Budget Forum 2024: Future Made in Australia

Before the budget the Australian Government announced a new program, Future Made in Australia.

The program’s main objective is to provide substantial government financial assistance for industries and firms to expand production and employment involved in the transition to a future of lower greenhouse gas emissions. In part, the program is argued to match similar programs in other countries, including the United States’ Inflation Reduction Act, the European Chips Act, the Made-in Canada Plan, and the Green Industrial Initiative of Norway.

However, this blog argues that the Future Made in Australia program is likely to have undesirable efficiency and budget effects. This is because selective industry assistance generally results in an inefficient allocation of scarce national resources and added pressures to the government budget.

Some context

Clearly, the Australian economy, as is the case for other economies, is facing the need for significant structural changes in the mix of goods and services produced and the methods of production. Causes for change include the continued development of new technology, shifting geopolitics and international trade, the transition to a greener economy, and changes in relative input prices and consumer tastes.

Inevitably, successful responses of the production economy to the on-going structural changes involve much experimentation, and there are winners and losers along the way. In most cases the private sector has the incentives, capacity, and flexibility to explore the options and then to increase investment in the more rewarding reallocations of inputs, production methods, and output mix.

Government policy interventions can play important complementary roles in this process, correcting market failures and facilitating better private sector decisions. This includes facilitating and promoting research and development, reducing external costs of pollution, or regulating natural monopoly of much infrastructure.

Inefficiency arguments

The rationales of subsidies for selected businesses, as proposed by the Future Made in Australia program, include creating a greener economy and matching similar policy programs in other countries. However, such subsidies are likely to result in an inefficient allocation of Australian inputs and mix of products produced and traded internationally when the subsidies are for a particular industry, and more so for a specific firm in an industry.

International prices for traded goods and services provide a guide to the opportunity benefits and costs for Australian exports and imports, respectively. If other countries subsidise some of their products or production methods, the subsidies change world trade prices and the relative opportunity costs facing Australia. That is, the policies in other countries to subsidise the costs of production for green and green-related goods and services, such as the US Inflation Reduction Act, reduce the comparative advantage for Australian production of these products.

In the case of imports, some of the foreign country subsidy is transferred to Australian consumers as lower prices than otherwise. By the same market adjustments some of an Australian subsidy on Australian exports will be passed forward to the foreign buyers as lower import prices.

The Future Made in Australia program already has offered specific firms with large financial support not available to other actual and potential firms in the industry or in other industries. This is a story of “government picking winners” and effectively overruling the more knowledgeable decisions of private sector businesses.

Both government and private businesses make mistakes in the choice of different products and production methods in an evolving world. Leaving decisions to competing firms in the private sector has the efficiency benefits of drawing on larger sources of information, more quickly assessing winners and losers, and withdrawing investment and production in the event of loss outcomes.

Some also argue that firm- and industry-specific special government subsidies, tax concessions, financial support, and so forth, foster private sector investment in rent seeking to obtain and increase government grants rather than investment in new products and production methods.

Subsidies versus taxes

Australian government subsidies to increase production of green products and to shift to less pollution-intensive production methods, aimed at reducing the production of greenhouse gases and other pollutants, are a less effective and socially costly way to reduce the external costs of pollution than a tax. The subsidy lowers the private cost of production and consumption of the products below the social opportunity cost. By contrast, a pollution tax raises costs and prices and internalises the external costs.

Even if some of the revenue gained from a pollution tax is redistributed for equity reasons to those on lower incomes, for example, by increases in social security payment rates, there is a net government revenue gain.

By contrast, a subsidy as proposed under the Future Made in Australia program involves an additional expenditure claim on the government budget. Given the structural deficit position of the Australian government budget, the tax correction instrument for the pollution externality is a major advantage.

Government support for research and development

Government support for research and development in a world of private owned and operated firms is an example of complementary government intervention to offset the external and public good benefits of such activities if left to the private sector.

General government support measures for research and development include a mix of government funding of research through universities, government departments and agencies, and the Commonwealth Scientific and Industrial Research Organisation (CSIRO), direct grants and tax concessions for private sector investment, and intellectual property rights, including patents and brand names.

There are compelling reasons for economy-wide government support programs for research and development rather than firm-specific, and even industry-specific, assistance. Certainly, the relative magnitudes of the external benefits of research and development vary across industries, firms, and over time. However, the information required, and the additional administration and compliance costs, for government to accurately quantify the relative magnitudes of external benefits across different industries and firms are very large. The costs and mistakes, therefore, stand as barriers.

Budget challenge

A major challenge for the 2024-25 budget is the need to reduce fiscal stimulus. This is a short-term macroeconomic policy objective to support the Reserve Bank in reducing inflation. Restraining expenditure also is a longer-term structural budget challenge, with rising demands for the National Disability Insurance Scheme (NDIS), defense, and an ageing population.

The Future Made in Australia program involves additional government outlays that are of limited society value for the reasons discussed above.

Conclusions

Government interventions to correct market failures play important complementary roles in a mixed economy, influencing the choices of efficient mixes of goods and services to produce, as well as the selection of production methods. However, financial assistance for specific firms, as proposed as a major component of the Future Made in Australia program, does not correspond to more general government policies towards the private sector.

The game of “picking winners” is bound to involve significant efficiency losses at a time when increased productivity is vital for Australia. Also, current fiscal policy objectives call for restraint on expenditure, with the Future Made in Australia program ranking low on the social efficiency index.