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Current Issues Brief

No. 4 1997-98

Industry Policy: Mortimer, Goldsworthy and The Economist Intelligence Unit

ISSN 1321-1560

 Copyright Commonwealth of Australia 1999

Except to the extent of the uses permitted under the Copyright Act 1968, no part of this publication may be reproduced or transmitted in any form or by any means including information storage and retrieval systems, without the prior written consent of the Department of the Parliamentary Library, other than by Senators and Members of the Australian Parliament in the course of their official duties.

This paper has been prepared for general distribution to Senators and Members of the Australian Parliament. While great care is taken to ensure that the paper is accurate and balanced, the paper is written using information publicly available at the time of production. The views expressed are those of the author and should not be attributed to the Information and Research Services (IRS). Advice on legislation or legal policy issues contained in this paper is provided for use in parliamentary debate and for related parliamentary purposes. This paper is not professional legal opinion. Readers are reminded that the paper is not an official parliamentary or Australian government document. IRS staff are available to discuss the paper's contents with Senators and Members and their staff but not with members of the public.

Published by the Department of the Parliamentary Library, 1999

I N F O R M A T I O N A N D R E S E A R C H S E R V I C E S

Current Issues Brief No. 4 1997-98

Industry Policy: Mortimer, Goldsworthy and The Economist Intelligence Unit

David Richardson Economics, Commerce and Industrial Relations Group 27 October 1997

Acknowledgments

Matthew James, Tas Luttrell and John Kain, provided useful comments on an earlier draft.

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Contents

Technical Economic Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . i

Major Issues Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Mortimer Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

The Economist Intelligence Unit for the Metal Trades Industries Association . . . . . 4

Goldsworthy's Global Information Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Comment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Philosophical differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Cumulative Causation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Endnotes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

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Technical Economic Terms

Diseconomies of scale are the opposite of 'economies of scale' (see below).

Economies of scale or increasing returns to scale refer to the possibility that long run average costs will fall as production is increased. The importance of looking at the long run is due to the fact that, in the long run, the firm is able to vary all of the inputs: labour, capital, land, technology and other factors of production. In the short run, when at least some inputs are fixed, it is much less likely that the firm will be able to reduce average costs as production is increased.

Efficiency, or 'an efficient allocation of resources,' refers to the production of that combination of outputs which maximises their value to consumers and which is brought about by means of the most efficient deployment of society's resources. Competition is often claimed to produce this result as consumers can discriminate against inefficient producers who are forced to charge higher prices in the market.

Externalities are said to exist when an individual is affected either positively or negatively (in which case we can talk of positive and negative externalities) by an event under the control of another person and where the event is not the result of a market transaction. A positive externality, for example, occurs when each individual experiences a lower risk of contracting a disease as a result of other people being inoculated against disease. Pollution is a good example of a negative externality whereby an unwanted action on the part of one or more people imposes a cost on other people.

Imperfections are said to exist when there are features of the economy which prevent the attainment of an efficient allocation of resources (see 'efficiency' above).

Increasing returns to scale - see 'economies of scale.'

Inefficiency - see 'efficiency.'

Learning-curve economies or learning by doing, refers to the ability of firms to improve production techniques and lower costs through practice, experience and the accumulation of 'know-how' over time. Learning-curve economies give an advantage to the first firm to carry out a particular activity.

Market failure occurs where it is not possible for a market transaction to govern the terms on which a good is provided. If, for example, the beneficiaries of a good or service cannot be made to pay, the provider will receive less remuneration than warranted by the benefits provided. The result is likely to be an under provision of desired goods. The implication is

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that the government may have to provide the good. For example, in the absence of a market for defence services, governments normally provide for national defence. Externalities generally are indications of market failure and are likely to lead to the under provision of goods with positive externalities and over provision of goods with negative externalities.

Neo-classical economics is that school of economics which uses marginal analysis to analyse the working of the economy, including the prices of outputs and inputs, including capital and labour. A perfectly competitive market for all possible goods and services is assumed. All markets are assumed to clear in the sense that no buyers are left unsatisfied and all sellers make sales. Prices are based on demand and supply and the value of a good or service is related to its relative scarcity as mediated through the market place. The neo-classical model has many implications, a particularly controversial implication is that, in the absence of any imperfections (see above), market clearing assures that full employment is the norm in a competitive neo-classical economy. A number of conditions are necessary for the neo-classical results including perfect knowledge, free entry and exit in all industries, production of homogeneous products by a multitude of independent producers to give just a few of the necessary conditions. There are neo-classical economists who

assume the theory is a reasonable approximation of the real world. However, other neoclassical economists merely claim they study neoclassical economics and its unrealistic assumptions to point to how problems may arise in the real world when those assumptions are not met.

