Like a Tiger: Upgrading Australia’s Economy

Australia has been extremely fortunate in recent decades to have benefitted from a once-in-a-century boom for the resources we export. What this boom has masked however, is an economy that is otherwise stagnant, undiversified and unsophisticated. Harvard University ranks our industrial complexity (an indicator of our productive knowledge – our ability to add value and therefore create wealth and prosperity) as a dismal rank #93 in the world, between Pakistan and Uganda. This indicator matters: it has been shown to be a strong predictor of both national income and economic growth.

Our reliance on exporting raw commodities to a small number of countries is problematic for obvious reasons. In an increasingly volatile geopolitical environment, these income sources could all but vanish overnight should the USA move towards all-out containment of our main customer, China. A prolonged downturn in commodity prices would be almost as devastating, and not unlikely given that the Chinese are running out of things to build (hence their belt and road initiative).

Not only does having an undiversified commodity-based economy presents many risks for Australia, we are also foregoing the economic benefits that come from having a value-adding, high complexity economy. Take the example of Singapore: a country of 6 million people and basically no natural resources, their per-capita GDP (PPP) is the highest in the world because their economy is based on adding value to raw materials, and they provide an open and attractive environment to do business. Singapore ranks #5 in the world for economic complexity. We may be the lucky country but Singapore made their own luck.

Considering that less than 1% of Australians are employed in mining, imagine if the other 99% were participating in an economy as dynamic as Singapore. Even without mining we would be much richer than we are now - add to that our mining income and we would be the envy of the world.

One of the reasons that high-complexity economies perform so much better is that their industries have more capacity for innovation and productivity growth. Simple industries like mining and agriculture have few moving parts: grow it, harvest it, sell it. There’s only so much you can do to boost productivity in these industries. Complex industries have much greater scope for highly paid workers to improve the product and the production process.

A key priority for our party should be to adopt policies that will help Australia transition from a simple economy to a complex one.

In doing this, we would be wise to learn from the experience of the countries that have been most successful in achieving this transition: the four Asian Tigers of Singapore, South Korea, Taiwan and Hong Kong.

Although there is considerable debate about the role of government policy in the “East-Asian Miracle”, there are nevertheless some clear lessons we can apply in Australia.

First is the importance of investment in export-focussed industries. All of the Tigers had clear and effective policies that fostered investment and promoted growth of export industries. Some of these may not be very palatable to the more doctrinaire neo-liberals among us, but others are no-brainers.

At the very least, we should be adopting a key Asian Tiger policy: very low taxes for export industries. We should adopt a policy that cuts the company tax rate to 10-15% for all companies that derive a certain portion of their revenue from exporting manufactured goods. We could even go further and give companies that commence significant exports a period of 5-10 years tax free.

In the case of Taiwan and South Korea, their growth involved significant levels of protectionism and direct investment of taxpayer funds in new industries. Although both of these policies are frowned upon by modern Liberals (and with good reason), we should not be too quick to dismiss them altogether. In particular, a degree of protectionism can help infant industries to scale up to a level where protection is no longer required. A key characteristic of the Asian Tiger protectionism was that there was a central bargain: the state would provide protection and in return the protected firms would be expected to achieve increases to their productivity and competitiveness. This two-way bargain was crucial to avoid rent seeking.

Unfortunately, Australia has a history of the wrong kind of protectionism: pouring taxpayer funds into dying industries like car manufacturing to avoid politically inconvenient layoffs. Instead, we should be seeking to protect emergent industries where we can have a strong competitive advantage. This could take many forms: subsidies, tariffs, cheap credit or government procurement quotas are all ways we could help nurture nascent export-focussed industries.

There are many examples of high-growth, high-complexity, export-oriented manufacturing opportunities for Australia, I’ll name just two. The first is medical devices: Australia has a rich history of expertise and innovation in this field: the bionic ear, the pacemaker, and the ultrasound were all invented in Australia. CSL (a biotechnology company) is our third largest company by market capitalisation. This is an industry which is going to grow massively in the century ahead, as healthcare becomes a bigger share of world GDP. The second is batteries: regardless of one’s opinion about batteries and net zero, it’s undeniable that demand for batteries is going to skyrocket in the coming decades. Australia has the advantage of producing almost every raw material needed for manufacturing batteries, and close proximity to the major electric car manufacturing countries.

It's often claimed that we can’t do manufacturing because our labour costs are too high – but this misses a key point about high tech manufacturing: the labour costs are irrelevant because the factories are almost fully automated. What’s often lacking is the skills and expertise required, which leads directly to the other key ingredient of the Asian growth miracles: education.

A discussion of the role of education in transforming the Australian economy would warrant an entire blog post, but it boils down to this: STEM education and high-tech jobs are like the proverbial chicken and egg. Without high-tech jobs, students won’t pursue STEM education, but without a STEM qualified workforce, it’s difficult to create a competitive high-tech industry. What’s needed is an overarching policy framework that provides both simultaneously: incentivising top students to pursue STEM, while also providing attractive job opportunities for them through effective industry policy, with a skilled immigration program to fill the short-term gaps.

As well as physical goods, we should also find ways to increase our exports in services, particularly digital ones.

We can start by overhauling the Research and Development Tax Incentive. This incentive exists to encourage businesses to invest in R&D by essentially funding half of the costs. The scheme, while well intentioned, has a number of major flaws. Firstly, it applies to a very narrow version of research and development that seems to be written by a high school science teacher: eligible activities must “proceed from hypothesis to experiment, observation and evaluation and lead to a logical conclusion”.

This definition of eligible activities is utterly ridiculous, and there is now an entire consulting industry built around creatively reframing all manner of business activities into eligible ‘experiments’ so as to claim the substantial tax benefit.

The main problem with this definition though is that it excludes the single most important area of innovation: digital products and services. Almost every major productivity improvement of recent decades has involved software, yet software development is not counted as R&D. Almost every ‘unicorn’ startup (i.e. valued over $1B) is a software business, yet early stage startups are ineligible because they don’t experiment with test tubes, they experiment with products and business models. I have a relative whose business gets millions in R&D tax incentive for developing new facial creams, is that business really more deserving than a software startup?

At the very least, the tax incentive should be broadened to encompass digital innovation. Ideally it should incentivise all types of innovation including new business models and the application of existing technologies in new contexts. This will no doubt cost more than the current $3.2B per year, but the economic benefits of such a policy would far outweigh the costs.

Finally, Australia’s tax treatment of dividends provides a strong incentive for businesses to pay out profits as dividends rather than invest them back into their businesses. Australia is one of only five OECD countries that has fully imputed dividends (franking credits), with many countries deliberately ditching the system such as the UK, Singapore, Malaysia and a number of European countries. In most cases this coincided with cuts to the company tax rate, further boosting investment.

Franking credits might seem great for those living on passive income, but they are bad for our economy because they lead to lower investment and therefore less innovation and slower productivity and economic growth. It would be politically challenging, but we should seriously consider removing dividend imputation and simultaneously cutting the company tax rate.

Australia is the lucky country, but the mining boom was just that: good luck. The Liberal Party needs to have a vision for an Australia whose prosperity is undergirded not by what we dig up, but by what we know and what we make.