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The Case for Protectionism and the Subsequent Revolution


Sharon Lai

By

October 14th, 2012


Where Australian protectionist policies came from and commentary on their relevance today.


Welcome to the third and final installment of my series on the history of protectionist policies in Australia! My first article sketched out the political economy theories that can be used to analyse the rationales of protectionist policies, whilst the second outlined the key events in trade protection over the 20th century. This article takes us back to the first principles of economics as we explore the economic arguments for protectionism that were presented during that era. We also consider the primary causes of tariff reform in the 1980s and the potential reasons for their lasting impact. When thinking of rationales for protectionism, the “infant industry” argument immediately comes to mind.  Protection is deemed to be necessary for incumbent firms in emerging industries because these industries do not have the economies of scale to compete successfully with established enterprises in other countries.  As such, we see countries adopting high tariffs to protect domestic manufacturers against international competition. The fundamental qualification of this argument is that protection is only required during the early years – a temporary cost in the present to gain a strong domestic industry in the future. However this very assumption elicits the most criticism, as industries may remain protected even after they have passed their stage of “infancy”.  Here I draw your attention to a quote from John Kenneth Galbraith[i], one of the economic elites of the 20th century:

Friedrich List, were he to return to the United States today, would observe with interest the modern manifestation of his case for protection. The evolutionary process that he described does not end, as he held, with an equilibrium of mature industry and agriculture for which tariffs are irrelevant. There comes at that point an aging process in the more mature countries, and from this comes pressure for protection against newer and more vigorous arrivals on the industrial scene…The former infant-industries exception has become the aged- and senile-industries exception. In tactful modern terminology, it is called not protection but an industrial policy. 

– John Kenneth Galbraith (A history of economics: The past as the present).

What an ingenious (and accurate) observation!

Several other arguments for protection were put forward on economic grounds during the 20th century. As I discussed in my last article, it was believed that protection would shift the distribution of income towards wage earners. This was partly based on the belief that protection could maintain output and employment during troughs in the business cycle. The need for a more balanced economy was another central argument for manufacturing protection in Australia[ii]. Primary production had dominated Australian industry since the turn of the century. Given that the world’s leading economies were also the most industrially advanced, there was much public support for building and sustaining a domestic manufacturing sector.

Thus throughout much of the 20th century, protectionism ideologies were rooted deep within the political doctrines of governments. The strength of these principles was such that policy reform would occur only in response to international and domestic pressure or fundamental shifts in party creeds – both of which incidentally came to manifest in the 1980s.

Coming into the latter decades of the 20th century, there was growing dissatisfaction with the poor outcomes invoked by protectionist policies. Australian manufacturing firms had become uninterested in research and development, content to produce only for the domestic market. This complacency inadvertently implied that protectionist policies had failed to develop an internationally competitive manufacturing industry, and a viable export trade.

Domestically, private interest groups began lobbying for tariff reform during the 1970s, including the National Farmers’ Federation, some mining companies and a few manufacturers involved in exporting[iii]. Furthermore, international developments meant that Australia could not maintain protectionist policies for its manufacturing industry whilst simultaneously pursuing freer world trade in agricultural products. International pressure arose as a result of Australia’s greater reliance on Asian trading partners. The transition of these countries into construction-intensive stages of development opened up markets for Australian exports of commodities. However this also created a need to accommodate their manufactured exports.

Finally, the state of politics during that time was also remarkable. The Labor party had historically been an unequivocal supporter of protection for the manufacturing industry. The Party abruptly changed its stance towards protectionism during the 1970s and 1980s. This change of attitude was accompanied by a noteworthy and atypical advantage for a government inclined towards reform – the support of the Opposition. The Coalition agreed with the microeconomic reform direction of the Labor government and even attacked it for not pursuing these reforms more rapidly.

Accordingly, the industry and trade policy revolution arrived, initially led by the Hawke Labor government, and continued by Keating in the 1990s. The rest of the story is relatively easy to infer. From March 1983, the government pursued an industry and trade policy mix that attempted to restructure the Australian industry. Improving efficiency and international competitiveness were the primary aims of microeconomic reform. In a sharp contrast to the preceding seven decades, trade liberalisation initiatives during the 1980s targeted the most heavily protected industries. The culmination was that by the 1990s, average nominal rates of industry protection had fallen by 8 per cent[iv].