Rent-seeking refers to activities on the part of a supplier of goods or services to improve his/her income by influencing government to provide protection from competing suppliers. 'Rent' refers to the income earned under protective arrangements over and above that which would be earned by the same supplier in a free market.

Social returns (as distinct from private returns) from an activity refer to the total income (either in kind or pecuniary) earned as a result of that activity on the part of a person or company. This may differ from the market payments actually received by the person or company when the activity generates externalities for other unrelated parties. For example, when a company carries out research and development activities which generate benefits beyond those it realises for itself, the social returns can be said to exceed the private returns.

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Major Issues Summary

Three prominent reports on Australian industry have been released in quick succession; Going for Growth: Business Programs for Investment, Innovation and Export, Review of Business Programs, headed by David Mortimer;1 Make or Break: A Report for MTIA by EIU Australia2 (the EIU being The Economist Intelligence Unit) and The Global Information Economy: The Way Ahead by the Information Industries Taskforce chaired by Professor Ashley Goldsworthy3.

The three reports are similar in many ways and together can be regarded as putting a business perspective which in many respects challenges the neo-classical orthodoxy. Mortimer recommends adopting a 3.4 percent growth target for per capita income as the context in which he makes the industry policy recommendations. His other main recommendations are:

developing 'action agendas' for specific industries based on the 'Supermarket to Asia' model,

consolidating business support programs into five key programs; the investment program which would include responsibility for incentives of $1 billion aimed at attracting investment, the innovation program responsible for a single research and development (R&D) scheme, an exports program, business competitiveness program and sustainable resource management program.

developing new criteria for vetting new business programs, and

developing 'first stop shop' arrangements and a single claim form for all entitlements.

The other two reports are similar in major respects. Each proposes subsidies to attract investment, greater R&D/innovation incentives and industry specific planning mechanisms. These are the main elements of the industry policy proposed in each of the reports. Each of the Reports also has something to say about appropriate taxation arrangements and other economic policies which are not the subject of the present paper.

The appearance of these three reports with similar views from business circles suggests they represent a business perspective on industry policy. Mortimer distances his report from views 'that Australia should accept simply what the market determines'. Among other

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people, the Chair of the Industry Commission, Bill Scales, has chosen to associate himself publicly with the attack on Mortimer. Scales complains that Mortimer has not provided any 'rigorous analysis' in advocating a $1 billion incentive for investment and the other recommendations.

To help understand the debate, this paper outlines the different perspectives offered by the different parties. Neo-classical economics defines efficiency in terms of best meeting the needs of consumers. Mortimer and other business people do not necessarily have that goal in mind; they tend to talk in terms of maximising wealth and investment. Since the goal they have in mind differs it is not surprising that their conclusions differ. However, they leave themselves open to misinterpretation by not spelling out their points of difference and exploring the implications of those differences.

Mortimer and the others often give the impression that they believe the additional investment they are trying to attract will lead to snowballing effects and that these snowballing effects provide a justification for interventionist policies. Unfortunately those effects are not clearly articulated. However, there are notions of 'cumulative causation' in the literature which would go a long way towards explaining what Mortimer and the others have in mind. Some of the mechanisms behind 'cumulative causation' are outlined. If those mechanisms were shown to be pervasive in the Australian economy they would provide a substantial justification for Mortimer's opposition to the 'view that Australia should accept simply what the market determines.' Identification of those mechanisms would also provide clues as to where industry policy might be best applied.

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Introduction

In July 1997 the Minister for Industry, Science and Tourism released Going for Growth: Business Programs for Investment, Innovation and Export, Review of Business Programs, a report prepared by a Government-appointed committee headed by David Mortimer, the Chair and Chief Executive of TNT, Asia Pacific Region. This report had been keenly awaited and there has been a good deal of interest and debate ever since. Two other major reports on industry policy have been released since. First there was the report released on 10 August 1997 by the Economist Intelligence Unit (EIU) for the Metal Trades Industry Association (MTIA), Make or Break: A Report for MTIA by EIU Australia. The EIU is part of The Economist newspaper group. The objective of this report was 'to present the thinking of business on what industry policies have the best chance of being effective in meeting our national development goals.'4 Following that, on 24 August 1997 the Government released the report of the Information Industries Taskforce, The Global Information Economy: The Way Ahead. This taskforce was chaired by Professor Ashley Goldsworthy from Bond University. Within the 'vision' of the Goldsworthy report was that 'Australia must become a world Top 10 producer as well as user of information and communications technologies'.5

The most influential is likely to remain the Mortimer Report. As an official report it has more status compared with the EIU, and Mortimer provides a wider sweep than the Goldsworthy report which is necessarily focused on the information industries. This paper seeks to first outline the Mortimer, Goldsworthy and EIU reports and then attempts to assist in understanding the debates on industry policy. The main themes of the three reports are stressed. In an important sense these three reports present the business perspectives on the debates. The discussion which follows attempts to explain the difference between the business perspective and the neo-classical economics perspective as represented by, for example, the Industry Commission. Some comment is also made on the 'cumulative causation' mechanisms which can be used to make a case for industry policy interventions along the lines of the three reports.

