New economics looks like old-school picking winners

Anthony Albanese’s Future Made in Australia push no doubt holds an easy but superficial attraction to an electorate worried about what is happening in a fast-changing world. If implemented, however, the policies are likely to deliver higher inflation, make it more difficult for the majority of businesses to find capital and workers, and leave behind the wreckage of blue-sky industries that find out at considerable public cost that they cannot survive without never-ending subsidies. It is a recipe for a two-speed business world, one that government funds and controls, and another that pays the bills but gets the crumbs.

The risk is that a government push to pick winners is likely to compound the global misallocation of capital to an ill-conceived and poorly executed transition to a lower-emissions economy. For Australia, this transition has already undercut one of our greatest areas of competitive advantage, cheap energy. The federal government’s “made in Australia” push risks worsening the situation by favouring uneconomic or undeveloped technologies over existing industries that will be compromised but still expected to pay high royalties and taxes.

History shows that doubling down in the hope of out-competing other nations in the rush to new technologies such as green manufacturing, green steel and hydrogen production is likely to look much better on paper than it does in economic reality.

This does not mean the Prime Minister is not correct to say the world is entering a fundamentally different economic future.

It will be one increasingly defined by great-power competition between the US, China and Europe.

Australia must adapt to this reality but it must do so in co-operation with its allies rather than in competition with all-comers. This is already happening with rare earths, an area of genuine strategic competition. Fearful of disrupted supply lines, the US has opened the Inflation Reduction Act subsidies to Australian projects and expertise.

Mr Albanese’s proposed Future Made in Australia Act goes much further than that. It seeks to put government at the centre of decision-making as a “partner, investor and enabler”. It wants government to “act fast at scale” and “be more assertive in capitalising on our comparative advantages and building sovereign capability in areas of national interest”. He says the federal government is “open to all good ideas, from business, from industry, from unions, from state and local government, and from across the parliament”.

Fundamentally, Mr Albanese appears to be focused on old-style industry protection rooted in a belief that a command economy can deliver. The rhetoric used is the same as it always has been. “We have massive advantages under the ground with our resources, but also in the sky with our solar resources,” Mr Albanese said. “That will enable us to develop a green hydrogen industry, for example, that can then be used to drive green metals manufacturing in areas like aluminium and steel. We have enormous opportunity here to value-add, and the theme today is pretty simple. Which is, we’ll continue to be an exporting nation, we’ll continue to export our resources. But where possible, value-add here, create jobs here, create value here, create that economic prosperity here.” The same things have been said, and billions of dollars squandered, in the quest to downstream process our major commodities, notably iron ore.

The antidote to Mr Albanese’s lofty rhetoric is contained in the International Monetary Fund’s latest Fiscal Monitor. It says “industrial policy that steers innovation toward specific sectors such as ‘green’ technologies is experiencing a resurgence in many major economies amid concerns about economic and national security, often at a hefty fiscal expense”.

The IMF says history shows that industrial policy is prone to policy mistakes. Even when projects transform industries, they often entail high fiscal costs and negative cross-border spillovers. It says welfare gains from industrial policy easily turn negative if subsidies are misdirected (for example, towards politically connected sectors) instead of being driven by social returns. It says policies discriminating against foreign firms can prove particularly self-defeating, as a large share of knowledge is imported even in major advanced economies, and such policies can trigger costly retaliation. The warning lights are flashing in Labor’s attempts to pick industry winners across all of the IMF’s areas of concern.

There is also a warning in the timing of the federal government’s announcement, coming as it does with confirmation that the inflation challenge in the US is going to be more difficult than expected. As Robert Gottliebsen notes, in the US, demand for labour and materials to implement President Joe Biden’s “Made in America” strategies is pushing up US inflation and causing the US bond market yields to rise, foreshadowing an end to dreams of lower interest rates. They may even rise further.

Opposition Treasury spokesman Angus Taylor is correct in saying that inflation will not be solved by big government but by getting government out of the way.