much poorer country. The Japanese economist Katsuro Sakoh stated that Japan’s economic success is “based not on how much it [the Japanese government] did for the economy, but on how much it restrained itself from doing”. Trying telling that to Haermeyer & Co. So we find that the MITI’s astonishing powers of foresight are nothing but a statist myth and that the real glory lies with Japan’s entrepreneurs.

One of the problems with the industry policy approach is that it basically treats entrepreneurship as a form of arithmetic. Entrepreneurs are faced with prices and costs which they then calculate in a way that minimises their costs of production. This approach barred MITI planners from appreciating Masaru Ibuka’s plans to use transistors to mass produce electronic goods.

Entrepreneurship is about being alert to new opportunities and situations, of being able to successfully assess them or even create new ones. Ibuka’s entrepreneurial drive alerted him to the possibilities of the transistor; from there he imagined other possibilities and assessed them correctly. On the basis of these assessments he built a successful industry.

But notice that the information that inspired his vision was shared by others and yet only he saw the potential. Why? Clearly it is not information per se that matters but the entrepreneur’s interpretation of it. This brings us to the point that entrepreneurial decision-making is a purely subjective activity with, at times, an inspirational element. (Those who join bureaucracies or spend their working lives engaged in politics are scarcely likely to exhibit the same kind of business ability or even appreciate it. This is another reason why bureaucrats and politicians fail when they meddle in business).

The tendency to look on entrepreneurs as mere calculators or lucky winners in an economic lottery means that interventionists see prices as given, mere data that works to guide entrepreneurial behaviour. (To be fair, most economists share this view). But the case histories of Masaru Ibuka, Bill Gates, Steve Jobs, Rupert Murdoch, Richard Branson, Henry Ford, Richard Arkwright, and a host of countless entrepreneurs, easily disposes of that fallacy and makes clear the subjective nature of entrepreneurial decision-making.

This is a vitally important insight because it brings to light the essential role entrepreneurship plays in coordinating prices. Too many economists are in the habit of treating prices as if they are in equilibrium. They are not. Prices are in disequilibrium, meaning that there maladjustments between supply and demand. Entrepreneurs seek out these maladjustments ––even creating them in some cases –– and by adjusting production to meet consumers’ wants eliminate them. But by definition this activity must alter the structure of prices.

What we conclude, therefore, is that costs (the prices treated as given) are actually determined by the total entrepreneurial demand for factors of production which in turn is driven by consumer preferences, or anticipation of preferences. Any action by governments that hamper the entrepreneur’s production-adjusting function will lower productivity by sabotaging the coordinating function.

Entrepreneurs, acting on price signals and their assessment of the situation and production possibilities, will construct factor combinations that they believe will successfully eliminate maladjustments. Profit, of course, being the measure of success.

Enter the Haermeyers and Holdings of this world to usurp the entrepreneurial function. By directing resources to their favoured lines of production (usually through ‘cheap’ loans and subsidies, though threats and intimidation should not be ruled out) they deny them to other lines of production by changing factor prices.

This forces businesses that have been denied access to the necessary quantity of capital goods to change their production plans causing them to construct less productive combinations. After all, if the new factor combinations were not economically inferior they would have been the entrepreneur’s first choice.

The same goes for loans. By granting ‘cheap’ loans and subsidies to favoured businesses savings are denied to other businesses. These businesses must now borrow at higher interest rates, which mean that not only are marginal investments not undertaken but other businesses must curb their investment plans. You cannot advantage one business without disadvantaging others.

Changes in factor prices are not confined to firms directly bidding for the same factors. When these firms change their production methods they also change their demand for inputs. The effects of these changes ripple through the production structure, changing relative prices and factor combinations along the way. The effect of these changes in factor prices on production methods is profound with far-reaching ramifications for investment and living standards.

In a free market entrepreneurial behaviour tends to allocate factors to the margin, their most productive use. Allocating them elsewhere would lower their productivity and hence their earnings. By now it is clear that ‘cheap’ loans and subsidies are a means by which favoured firms can bid factors away from more efficient lines of production and superior entrepreneurship. If this were not so, then these favoured companies would not need subsidies.

We have also deduced that the firms who bid away the factors are also constructing less inefficient capital combinations at the expense of efficient combinations elsewhere. There is no trade off!