Mortimer Recommendations

The following summarises the main recommendations in the Mortimer report. Mortimer says the Government should:

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• Adopt a target per capita income growth of 3.4 per cent per annum to be achieved through increasing national savings and investment, maintaining low inflation and microeconomic reform.6

• Develop 'action agendas' in priority areas with such agendas to be jointly formulated by industry leaders and government using 'Supermarket to Asia' as a model. The aim of Supermarket to Asia is to improve access to Asian markets and cut costs of exporting. The Supermarket to Asia strategy involves the establishment of an

industry/Government council to provide direction and leadership, focus on business competitiveness and productivity, sustainability and quality, trade and market development, and communication.7

• Consolidate business support programs into five key programs, from the roughly 70 Mortimer looked at, with guaranteed five-year funding arrangements which Mortimer costs at $20.75 billion, up $0.84 billion on forward estimates. The five key programs would be:

1. Investment. This program would be responsible for promoting and facilitating investment. A proposed 'Invest Australia' would be responsible for promoting and attracting investment, including foreign investment, identifying global investment proposals suited to Australia and formulating strategies to win investments where there is a net economic benefit. An Investment Advocate would liaise with business and advise the proposed Cabinet Committee and the responsible Minister. Tailored investment incentives would be developed and administered in this program subject to a five year spending ceiling of $1 billion.

2. Innovation. This program would manage new sub-programs, Innovation Rebates, Venture Capital, and Public Research Infrastructure. There would be a single R&D scheme based on the tax concession at 100% (down from 125% at the moment) plus an innovation rebate at 14 per cent of eligible expenditure. Together that gives a government: private 50: 50 contribution to private R&D expenditures. Payments would be made quarterly under five-year contractual arrangements. Ausindustry would be terminated but the innovation rebate would also be payable to small business for management improvement services and advice on technologies. Public organisations such as the Commonwealth Scientific and Industrial Research Organisation (CSIRO), the Australian Nuclear Science and Technology Organisation and the Australian Institute of Marine Science would be required to increase their external funding. CSIRO and the universities would be required to double their support for spin-off companies. Cooperative Research Centres would be terminated where there is a predominantly private benefit.

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3. Exports. This program would absorb existing programs such as Austrade and the Export Market Development Grants Scheme. It is proposed that a Cabinet Committee on Trade and Industry Policy put priority on the development of 'focused bilateral market access strategies' where Australia has strengths. This would be carried out by a proposed 'National Trade Negotiator'. Austrade would be better focused by getting out of 'mature markets', other than on a user pays basis. Austrade should also work harder to promote an export culture and promote Australian capabilities.

4. Business Competitiveness. This program would include the sub-programs, farm business, adjustment and competitiveness rebate. The first two would carry on existing farm business training, management and adjustment activities. The competitiveness sub-program would include the diesel fuel rebate, the factor (f) scheme8 and the current array of import duty rebates through a single scheme.

5. Sustainable Resource Management This would include the sub-programs; land and water natural heritage trust programs, energy efficiency, forest industries and fisheries management.

• Develop formal assessment procedures to vet new business programs. The criteria for new business programs would be based on net economic benefits and addressing market imperfections. The programs themselves would have clear performance criteria to determine whether they are meeting their objectives, separate policy delivery structures would be developed with opportunities to outsource the latter.

• The three agencies involved, Industry, Science and Tourism, Primary Industries and Energy and Foreign Affairs and Trade, develop 'first stop shop' arrangements and develop a single claim form for all entitlements.

Mortimer has proposed a total budget for the five programs of $20.75 billion over the years 1989-99 to 2002-03. That would be broken down according to the following table. The table also shows the net change sought by Mortimer.

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Mortimer funding proposals, 1998-99 to 2002-03. $billion

Proposed Change

Investment 1.11 0.99

Innovation 3.64 -0.22

Export 1.77 0.00

Business Competitiveness 13.26 0.09

Sustainable Resource Management 0.97 0.00

TOTAL 20.75 0.84

The Economist Intelligence Unit for the Metal Trades Industries Association

The EIU made seven recommendations for 'government policy to win investment'. These include:

1. Good macroeconomic policy.

2. Tax reform with the intention of boosting export competitiveness and addressing inefficiencies.

3. Investment incentives.

4. Joining with the ASEAN Free Trade Area.

5. Industrial relations reform.

6. A powerful Australian investment agency.

7. A strong, central coordination of industry policy.

Of the above list, 3, 6 and 7 are the major recommendations which specifically address industry policy rather than addressing what might be described as an economic climate business would like. These recommendations are described in more detail in the following box.

