Why Australia should stop digging into industrial policy

The Albanese government claims it wants to take a "new approach" to industrial policy, using "government investment... to get private capital flowing towards our priorities effectively and efficiently".

Sounds great, right – who would dare complain about a government achieving its priorities effectively and efficiently? But just because a stated aim sounds good, it doesn't mean it will produce good outcomes. And once you start to scratch beneath the surface of this "new approach" it quickly becomes clear that it is neither new, effective, nor efficient.

A future made in Australia

If Australia wants to become a renewable energy superpower, Prime Minister Anthony Albanese (Albo) said last month, then "the government has to be a partner in this, not just an observer".

Cue an $800 million loan and grant package for a Gina Rinehart rare earth project here, a billion dollars for Hunter Valley solar panels there, and tens of billions for government-led "investment" funds, and very soon you're talking real money. According to Albo, these investments "will supercharge Australia's ambition to become a renewable energy superpower at home and abroad".

Albo's Resources Minister, Madeleine King, is just as enthusiastic. After announcing a $230 million below-market rate loan for a struggling lithium miner owned by Rinehart, King said:

"Australia just needs to be using its minerals and processing them here for ourselves as a nation to be able to make more things. We really need government support to make sure we can get this [lithium processing] industry off the ground."

But despite what the Albanese government claims, this is not a "new approach" to industrial policy. The only new thing about it is that they're "investing" in (subsidising) clean-energy related commodities and manufacturing, rather than using tariffs and various other protectionist means that were used here in the middle of the 20th Century. But really, it's all about local jobs. For example, after spending $100,000 on two RAAF jets for a brief photo op in Muswellbrook, where Albo and Energy Minister Bowen unveiled $1 billion in funding for solar panel manufacturing, Albo did not mince his words:

"We're here today to talk about jobs, jobs and jobs. I campaigned hard, talking about jobs all throughout the election and now we're in it, and now we're showcasing what we're doing. We are talking today about many, many jobs here for the future for the Hunter Valley. I made a commitment to the people of the Hunter to make sure that we had safe, secure, high paying jobs in the Hunter. And that is what he's going to come from today's announcement."

On that, Albo's new approach to industrial policy is no different to previous versions of Australian industrial policy. Peter Varghese, Chancellor of The University of Queensland and former Secretary, Department of Foreign Affairs and Trade, said that the "overall objective" of Australia's old industrial policies was:

"...job-creation and security, particularly in the manufacturing sector. We argued that without protection, Australia's small domestic market, high wages and infant industries, Australian manufacturing would not be viable.
...
While it's true that protection might allow infant industries to begin, a protected industry also generates its own lobby groups and mutual protection societies, creating a perverse incentive against innovation, improved productivity and the growth of new sectors.

That political reality came to define Australian society."

The means might have changed, but underneath it all Albo's industrial policy is still very much the same as the one that sapped growth and productivity for decades in the mid-20th Century, given that its core purpose is to "deliver critical jobs and economic development... to bring together our plans for a future made in Australia, our prospects in critical minerals, and our co-investment agenda into one piece of work to boost investment in our economy".

Sounds great. But is it worth the cost?

You cannot prioritise everything

Based on its actions, the Albanese government intends to prioritise jobs at all costs, specifically union jobs. Its "new approach" to industrial policy, using grants and subsidies to prop up green energy industries in the name of the environment, is a cover. Just look at this tweet from Energy Minister Chris Bowen:

Now don't get me wrong: policies that boost good quality local jobs can of course be desirable. Jobs aren't just a means to consume; they also give people purpose and meaning in their lives. But these jobs are skilled jobs, and you can throw as much money as you like at new green investments but it won't make a difference if you don't have the skilled workers to do the job. If those jobs are bid away from elsewhere in the economy (need I remind you that the unemployment rate is close to a 50-year low 3.7%?), or come at the expense of economic competitiveness, innovation and productivity, which in the long run is the only way to create good quality jobs for everyone, then they may not be worth "delivering" at all.

The new chair of the Productivity Commission, Danielle Wood, last month warned that when you engage in industrial policy, "you also run the risk that you throw a lot of money at sectors … that we [won't] have a long-term competitive advantage". Her deputy chair, Alex Robson, said:

"The scope for failure and spectacular waste under this approach seems great – and this is historically proven to be so."

Those are fair warnings given that is precisely what happened the last time we tried industrial policy in Australia, as Robson stated. Historian Donald Horne observed the effects of the previous iteration of Australian industrial policy firsthand, writing in 1964:

"Once protection is dished out it usually stays. In the absence of any government plan for sustaining unemployed men over a retraining period or in assisting diversification, the political risks in allowing an inefficient industry to collapse are too great."

Subsidies, like tariffs, are a form of protectionism. Do you honestly believe that this, or a future government, will stop providing support for solar panel workers in the Hunter Valley when the current billion-dollar program runs out? Of course not; think of the political risks in doing so! There's a reason why we made cars in this country until 2017, decades after any kind of competitive advantage we might have had was long gone. Once you subsidise something or someone, it can be incredibly difficult to wean them off that dependence without a significant political backlash.

The Albanese government needs to learn that it can't prioritise everything. The fact is, other countries make certain goods at a much lower cost than we can in Australia. For example, by producing solar panels in the relatively high-cost Hunter Valley rather than importing cheaper panels from China, we're wasting scarce resources – including labour! Those resources would be better off used something that makes economic sense to produce without subsidies, and then trading for the solar panels.

