Adam Triggs | The Australian government should tread carefully on industry policy

The United States is pumping hundreds of billions of dollars into industries to support everything from electric vehicles and semi-conductors to steel and aluminium.

The EU's "open strategic autonomy" strategy and China's "dual circulation" strategy promise similar levels of industry support. Japan, Germany and Korea are moving in similar directions, justified on geopolitical, economic or environmental grounds.

Should Australia do the same?

In some ways, we already are. The Productivity Commission outlined last week that the federal government spends a whopping $13.8 billion on industry assistance each year.

The National Reconstruction Fund is another $15 billion frolic into the world of industry policy.

The fundamental challenge Australia faces is this: the costs of industry policy are big and guaranteed, whereas the net-benefits have historically been small and uncertain at the best of times, let alone when the world's superpowers are playing in the same space.

If Australia wants to ensure that the benefits outweigh the costs, there are some guiding principles we need to keep in mind.

Let's start with the costs of industry policy.

Those who regularly advocate industry policy often start from the (implicit) assumption that you can have a free lunch.

MORE ADAM TRIGGS:

The government plucks money out of thin air to fund "Made in Australia" projects. Those projects employ workers out of thin air to work with capital, energy and materials which are also plucked out of thin air, with no impact on inflation, prices, interest rates or the exchange rate.

Industry policy makes perfect sense in this world. But this world doesn't exist.

In the real world, Australia has a limited pool of resources with which to produce things. Redirecting resources into one industry means taking them away from others.

Suppose the government wanted Australia to be the world-leading producer of buttons for shirts. What would be the cost of this?

If the government kickstarts our button industry through subsidies or tax breaks, it must increase taxes elsewhere, raise the deficit for future generations to pay back, or cut its spending on things like healthcare, education, infrastructure or defence. There's no free lunch.

Alternatively, if it kickstarts the industry through tariffs on imports, it is implicitly taxing households and consumers by reducing their purchasing power and making our cost of living crisis worse. Again, no free lunch.

And regardless of how the government kickstarts Australia's button industry, that industry will need workers, capital, energy and materials. This means less of those things for other industries along with more expensive goods and services, higher interest rates, an appreciated exchange rate and reduced international competitiveness.

Industry policy is the government deciding what you want produced, instead of you exercising your choice in the market. So, a big cost of industry policy is what the economy could have been without it.

And if the government picks the wrong industry to support, the outcome is lower productivity as resources are redirected away from productive industries towards those that can only survive with government protection.

Industry policy also tends to favour existing firms who can lobby hard for support to shelter them from competition and block new entrants.

None of this means industry policy is definitely bad. It just means that the benefits need to be big enough to justify the costs and risks.

Industry policy only makes sense if it addresses a market failure. Supply-chain vulnerabilities and exposure to geopolitical risks fall into this category, but only if they actually exist.

After all, national security commentators claimed for years that Australia is too exposed to economic coercion from China. And yet, when China hit Australia with unprecedented trade restrictions, the impact was almost non-existent.

The same is true for supply chain vulnerabilities. Out of the hundreds of thousands of goods and services that flow around our economy each year, only a fraction of 1 per cent of them have got into trouble.

So, what are some guiding principles for government in thinking about industry policy?

First, measure the costs. It is ethically and economically wrong to suggest that industry policies are costless. Will taxpayer support be a one-off? Or will it be needed for decades to come? And who gets the benefits?

Second, the government should clearly articulate what the market failure is they are seeking to address. They must prove it exists and measure the benefits of addressing it to ensure we aren't just lining the pockets of business.

Third, the government should explain why the market failure exists. After all, there are sensible reasons why entrepreneurs don't make semiconductors (or buttons) in Australia. The government should be able to explain those reasons so we know the policy is sensible.

Fourth, if global superpowers with budgets 10 times larger than ours are already moving into particular areas, Australia should not try to compete. Instead, we should find ways to free-ride on their assistance and use our political connections to get our businesses into their supply chains.

History shows that industry policy has a poor success rate, so we need to be very clear on why we think it will work this time. As the old saying goes: governments might be terrible at picking winners, but losers are great at picking governments.