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Investment incentives. Suggested here are:

• Introduction of a 200 per cent deduction for R&D in line with some other countries in our region.

• Incentives using grants and tax concessions for major investment projects.

A powerful Australian investment agency. Taking a lead from Malaysia, Singapore and Ireland, the EIU suggests:

• Creation of a central agency for investment promotion with the authority and resources for rapid responses.

• Assistance for the Prime Minister and the proposed investment agency through the creation of an advisory board, with the agency staffed by people with business experience.

• Development of guidelines for cooperation and coordination with State Governments.

A strong, central coordination of industry policy. For this purpose the Prime Minister's department would be the coordinating authority. The ACCC, Productivity Commission and other agencies to be reviewed to ensure consistency with the proposed new authority of the Prime Minister's department.

Goldsworthy's Global Information Economy

Goldsworthy puts forward seven challenges with proposed action agendas built around them. These challenges with the major action agendas are summarised as follows:

• Adopt and implement a National Information Industries Policy.

• National Leadership. Appoint a Cabinet Minister for Information Industries, establish an Information Industries Council, pursue a national agenda working with State and Territory Governments, and establish an information industries fund to undertake feasibility studies on identified opportunities. Also included here are strategies to use the government as a leading edge purchaser so as to maximise industry development opportunities from government procurement, including the use of outsourcing.

• Proactive Investment Attraction should be undertaken through a proposed investment attraction agency to attract foot-loose investments and encourage the transfer of technology and skills. Access to capital should be encouraged through

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the development of venture capital and development finance, including through assistance to get businesses 'investor ready'.

• Going Global. This includes efforts to try to overcome external barriers through trade bargaining and similar initiatives, enhancing the capacity of firms to export through an 'Export Ready Program,' improved coordination among industry and government bodies at all levels, a replacement for the defunct DIFF scheme and extending the Export Market Development Scheme. It also proposes support for globalisation through the development of contacts abroad and a proposed outward investment facilitation program.

• Getting On-line. There is an important role for the Government as champion for going on-line and the promotion of exciting case studies as well as the Government itself acting as a leading-edge user. Government should also encourage electronic commerce as both desirable in itself and as an industry development matter.

• Enhancing Skills Formation. Government should enhance the links between education providers and business as well as increasing the resources going into information and communications training and education.

• Enhancing Research, Development and Innovation. Goldsworthy says Government should introduce a 'competitive R&D tax concession' and ensure there is more information and communications focus in the R&D institutional structures. Australia should actively participate in standards development processes and disseminate information and intelligence to industry. Support should be provided for major international projects and key infrastructures.

Many of these specific recommendations involve close personal collaboration between industry and industry's global leadership, and the Australian Government at the highest levels. There is an important sense in Goldsworthy and other such proposals that personal relationships and negotiation between business and government can play an important part in industry policy. (One is reminded of the personal efforts Senator John Button used to put into the relationship between key businesses and government.)

In addition to the above list of specific industry policy measures, there are a certain number of general economic policy recommendations, such as ensuring taxes are simpler and internationally competitive. Those other recommendations are not the subject of this paper.

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Comment

These reports have a good deal in common. The main common features are:

• Investment attraction subsidies

• Greater incentives for private research and development/innovation, and

• Industry specific planning.

On the investment attraction subsidies, Goldsworthy and the EIU would include tax holidays for major concessions similar to those which operate in some Asian countries. These tend to be concessional taxes on income (Goldsworthy suggests 10 per cent) for say a five year period. Goldsworthy, perhaps anticipating possible objections, says a 'tax holiday for an investment that would not otherwise have been made is not tax revenue foregone.'9 That is no doubt true if they can genuinely be confined to investments which would not have otherwise occurred. In addition to the tax concessions, all three reports have in mind some sort of fund for use in making grants to sway investment decisions on the part of wavering multinationals.

The second common factor is the suggestion of enhancing the R&D tax concessions. This is combined with some criticism of the decision to reduce the concession from 150 per cent to 125 per cent in the 1996 Budget. Goldsworthy and the EIU seek a 200 per cent deduction in line with the 'double deduction' allowed in some Asian countries, although Goldsworthy would limit the 200 per cent to R&D related salaries. Of course the double deduction is a greater benefit the higher is the company tax rate in the first place. Under the current Australian company tax rate a double deduction would mean the private:public contribution to a business' R&D would be 28 to 72. That compares with Mortimer's suggested 50:50 split and the present 55:45.10

An important feature of the Mortimer Report is its recommendation which calls for 'action agendas.' Mortimer recommends that action agendas be developed jointly by industry and government using the Supermarket for Asia as a model 'action agenda.' The aim would be to examine current performance with respect to exports, R&D and other characteristics so as to identify impediments to growth, the availability of trained labour, regulatory and other issues. Following that, industry and government would commit to an action agenda designed to improve industry performance and with responsibilities for specific actions shared between the parties.