The environment, or green union jobs?

The great economist Frédéric Bastiat once penned a famous, satirical letter to the French government, urging them to block the "ruinous competition of a foreign rival who apparently works under conditions so far superior to our own for the production of light that he is flooding the domestic market with it at an incredibly low price".

That foreign rival was the Sun.

Bastiat was of course poking fun of protectionism, taking the logic of those calling for government-supported domestic manufacturing of [insert any good here] to the extreme. Just think, he said, of the economic bounty that would be created if we were only to "pass a law requiring the closing of all windows, dormers, skylights, inside and outside shutters, curtains, casements, bull's-eyes, deadlights, and blinds":

"If France consumes more tallow, there will have to be more cattle and sheep, and, consequently, we shall see an increase in cleared fields, meat, wool, leather, and especially manure, the basis of all agricultural wealth.

If France consumes more oil, we shall see an expansion in the cultivation of the poppy, the olive, and rapeseed. These rich yet soil-exhausting plants will come at just the right time to enable us to put to profitable use the increased fertility that the breeding of cattle will impart to the land.

Our moors will be covered with resinous trees. Numerous swarms of bees will gather from our mountains the perfumed treasures that today waste their fragrance, like the flowers from which they emanate. Thus, there is not one branch of agriculture that would not undergo a great expansion.

The same holds true of shipping. Thousands of vessels will engage in whaling, and in a short time we shall have a fleet capable of upholding the honour of France and of gratifying the patriotic aspirations of the undersigned petitioners, chandlers, etc."

But those benefits come at the expense of the consumer, who is "sacrificed... whenever you have found his interests opposed to those of the producer".

To be clear, Bastiat's fable is more appropriate for tariffs and prohibitions on trade than subsidies. But subsidies, while not explicitly blocking foreign competition, still cost the consumer: the government doesn't have an infinite pool of wealth from which to draw. The subsidies being dolled out to solar panel workers in the Hunter Valley come by taxing other more productive activities, raising prices elsewhere in the economy. With industrial policy and protectionism – even subsidies – eventually the consumer pays the price.

Instead of protectionism, Bastiat advised the government to accept the "gifts" from abroad:

"When a product—coal, iron, wheat, or textiles—comes to us from abroad, and when we can acquire it for less labour than if we produced it ourselves, the difference is a gratuitous gift that is conferred upon us. The size of this gift is proportionate to the extent of this difference. It is a quarter, a half, or three-quarters of the value of the product if the foreigner asks of us only three-quarters, one-half, or one-quarter as high a price. It is as complete as it can be when the donor, like the sun in providing us with light, asks nothing from us. The question, and we pose it formally, is whether what you desire for France is the benefit of consumption free of charge or the alleged advantages of onerous production."

Support industry, not industrial policy

The Albanese government has embarked on the largest industrial policy experiment Australia has since the mid-20th Century. Some of its bets will inevitably pay off; but many – and I'd be inclined to say most – will fail. By definition, these "investments" are being made at below the rates a market actor would pay, reflecting their uncertainty and risk. Worse, they're being financed with borrowed money, not higher taxes or a reduction in spending elsewhere.

There is no reason to be deficit spending – engaging in fiscal stimulus – when the Reserve Bank of Australia (RBA) is pushing against you and trying to get inflation down. In fact, cutting spending would make the RBA's job easier, reducing interest rates sooner than otherwise and encouraging activity to pick up in the more productive, unsubsidised parts of our economy.

A great thing about markets is that when businesses fail, as they inevitably do, they both free up resources that can be better used elsewhere and they stop wasting even more resources. Albo's industrial policy does the opposite. By propping up failing "critical minerals" companies with government funds, he's preventing Schumpeterian creative destruction.

For example, the nickel industry has been in strife lately, with many companies receiving state and federal government support. But those that were allowed to fail, such as Poseidon Nickel, had their assets quickly snapped up by entrepreneurs with completely different plans for those scarce resources:

"Mining billionaire Chris Ellison will seek to profit from the collapse of the Australian nickel industry by retrofitting infrastructure in Western Australia to process lithium.

The Mr Ellison-led Mineral Resources will buy Poseidon Nickel’s concentrator plant and tenements at Lake Johnston in the Goldfields region of WA for $15 million and a royalty stream as part of its lithium strategy."

Industrial policy feels great in the short run; "good jobs" with high wages are created through the financing of investments with borrowed money. But in the long run, those investments must pay off, or we'll all be worse off. The most likely outcome of the Albanese government's "new approach" to industrial policy will be good jobs for union workers in places such as the Hunter Valley; good jobs for the bureaucrats in charge of its various funds, such as the National Reconstruction Fund; and good jobs for labour lobbyists looking to allocate subsidies to favoured businesses. All at the expense of working-class Australians toiling away in other parts of the economy to pay for the largesse.

Instead of trying to reinvent industrial policy by painting it green, a better approach at boosting industry would be sector-neutral tax reform, such as cutting the corporate tax rate, which reduces taxes on capital investment. Want most of the investment to go towards green industry? Do it alongside a revenue-neutral carbon tax. Not only would that boost industry, but it would also avoid the waste that goes with selecting certain industries that politicians believe to be important, handicapped as they are with an absence of reliable price signals and the relentless attempts from rent seekers trying to extract personal gain from the policy.