Not only that, favoured firms will tend to expand production beyond a point justified by any market conditions because ‘cheap’ loans and subsidies are the equivalent of raising the firm’s internal rate of return; this encourages overinvestment and production at the expense of less investment and production elsewhere in the economy, creating even more economic inefficiencies.

There is also the little realised effect that subsidies have on the recipients’ decision-making processes. Decisions are choices and choices are displaced alternatives. To entrepreneurs decisions are displaced revenues. These are their opportunity costs. Subsidies of any kind will change their decisions and hence their demand for resources by changing their opportunity costs.

Alternative actions that are economically rational in that they result in a more efficient allocation of resources will be abandoned in favour of an irrational allocation of resources made profitable by government intervention. Industry lobbying will be substituted for entrepreneurial activity.

It follows from this analysis that the greater the intervention the greater the misallocation of resources and hence the lower productivity will be. However, massive savings can conceal, though not compensate, for the damaging effects of irrationally allocating resources. It does this by significant increases in annual GDP. This is precisely what happened in Asia.

While interventionist policies misdirected investment thus lowering productivity, massive savings covered up this irrational policy by generating high annual rates of growth in GDP. Interventionist Singapore and free-market Hong Kong provide a striking contrast of the results of this process. Both started on a similar footing and both grew at about the same annual rate. The similarities end at that point.

From 1970-1990 output per worker rose by 150 per cent in Hong Kong but only 100 per cent in Singapore, even though Singapore invested 40 per cent of its income compared with Hong Kong's 20 per cent. The same period saw output per unit of capital in Singapore fall by over 50 per cent while remaining comparatively constant in Hong Kong. To make the comparison even worse, by 1985 Singapore’s rate of return on capital had dropped from about 40 per cent to 11-12 per cent.

By 1990 she was investing twice as much as Hong Kong to get the same output. In other words, she was investing more and more to get the same result. Studies found exactly the same economic phenomenon in Taiwan, Korea, Thailand, et al. Only non-interventionist Hong Kong had a positive result. It is obvious that the productivity differences are due to misallocated capital and not diminishing returns, as Professor Krugman claims.

Readers may have noticed that I have largely ignored the question of moral hazard. This is not because I consider the question unimportant, far from it, but because it needs to be shown that it is only incidental to the subject of industry policy. It has to be shown that it is the policy that is inherently flawed, not just the participants. All that corruption does from an economic angle is make resource allocation even more irrational — it does not cause it.

By concentrating on corruption opponents would not only be displaying an ignorance of what is irredeemably wrong with industry policy but they would be giving its supporters the opportunity to strengthen their case by asserting that they can build into the policy sufficient safeguards against corruption. I repeat: corruption is not the problem!

The critique of industry policy can be summarised with six points:

1. It is impossible for planners, i.e., politicians, bureaucrats, etc, to collect, let along coordinate, the billions of pieces of information that the market gathers, collates and coordinates every minute of everyday.

2. The entrepreneur is the prime mover in the economic system. I have shown why no government agency or bureaucrat can successfully perform this function, especially its coordinating aspect, even if they had the talent.

3. Industry policy distorts the pattern of production and lowers productivity by irrationally allocating resources.

4. The greater the intervention the worse the economic consequences will be.

5. Demands for more intervention will tend to grow as the consequences of previous interventions emerge.

6. These policies make political lobbying more profitable than true entrepreneurial activity thus misdirecting and stunting economic development.

The case against industry policies is damning and conclusive. The case for it rests on prejudice, ignorance, ideology and, all too frequently, the lust for power. The tragedy is that the Australian public has been denied access to the case against industry policy. Those Australians who took it upon themselves, to the deliberate exclusion of others, to defend the market have much to answer for.

The following material is essential reading for those interested in economic planning and industry policy.

From Marx to Mises: Post-Capitalist Society and the Challenge of Economic Calculation, David Ramsay Steele, Open Court, 1992

Ordeal by Planning, John Jewkes, MacMillan & Co. LTD, 1948

Economic Calculation in the Socialist Society, Trygve J. B. Hoff, LibertyPress, 1981

Economic Calculation in the Socialist Commonwealth, Ludwig von Mises in Collectivist Economic Planning, Augustus M. Kelley, Publishers, Clifton, 1975

Gerard Jackson is Brookes’ economics editor

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