Instead of Mortimer's action agendas, the EIU bases its industry-level discussion on the existing programs—cars, TCF industries, pharmaceuticals and the IT industries. It believes the industry sector programs have been 'both inward and backward looking' and would seek to redirect the focus to make them 'outward and forward looking.' The EIU would have the existing programs opened up 'to any industry where both companies and

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government were confident that sustainable competitive advantage in a global market could be achieved.'11 All of that would be managed by the proposed investment agency. However, the EIU does not go any further and provide any guidelines as to how the existing sectoral programs might be transformed into outward and forward looking programs. On the other hand, the Goldsworthy report, since it focuses on just one industry, virtually provides a complete action agenda already, albeit with assistance features which may be controversial.

The three reports being discussed here can be seen as part of a common approach— perhaps a business perspective on industry policy. Purists, including some of the newspaper editorial writers, see the Mortimer recommendations as self-serving arguments for handouts to business. In the rest of this paper we attempt to concentrate on the calls for industry intervention put by Mortimer.

Mortimer recommends that 'the Government adopt a whole of government industry policy'.12 The problem though is that Mortimer offers no real guidance as to what that 'whole of government industry policy' might look like or how one would go about putting that together. In a similar way Mortimer observes that '[b]usiness is calling for a vision, but is not doing well at articulating for Government what it means by this.'.13 While endorsing those sentiments Mortimer does not specifically identify what the vision should be or how it might be created.

Mortimer specifies that an industry policy should go 'beyond the narrow view that Australia should accept simply what the market determines'.14 This reflects the general recognition in the community that there are problems with the market which, ideally, government intervention is designed to address. The Industry Commission in a submission to the Mortimer review set out suggested criteria which it recommends should be used to see if intervention is warranted. The main criteria are:

• first, there must be an issue or a problem which is producing an externality, an example of a positive externality would be research and development expenditures which produce benefits which cannot be captured by the person undertaking the expenditure,

• secondly, the externalities must be significant in terms of the costs or benefits which are involved,

• third, government intervention needs to be shown to be the best alternative compared with other possible alternative solutions, and

• in addition to the above, it must be shown that the benefits of intervention will outweigh the costs of intervening.

In the event that all of that is satisfied, the Industry Commission sets out a number of design and delivery criteria which it recommends.15 Mortimer outlined a similar set of

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criteria in chapter four of the report but then departs dramatically from those criteria when discussing the need to 'stimulate domestic investment in new industries' and asserting that a 'strong national capability in investment attraction and facilitation is required.'16

Mortimer tends to use arguments of the type: 'if it is alright in ASEAN countries we should do it too.' In Mortimer and the other reports there is the sense of an international competition for footloose investments, investments which could be situated in a number of locations, and the choice is likely to depend on the incentive different competing countries are prepared to offer. However, there is one important case where Mortimer relies heavily on generally accepted externality arguments. That case is the Research and Development (R&D) area. In that case Mortimer refers to the earlier studies which show a strong social return to R&D spending far in excess of the private return to R&D spending. If the social return exceeds the private return it means society is getting a benefit beyond that which the people involved are paying for. That implies that society would have been willing to pay more for the additional benefit. Furthermore, if the payment is not commensurate with the benefit, it is likely to mean that there will be insufficient effort into providing the beneficial 'good' in the first place. There is a wide variation in existing estimates of the social and private returns so Mortimer opts for a 50 cents in the dollar contribution— meaning the private and social contributions are equal.

In a recent speech to the Committee for Economic Development of Australia, Bill Scales, the Chair of the Industry Commission, severely criticised proponents of interventionist industry policy, including the Mortimer report itself. Scales accepted the Mortimer recommendations to the effect that new policy should satisfy cost benefit criteria and should incorporate performance measures. Indeed, those recommendations reflected the submission the Industry Commission made to Mortimer. However, Scales complains that Mortimer 'does not apply its own established principles of rigorous analysis to this [the $1 billion investment attraction mechanism], and other such recommendations.'17

Scales says that there is no theoretically justifiable argument in Mortimer which puts an intellectually respectable case for industry intervention in many of the ways recommended in the Report. The exception is the references to R&D as discussed above. The Industry Commission itself in its monumental work on R&D argued that there are strong 'market failures' which result in under expenditures on R&D and which require government intervention to correct.18 Scales says '[a]nyone who has even a passing familiarity with the Industry Commission's work would know that we are advocates of government support in this area.' Here Scales is critical of the Mortimer report which wants to scale down the Commonwealth Scientific and Industrial Research Organisation, universities and the Cooperative Research Centres and suggests Mortimer is going in the wrong direction. Mortimer may be motivated, at least in part, by the desire to keep down total outlays within his package of recommendations.