Where does that leave us today? Obviously we are not going to expect a sudden change in policy towards greater protectionism, but why exactly have these reform principles endured? After mulling over this for some time, I can only surmise that the protectionist policies were triggered by a unique set of factors that are no longer relevant. In the post-war era, governments thought it crucial to engage in nation-building by developing a strong and self-sufficient domestic industry. As such, tariffs represented a plausible policy response to generate the demand for labour needed to sustain rapid population growth. In recent decades however, the services sector has overtaken the manufacturing sector in relative importance for employment and output. This is an inevitable consequence of our transition to a knowledge, and services-based economy. Thus although manufacturing protection may have had merits on economic and political grounds during the 20th century, a case for protectionism simply no longer exists.

 



[i] John K. Galbraith, A History of Economics: The Past as the Present (London: H. Hamilton, 1987).

[ii] Albert G. Kenwood, Australian Economic Institutions Since Federation (Melbourne: Oxford University Press, 1995), 67.

[iii] ibid, 80.

[iv] D. Clark, “Microeconomic Reform,” in The Australian Economy: The Essential Guide, ed. Peter Kriesler (NSW, Australia: Allen & Unwin, 1995), 151.

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

  • Theo Josseff

    A great conclusion to a fascinating series. As a keen economics student myself, I often find myself engrossed in the 24 hour news cycle. But your articles are a reminder of the importance of being aware of the historical context of current policy decisions.

    My question is in relation to the current state of protectionist policies in Australia, especially regarding subsidies to the car manufacturing industry. Do these policies at least have some merit, when considering workers who simply do not have the transferrable skills to move to other employment opportunities in different areas of the economy?

    • Sharon Lai

      Hi Theo,
      Thanks for your comment! Stressing the importance of economic history was actually a key aim of this article series – I’m very glad that you were reminded of this! Subsidies to the car manufacturing industry have obviously generated very interesting and heated public discourse for some time now. I think that it’s very difficult to justify these subsidies on economic grounds. For starters there’s the issue of opportunity cost and scarce resources – the value of assistance to the automotive industry could be used more efficiently in other areas, and there may be other more efficient industries competing for scarce resources. The protection of jobs (given that car manufacturing is labour-intensive) is ultimately a political aim, as protectionism imposes a huge economic cost on other parts of the economy. Furthermore, workers are currently being displaced in other areas of the economy in industries that do not receive assistance– here I’m thinking Darrell Lea, Allans Billy Hyde music chain, etc. Support for the car manufacturing industry thus seems to be derived from political grounds (considering that 1. we don’t have a comparative advantage in this anymore; and 2. the industry is internationally uncompetitive and unresponsive to consumer demands). Putting all this together, if the car manufacturing industry is ultimately going to be unviable and unsustainable, efforts would be better directed towards retraining workers. There’s also the risk of perpetuating the issue of workers not having transferable skills (as you stated in your question) and imposing these costs onto other generations. Let’s say these policies are not reformed for another five decades, yet at the end of those five decades the dominant view is that the local car manufacturing industry is unsustainable. In that sense then, these current policies would have propped up a whole new generation of workers in an economically unsustainable industry. I think this may ultimately have bigger social and welfare repercussions than if we were to begin thinking seriously about reforms now. BUT having said all that (and I realise that I’ve skirted around your question), I would conclude that these policies definitely have political merit now, and also social/welfare benefits by assisting the current workforce to continue working in their chosen industry. However I do think that propping up an inefficient car manufacturing industry is delaying the inevitable, has little merit on economic grounds, and may have long-term repercussions due to the diversion of resources from other uses and the potential of imposing this same debate on the next generation. Given that the current state of politics is not very conducive to long term economic management, I doubt we are going to see reforms any time soon. Hope that’s provided some food for thought – apologies for the very long reply!

