Is the Productivity Commission an institution beyond repair?

Jul 30, 2023
Silhouettes of business people meeting with business symbols indicating productivity Image:iStock/ Rawpixel

The appointment of Chris Barrett to head the Productivity Commission puts its Trade and Assistance Review under the spotlight.

While it has become commonplace in recent years to ignore the PC’s regular evisceration of anything that smacks of market intervention, it has this year chosen to target the very policy platform on which the Albanese government was elected.

And just when the Treasurer has signalled his interest in “renewal” of the institution.

Perhaps this is the PC equivalent of a tribute tour which provides a final opportunity to relive past success in overseeing the removal of tariffs, the privatisation of public enterprises and outsourcing of public services. Though even here the failures of “contestability” have had to be conceded by the PC itself.

Essentially, the PC wants us to know that the present government’s approach to tackling climate change and energy transition amounts to an industrial policy in all but name, and should therefore be subject to scrutiny for the inevitable misallocation of resources and sub-optimal outcomes.

How disappointing it must have been to have nothing ambitious to scrutinise under the previous government.

In particular, the PC takes issue with the announced intention to promote battery manufacturing in Australia, given that we produce 50 per cent of the world’s lithium, export almost all of it and capture only 0.53 per cent of its final value.

The thinking is that Australian industry might for once move up the value chain and begin the task of diversifying our narrow trade and industrial structure, based as it is on the export of unprocessed raw materials.

In a world where the biggest gains from trade are in knowledge-driven goods and services, a resources dependent industrial structure lacks the economic complexity to achieve these gains, and is increasingly vulnerable to supply chain shocks.

Australia has now fallen to 91 out of 133 countries in the Harvard Atlas complexity rankings, just ahead of Namibia, as measured by the diversity and research intensity of our export mix.

The problem is that while successive commodity booms made Australians richer through appreciation of the dollar, they also made much of the manufacturing industry uncompetitive both domestically and in global markets.

This is the so-called “Dutch disease”, which describes the impact of North Sea gas on Dutch manufacturing in the 1970s, and then similarly the UK’s North Sea oil.

Australia’s deindustrialisation is not a case of “market failure”, as the market operated in the way textbooks prescribe, but one of abject policy failure. Instead of canvassing options for intervention, previous governments absented themselves from a major economic policy challenge.

If ever there was a sub-optimal outcome, this is it.

By contrast, Norway took a public stake in its North Sea oil and gas, imposed a 76 per cent resource rent tax and created the world’s biggest sovereign wealth fund. Norwegians now have the wherewithal to participate in global manufacturing supply chains, create a net zero emissions economy and build a world leading research and innovation system.

However, this is heresy in the parallel universe of the PC, which takes a perverse pride in the destruction of local manufacturing capability. In pursuit of an outdated theory of comparative advantage, it believes that Australia should double down on its status as the world’s most efficient quarry, and repudiate efforts at local value adding as they would supposedly cost more than the potential benefits.

The most remarkable, unquestioned feature of this approach is that it is based on no empirical evidence. In the case of batteries, experts have calculated that domestic manufacturing would deliver $55 billion to GDP a year, for a total investment of $35 billion through 2035, and a tax take on earnings over two years of $30 billion.

The battery manufacturing value chain is an example of how to turn a comparative advantage based on natural endowments into a “competitive advantage”, based on knowledge and ingenuity.

As always, the fundamental problem with the PC’s approach comes back to reliance on a static equilibrium model of the economy, where the assumptions themselves give rise to predictable winners and losers.

The fact that productivity has stalled in Australia for the past 20 years, now with accompanying wage stagnation, is not due to governments ignoring the PC’s recommendations, but implementing them.

Meanwhile, industrial policy elsewhere around the world is generally devised as part of a dynamic model of growth and innovation, preparing nations for the industries and technologies of the future.

Clearly, the PC is not fit for purpose in this environment, with consulting firms also under scrutiny. Chris Barrett’s renewal task is a formidable one.


First published in The Canberra Times July 27, 2023

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