At the time of writing, the Government has not responded to these reports, although Senator Richard Alston, Minister for Communications and the Arts, has also been

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appointed Minister for the Information Economy. In addition, a new National Office for the Information Economy has been created. While these changes follow the Goldsworthy Report, the Prime Minister, Mr Howard, was reported as saying that rather than Goldsworthy, the changes reflected earlier discussions on the beneficial impact of the information economy with US Federal Reserve Chair, Alan Greenspan.19

Philosophical differences

When Scales complains that there is no justification for aspects of the Mortimer Report he is definitely rejecting the proposition that investment should be subsidised, unless a case can be made on market failure or similar grounds as described above. Scales, the Industry Commission and many other economic commentators rely heavily on neo-classical economic theory in their arguments. Imperfections and market failures can occur and provide a justification for intervention in the neo-classical theory. However, these are the exceptions and do not provide a general case for intervention.

One important implication of the neo-classical theory is the view that '[a]ctivity encouraged by government business programs typically comes at the expense of activity elsewhere in the economy.'20 Moreover, neo-classical theory suggests the activities into which you have to 'push' the economy are likely to be less productive than those activities which happen naturally through the ordinary workings of the market. Hence there is a net

'loss' to the economy through such interventions. Of course Mortimer puts himself directly at odds to this way of thinking when he says in the passage referred to above that we should go 'beyond the narrow view that Australia should accept simply what the market determines.'

Mortimer is more inclined to use language such as 'wealth creation' and 'boosting investment' rather than 'increasing efficiency' and 'overcoming market imperfections' which are the catch cry of neo-classical economics. There is certainly nothing in the Mortimer report to suggest the view that induced activity detracts from the overall performance of the economy. Instead there is a perhaps simple view that additional incentives for promoting and facilitating investment will increase our growth rate and so address problems associated with unemployment.

There is also a view in Mortimer and the other reports that investment begets investment. Or perhaps 'business begets business' is a better description. It seems to be a reasonable view in business circles that new business activities create new opportunities for others, spread confidence and in other ways induce even more activity. Indeed, Mortimer's proposed investment incentives should be designed to attract projects 'that will provide the largest spillover benefits to the Australian community.'21 Nevertheless, emphasis on investment and wealth generation challenges the basis of neo-classical economics.

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It is easy to criticise the business perspective, as represented by the Mortimer Report, as just special pleading or 'rent-seeking' on the part of business. On the other hand, business people may find it hard to understand that the interests of business may not be congruent with the interests of society at large. When there is blank misunderstanding like this it is often a result of people seeing the world in completely different ways. It is that which makes for difficult communications between business and institutions such as the Industry Commission and other economic policy making areas of government.

To appreciate this 'communication gap' it is worth pausing to outline how the neoclassical economist sees the world. Important features of the neoclassical vision include the dominance of competition in free markets and the importance of competition in producing the most efficient allocation of resources. Competition and the search for the competitive advantage in the market solves the problem of how and where to produce goods and services in this vision. However, the what to produce is decided entirely by those who want to make a purchase. The consumer is 'king' in this world. Profit can only be made by meeting the needs of consumers, so self interest is harnessed in the cause of meeting the needs of consumers and, therefore, the needs of society. Consumers in turn are assumed to be interested only in maximising the satisfaction they obtain through their purchases in the market.

Maximising welfare means most efficiently deploying society's resources to best meet the needs of consumers. That means setting up the processes in which producers compete for the consumer's dollar, with only those producers who can best meet consumer needs surviving in the long run. Savings and investment are only minor complications in the vision. People are seen to save in order to spread their consumption forward over time. By doing so they make resources available to those producers who wish to expand their capacity to meet the needs of consumers in the future. Saving is deferred consumption which frees present resources so that producers can invest to meet the needs of future cohorts of consumers.

There are many points in the argument where we might want to object or make qualifications. However, that is beside the point for present purposes. Without specifying our objective for the economic system there is no way we can argue that this or that organisation of economic activity is better than some other alternative. The important point is that in the neo-classical vision the objective of economic activity is the maximisation of aggregate consumer satisfaction. That is what is meant by the objective of maximising economic welfare.

However, this vision, or at least this objective, does not really seem to be shared by some of the other perspectives on economic policy such as the perspectives contained in the three reports. The Mortimer report certainly does not talk about how to best address the needs of Australian consumers, although there is no reason to doubt that Mortimer himself would also regard that as a very desirable objective. Instead Mortimer talks about wealth creation and the need to increase wealth, which he sees as the imperative of economic

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policy. Mortimer of course has titled his report, 'Going for Growth.' In addition there are references to enhancing 'the community's capacity to create wealth,' 'increasing the wealth of all Australians, 'boosting investment,' 'more proactive in promoting and facilitating investment.' Key words are 'wealth', 'growth' and 'investment.' Government policies are assessed in terms of their effects on wealth creation. In this Mortimer is not alone. Other business people talk about the objective of policy in terms of creating wealth or increasing investment.