  • Duncan

    If the argument against protectionism for our manufacturing sector was that trade liberalisation would make it more efficient, as I think you argue here, then the policy has failed miserably. Instead, it’s destroyed the manufacturing sector. I’m not sure this won’t have consequances in the future.

    • Sharon Lai

      Hi Duncan,
      Thanks for your comment! One of the rationales for trade liberalisation was definitely to enhance the efficiency and international competitiveness of the manufacturing sector. I do agree that the current state of the manufacturing sector (particularly car manufacturing as the question above emphasised), suggests that these reform policies did not achieve the desired aim. However initially, firms became outward focused and more inclined to grow their export markets. I think it’s also important to think about the alternatives to trade liberalisation. If reforms hadn’t occurred, we may well still have the highest manufacturing tariffs, which would impose significant economic and social costs on the Australian community. Moreover, Australia’s transition into a services-based economy over the past few decades means that the manufacturing sector has contracted in both relative and absolute terms. Let’s take Victoria as a case in point, where manufacturing has historically played a very important role in terms of both employment and output. However, our comparative advantages in Victoria now lie in having an extremely educated and skilled workforce, deregulated financial markets and access to capital, flexible markets and a diverse industry structure, etc – all consistent with why the services sector has recently become relatively more important for Victoria’s economic development than manufacturing. I wouldn’t say that the reform policies per se have destroyed the competitiveness of the manufacturing sector – rather it’s a product of several factors including the high Australian dollar, worldwide technological trends, lack of domestic innovations, and the mere fact that other countries are more superior at producing cars. There will definitely be consequences either way – this article on The Conversation provides a very interesting perspective: http://theconversation.edu.au/australias-choice-pay-for-a-car-industry-or-live-with-the-consequences-8305. =)

  • Vidit

    Just had a discussion with a friend about this.Thought I’d post it here.

    Q: what if protection of the auto industry ultimately unviable and internationally competitive?

    A:Well, I am sure they do the cost analysis. Think about it this way, if they ship the jobs because they cannot afford 15$ an hour(min wage) but they wouldnt if only they had to pay 12$ an hour, I say it’s worth it. Coz otherwise you’d have more people on dole.
    This allows the govt to save 18k on dole and an adds additional 3500 in taxes. They save 21500 per job saved and only have to shell out 7.2k per job for subsidy. This means a reduced spending of 14300$. So, every job counts.I think they do this analysis and subsidize until it is not viable anymore.

    Q But by subsidising,you may be inadvertently propping up a whole new generation of workers in an unsustainable industry. Then 40 years later you say, whoops the car industry is no longer sustainable.

    A: Well, you dont just let the jobs go overseas.You make risk assessments and see for how long it will be viable.And you train your future work force for the jobs of tomorrow.But this allows your mainly ageing semi-skilled work force to have the dignity of employment rather than making them dependent of the govt. Not to mention it saves money too (coz they only do it if it is viable)

    And this ensures that the car industry just doesn’t vanish. You also ensure you have a smooth transition as you keep the subsidy fixed after a point, so that if it’s not viable anymore, the jobs move overseas slowly.Not to mention it is good politics.

    Q: Of course it’s good politics. But what if management of this policy doesn’t proceed in the way you’re suggesting. Continuing to subsidise sends mixed signals to your labour force – namely that this industry will remain viable and competitive in the future when it is clearly not. What’s to stop a generation of workers becoming car manufacturers? And I don’t think that displacement from car manufacturing jobs = permanent unemployment. Efforts could be redirected towards training and re-skilling, yes even for an ageing semi skilled workforce.

    A:Well, you can change the training programs at TAFEs so that the skills are not just made for those fading jobs.And like I said, using pure numbers, until it brings in profit, it’s worth it.That is why I recommended a smooth transition which would ensure that you can use that very money that you would have lost otherwise into re-skilling laid off workers.

    And mind you, no one joins a drowning ship. If the firms are slowly shipping jobs overseas, they are unlikely to make new hires with limited subsidies.

    And yes, it all has to be managed well.That is why we need smart people in public service.

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