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The Liberal Party fails on Australian manufacturing and “industry policy”
Gerard Jackson
I’ve been warning on and off for sometime that government economic planning under the guise of “industry policy” was going to raise its ugly head again (Australian economy: the Labor Party and the unions put economic planning back on the drawing board). And so it has. Just more than a week ago the Victorian Liberal Party held its 144th State Council meeting at which the Victorian Liberal Party Berwick Branch called on the Federal Government to “rejuvenate Australian manufacturing industry”.
The branch noted that as a proportion of GDP manufacturing has fallen from 25 per cent in 1975 to 11 per cent today. The branch therefore concluded that this decline has damaged “Australia’s export capability” and also production for domestic consumption, a “situation that has significantly contributed to our continuing Current Account Deficits and present Net Foreign Debt of over $500 billion”.
The first thing to note is that it is fallacious to think that the decline in manufacturing as a proportion of GDP adds in anyway to the CAD or our foreign debt. Nevertheless, the branch correctly, albeit for the wrong reason, drew attention to the importance of manufacturing.
The blasé response of our “rationalist economists” to observations like theirs is to argue that Australia is undergoing a natural shift out of manufacturing and into services.
It therefore follows that as real incomes rise proportionally more of them will be spent on services causing manufacturing to decline in relative or even absolute terms. The logic is obviously valid. But is it true? Is Australia moving into what the likes of Barry Jones unthinkingly call a post-industrial era? I have certainly not been persuaded.
Membership of the Austrian school of economics fuels my caution. One reason is that Austrianism loathes the macro-approach (what Professor Lachman caustically called macromancy) because it conceals so much while assuming functional relationships between macro-variables that do not and cannot exist because of their micro-economic foundations.
The alleged shift from manufacturing to services is implicitly derived from a stages-of-development approach. I think it is important to emphasise that there is no such animal. The argument that the Industrial Revolution validates this thesis is based on a misunderstanding of historical events resulting in our economic commentariat taking a very sanguine view of the current economic situation.
What our commentariat overlooks is that services and manufacturing are closely linked. The term ‘service’ is very loosely used and is usually defined as wholly or in part as a product that is intangible. Now services are like any other good in that they are either consumed directly or indirectly. If it is the former, then it is plain that they have largely developed along with manufacturing, i.e., they are part of the manufacturing process.
Hence it would be a grave error to lump the expansion of these services with those that are directly consumed. Yet the manufacturing-to-consumption view not only makes no distinction between the two types of services, it actually seems to argue as if only consumption services exist and it is these that will create the new higher-paying jobs for everyone.
But this type of service, as classical economists pointed out, does nothing to raise real wages. This can only be done by increasing investment in those activities that raise the productivity of labour, a fact that the classical economists fully understood. That is why John Stuart Mill was able to write that “the demand for commodities [consumer goods] is not the demand for labor”1.
The Austrians stress that production takes place in stages which form a heterogeneous structure. The more a society saves the longer the structure becomes with stages becoming lengthier, more complex and productive. This is the process that raises real incomes. It is also a process that the GDP approach completely conceals. By adopting production-structure analysis we see that rather than being a separate economic sector agriculture, for example, is actually at the highest stage of production for the food industry.
Approximately 3 per cent of the workforce are directly engaged in agriculture of all kinds. But by adopting the production structure approach with farming being the highest stage of the food processing industry structure we might find as much as 20 per cent or so of the population is employed in food production, which also includes retailing.
A 1982 US Department of Agriculture report calculated that the food production structure employed 28.4 million people. In addition, GDP actually understate the contribution of manufacturing to the economy because it is not really gross. A great deal is left out on the specious grounds that it is double counting.
Now in the preceding paragraph I emphasised manufacturing. This is because food production is a manufacturing process. Just as minerals are mined and then transformed into higher-valued goods as they pass through various extremely sophisticated stages of production. One need only give a moment’s thought to how much is involved in the production of a loaf of bread or the amount of capital that goes into a canning factory to realise the complexity of the structure.
What is not considered by commentators is the enormous amount of services and manufacturing products that are tied in with food manufacturing. Transport, insurance, finance, storage, machinery, engineering design, genetic development, scientific research, chemical processes, synthetic fertilisers, veterinary services, distribution, retailing, and so on. It is now easy to see that the range of services that are complementary to agriculture are wide-ranging and sophisticated and that most of them should be sharply differentiated from consumer services.
So where doe this lead? To monetary policy. It is quite possible that a mismanaged monetary policy could artificially shrink the capital structure and force many firms to move their operations offshore3. The detrimental effects on living standards could be offset by significant increases in productivity and temporary improvement in the terms of trade.
To fully explain this process in detail would require an article several times as long as this one. Suffice to say at this stage that its rests on the following economic facts:
1. capital is a heterogeneous structure.
2. Prices guide production.
3. Money is never neutral
The problem is not the technical difficulty of the argument but the dismal fact that our “economic rationalists” refuse to even acknowledge its existence. I call this the Semmelweiss syndrome2. Their refusal to confront the argument only encourages more demands like those of the Berwick Branch of the Victorian Liberal Party.
Unless our ‘economic rationalists’ muster the intellectual courage to publicly debate this issue we are likely to find Liberal and Labor politicians eventually taking it upon themselves to ‘guide’ the economy. If this situation comes to pass then the likes of Paddy McGuinness and the Institute of Public Affairs will have a lot to answer for.
1. Mill understood that capital accumulation raised the productivity of labour, even though he had no concept of the margin. This is tragic considering that Samuel Mountifort Longfield developed the theory of the marginal productivity of capital to explain how labour benefits from increased capital formation. (Lectures on Political Economy, Richard Milliken and Son 1834, Ch. IX. Also see Samuelson’s Economics, 10th edition, McGraw-Hill 1976, pp. 731-33). Isaac Butt, an admirer and contemporary, extended the theory to other factors of production.
2. Ignaz Phillipp Semmelweiss (1818-1865) was a young obstetrician at the General Hospital in Vienna. He discovered that doctors could virtually eliminate puerperal infection (child-bed fever) by simply disinfecting their hands in a solution of chloride of lime. His reward was vilification by his so-professional colleagues. It became so bad that Semmelweiss moved to Budapest. Now who was it that said “that the more things change the more…”
3. Samuel Mountifort Longfield raised this very possibility in his In his book Three Lectures on Commerce and one on Absenteeism, Routledge-Thoemmes Press, 1996, Lecture IV (first published in 1835).
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 28 August 2006