Presumably Mortimer and others have in mind some notion of total wealth in Australia, though whether it should be Australian-owned as well is not made clear. Leaving that aside, a moment's reflection should make it clear that an approach to economic policy

which has the aim of increasing wealth may lead to outcomes not necessarily compatible with maximising welfare as described above.

To begin with, wealth is assets owned by people or companies, but the value of the assets which constitute wealth is determined on the market, the property market, the stock exchange or other similar markets. Now for most assets which constitute wealth, their value is determined in the market on the basis of many factors, among which the expected income yield or future profit is the overwhelming factor. Wealth in dollar terms then becomes the discounted present value of the expected income to be generated from particular assets held as wealth.

Given the public policy objective of increasing wealth, as put by the business community, there are measures which might be advocated even though they would not necessarily increase economic welfare according to the neo-classical vision described above. Tax incentives for business, financed by increasing taxes on consumers, would not necessarily meet the economist's criteria of maximising welfare. However, that policy switch would do the job of increasing wealth. Profit would be expected to increase as a result and so the present value of the future profit stream would be increased. Increasing incentives for business investment could well be criticised as 'business welfare'. It would be seen to distort the market so as to encourage an above optimal level of savings/investment. That would be reducing economic welfare below that attainable in the free market. However, such a policy would appear quite acceptable to the bulk of the business sector since it would be consistent with increasing wealth and maybe investment.22

To the business person thinking in terms such as those described above, there may be nothing intrinsically wrong with tilting the incentive structure in their direction so as to increase the wealth and investment being generated. The business game plan is to accumulate wealth, maximising value for shareholders. Similar objectives are often put as being the desirable objectives for a nation to pursue. That certainly appears to be the case with Mortimer who finds nothing wrong in adding a bit of incentive from the government.

Mortimer's views therefore can be seen to represent a rejection of neo-classical thinking, if not the theory. There is also a strong sense in Mortimer and the other reports that we can

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build a self sustaining growth momentum if we can encourage higher investment. Indeed, Mortimer suggests Australia should direct incentives to projects where there are 'demonstrable spillover benefits' which would be associated with new dynamic processes.23 In this sense Mortimer and the others could be regarded as making a contribution in the spirit of those who emphasise 'cumulative causation.'

Cumulative Causation

This section briefly looks at some of the cumulative causation mechanisms that might be advanced to give more theoretical justification for the government intervention recommended in Mortimer and the other reports. The expression 'cumulative causation' was designed to convey the notion that by bringing in activity X, further processes can be induced which have beneficial snowball effects on the rest of the economy. To illustrate the mechanism it is useful to consider the example of an innovative technology and how the initial training of the workforce spills over for the benefit of other employers.

When an employer trains employees we might at first suggest that it is entirely a matter between them. Both will benefit from a higher skilled workforce—the former receives more output per worker and the latter receive better pay and conditions. However, there is a significant turnover among workers which means that subsequent employers will also enjoy the benefit of the training provided by the first employer. It also means that if the first employer is also the first user of a new technology, the first employer will have to train not only the workers who can be expected to use the new technology in the first instance, but also later workers who are taken on to replace those who leave. The higher is the turnover, the greater is the training that will have to be given in order to ensure a sufficiently trained workforce at any point in the future. In this way the first firm generates benefits for subsequent employers for which it receives no consideration. That is certainly an example of an externality.

Installing a new technology for the new user, or supplying some of the components for it will mean that new skills are learned by the suppliers to the user of the new technology. 'Learning by doing' therefore extends beyond the main user of the new technology. That experience then becomes a valuable resource which can benefit other customers of the supplier firms. The important point is that in the normal course of events there are likely to be benefits which spin off for the benefit of unrelated parties.

The Industry Commission examined such linkages in its report on the motor vehicle industry. It admitted that externalities were generated by car manufacturers but could not identify a specific 'market failure' and so, under its own self imposed discipline, failed to see a reason for government intervention and was not convinced the externalities would have been big enough to warrant intervention.24

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Externalities and spill-overs are no doubt important in Australian manufacturing. However, equally important is the likelihood that economies of scale will be pervasive. Recall the view above that if we push the economy towards greater production of a particular good we are likely to reduce overall productivity. That in turn reflects the view that we run into diseconomies of scale, which means that beyond some point the unit cost of production increases as production increases. If instead increasing returns to scale are pervasive, then there is a strong argument for intervention to get industry as big as possible.25 In that case the more industry is pushed in a certain direction, the lower are its

costs of production. That in turn increases its competitiveness and increases overall productivity.

An influential observer of the East Asian economies has observed:

Where external economies, economies of scale, and learning-curve economies are important, the market structure is unlikely to generate socially desirable outcomes— rapid growth and shifts in economic structure towards higher value added products. In Taiwan, Republic of Korea and Japan, government policy has probably played an important role in stimulating their realization, and hence in improving domestic ability to compete against other countries' suppliers...If one accepts that external economies, economies of scale, and learning-curve economies are major sources of technological advance and productivity growth, the efforts of the state to make sure that market conditions do not obstruct their realization within the national unit take on great significance in explaining the superior economic performance of the East Asian three.26

The above discussion of cumulative causation is not a justification for industry intervention, however, it illustrates how such a justification might proceed and how a theoretical underpinning for Mortimer and the other reports might be developed. To do all that would be beyond the scope of the present paper. The considerations raised by the discussion of cumulative causation also indicate the type of characteristics which an industry might display in order to be a good candidate for government assistance and incentives. The likely candidates should display strong economies of scale (or similar attributes) which would imply that, once set in motion, they should quickly generate a life of their own and generate benefits for other domestic industries.

Conclusions

There have been vigorous debates about industry policy in Australia associated with the Mortimer Report, the Goldsworthy Report and the Economist Intelligence Unit Report for the Metal Trades Industry Association. The three reports seek to provide incentives for globally foot-loose industry to locate in Australia. Specifically, each of them advocates investment attraction subsidies, greater incentives for research and development and a greater emphasis on outward looking sectoral planning mechanisms. Economic commentators, including Mr Bill Scales from the Industry Commission, have criticised

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those aspects of the Mortimer Report in particular, as have some of the economic commentators in the Australian press.

Critics of the Mortimer and other reports believe intervention in industry is not generally warranted unless specific externalities can be found which necessitate government intervention and there is no other means of addressing the externality. It is not the purpose of the present paper to come down on one side or the other. However, it is important to appreciate that the opposite sides in this debate have rather distinct and different conceptions of how the world works. This paper has tried to outline exactly how, in the author's opinion, the respective views of the world differ. It was argued that while the neo-classical economist's argument is based on efficiency in terms of meeting consumer needs, Mortimer and the business perspective is based on increasing wealth and using the investment process as a mechanism to generate greater wealth. Those different starting points can lead to different outcomes. Also implicit in the business perspective is the view that economic performance involves a process of cumulative causation. Inducing greater activity generates its own momentum in this thinking, and if the necessary conditions are present, cumulative causation mechanisms can overturn the conclusions of the neo-classical theory.

Endnotes

1. Review of Business Programs, Going for Growth - Business Programs for Investment, Innovation and Export, June 1997 (Mortimer Report).

2. The Economist Intelligence Unit (EIU), Make or Break: A Report for MTIA by EIU Australia, 10 August 1997.

3. The Information Industries Taskforce, The Global Information Economy: The Way Ahead, July 1997 (Goldsworthy Report).

4. EIU, op cit, p. 4.

5. Goldsworthy, op cit, p. 4.

6. This represents a doubling of Australia's growth over the average of the last decade.

7. Hon J Moore, Media Release, Supermarket to Asia Strategy, 20 August 1996.

8. The factor (f) scheme compensates pharmaceutical companies with higher prices under the Pharmaceutical Benefits Scheme in return for commitments to research and development, exports and other desirable behaviour.

9. The Information Industries Taskforce, The Global Information Economy: The Way Ahead, (Goldsworthy Report) July 1997.

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10. The public 45 contribution is calculated as the tax deduction of 125 per cent times by the 36 cents in the dollar tax rate.

11. EIU, op cit, p. 109.

12. Mortimer, op cit, p. 6.

13. ibid, p. 4.

14. ibid, p. 7.

15. Industry Commission, Industry Commission Submission to the Review of Business Programs, February 1997.

16. Mortimer, op cit, p. 83.

17. W Scales, 'Which industry policy is the best policy for industry?' speech to the Driving Australia's Growth Conference, Committee for the Economic Development of Australia, 13 August 1997, p. 11.

18. Industry Commission, Research and Development, Report No 44, 15 May 1995.

19. AAP, Howard announces new portfolio, 16 September 1997.

20. Industry Commission, Industry Commission Submission to the Review of Business Programs, February 1997, p. v.

21. Mortimer, op cit, p. 13.

22. In practice, however, such a policy may well hurt those businesses selling to domestic consumers.

23. ibid, p. 90.

24. Industry Commission, The Automotive Industry, Volume 1, Report, May 1997.

25. Economic Planning Advisory Council, Competitiveness: the Policy Environment, Council Paper No 47, April 1991.

26 . R Wade, 'The role of government in overcoming market failure: Taiwan, Republic of Korea and Japan,' in H Hughes (Ed), Achieving Industrialisation in East Asia, Cambridge University Press, 1988, p. 154.