Defects in Economic Tactics, Strategy and Outcomes  (2000+)

There is great scope to improve Queensland's [and by extension Australia's] economic management tactics.

1. The Need for New Economic Tactics:

Australia has officially recognised the need to diversify its economy since the early 1980s.

This recognition followed from concern about the poor prospects of resource based industries, which traditionally constituted about 80% of exports. The problem was seen to lie in the slower growth of those sectors globally relative to manufactures and services, and the weak terms of trade which resource exporters faced (ie the price of imports usually rose faster than export prices).

But what was not considered was the diversification which was being forced upon those countries which already specialised in the areas into which Australia sought to diversify. The problem with this oversight was that those changes 'raised the goal posts' much too high for many in Australia.

Until the 1960s, capital intensive mass production (eg in manufacturing) had been the mainstay of the high productivity achieved in 'developed' North American and European economies. However this was then challenged by newly industrialising countries (NICs especially in Asia) often aided by multinationals who exploited improved global communication and transport to undertake capital intensive mass production in countries with low wages, and adequate basic skills. The NICs (initially Japan) had refused to follow economists' advise to specialise in their areas of comparative advantage (ie labour intensive industries where low labour costs gave then an advantage) because they recognised that this would permanently lock them into relatively lower incomes.

NIC competition lowered the productivity achievable from capital intensive mass production, and led to de-industrialisation in Europe and North America, and a need to shift to knowledge intensive production where higher value added could be achieved (eg because of the transient large returns available to successful innovators). Initially this proved hard to achieve on a large scale - though the emergence of the 'new American economy' suggests that this is now being achieved. The 'new' economy is characterised mainly by a change to the organisation of production to allow much faster learning by the use of networked rather than hierarchical structures - rather than by the IT sector.

These changes rendered Australia's traditional tactics for promoting economic activities (ie attracting investments to exploit 'comparative' advantages) obsolete. Firstly 'comparative' advantages (ie advantages associated with the existing characteristics of regions - such as natural resources) were losing potency relative to 'competitive' advantages (ie those associated with the capabilities of organisations, which could be created). Producers reliant on 'comparative' advantages lack market power (because all producers in a region have similar advantages) and thus find prices bid down to near costs - and have limited value added potential). This is the reason for the poor returns facing Australia's traditional commodity exports. Secondly seeking investment was a poor tactic as the productivity of capital intensive production had been eroded by NIC competition - and there were thus few desirable 'footloose' prospects. For this reason 'industrial recruitment' generally lost priority as a developmental tactic in Europe and North America after the 1970s - though it remained the state-of-art tactic in Australia. It is only by giving priority to acquiring commercially relevant knowledge that competitive advantages can be created so that investment is likely in higher value-added activities.

Many changes have adversely affected the prospects of commodity producers, who were the traditional core of regional economies (eg see Gottleibson R., 'The Grim Truth of Wealth Transfer', Business Review Weekly, 6/7/98). Furthermore (as above) diversification had come by the 1980s to require a shift into knowledge intensive industries. Only in the larger cities in Australia was there been any general basis for success in the new economic environment. This constraint could have been overcome - but was not due to a lack of appropriate institutions to manage strategic change.

2. Defective Strategy for Change

To achieve change, emphasis has mainly been placed on economic liberalisation (eg deregulation, reduced tariffs, competition policy) on the basis of microeconomic theory. Minor exceptions included: government 'assistance' programs (which lock-in market failures and have limited long term commercial relevance) and strategy processes - which are referred to again below.

Microeconomic theory suggests that market (eg price) signals will lead firms to the most productive use of resources. Unfortunately, though this theory recognises that economic change can not successfully be 'planned', it contains severe defects as a way of building economic competitiveness. Three related defects are that mainstream microeconomics does not properly deal with:

• the knowledge and skill assets of firms which are critical to their future performance - but not ensured by maximising financial results (see Carter C., Determining Industry Policy, AGSM Conference, Feb 1992; and Australian Economic Analysis, Critique of the Productivity Commission's Approach to Micro-economic Reform, 1996);
• the 'systemic' capabilities within (regional) economies, which must be effective as a source of relevant knowledge and support if firms and individuals are to successfully compete through innovation (eg industry cluster effectiveness issues like those identified, for example, in Michael Porter's work on The Competitive Advantage of Nations); and
• the effect relevant knowledge can have in accelerating the emergence of those capabilities.

In particular, while the central role of knowledge in economic growth is now widely recognised by economists - it is only treated (inadequately) in 'new' growth theories as an input to a production function, rather than as a means for changing the causal relationships which a production function models (Craig J. Transforming the Tortoise: A Breakthrough to Improve Australia's Place in the Economic Race, Prosperity Press, 1993).

Economists thus usually value understanding the causal relationships in an economy - so as to model them, but do not have a tradition of constructively changing those relationships. [This, it can be noted, is in marked contrast to the methods for problem solving used in those East Asian communities with an ancient Chinese (rather than a classical Greek) cultural heritage].

Amplification (added August 2003)

Economics has failed to develop a good theory of economic development, or a satisfactory theory of economic growth. Until the 1990s, the favoured view was that developed by Robert Solow in the 1950s, under which growth was analysed through a production function whose inputs were labour and capital - but it was recognized that most growth was not associated with those inputs but came from a 'third factor' which was ascribed to knowledge or technological change. In the 1990s economists tired of the 'exogenous' theories under which most economic growth was not explained by their models, and at the suggestion (initially) of Paul Romer many efforts have been made to develop 'endogenous' theories under which knowledge / information could be treated as the critical input to a production function.

Economists' goal has been to apply principles derived from the physical sciences to social systems. 'Positive' economics assumes that causal relationships are fixed in order to allow analysis and modelling, and that the goal should be to understand what the production function IS not to CHANGE it. The latter assumption follows from classical Greek thought, such as Plato's ideas that abstract 'forms' model reality;

The latter view is different to that in East Asia where ancient Chinese cultural traditions prevail, and problem solving methods tend to stimulate changes in causal relationships in social systems by introducing knowledge rather than seeking understanding as a basis for decision making (see 'Asia' Literacy). These methods have apparently been the basis of high rates of economic advancement (ie of economic 'miracles') - though they embody difficulties in dealing with finance as a key economic parameter (see Understanding the Cultural Revolution).

Examples of the 'systemic' capabilities which are needed within a productive industry cluster include arrangements providing: market and technological intelligence; support in business development or innovation; and business-relevant training.

Leadership in developing such integrated systemic capabilities is vital, as well as liberalizing the economy (as sometimes no component of such a system can be viable unless all the others also exist). Without leadership of such development, growth can be limited by the weak capabilities of under-developed economic systems (eg in marginal rural, coastal and metropolitan regions where the institutions needed for a knowledge-based innovation-capable economy did not exist). Accelerating 'learning' by the real economy is vital to develop such capabilities (see Towards Good Government in Queensland, Section 7). However political institutions can not lead this in market relevant ways - due to pressure from self-interested groups, and the probable lack of strategic commercial value in ideas which are so well known that they are politically acceptable (opcit, Attachments G).

In Queensland (and perhaps elsewhere) the professional Public Service had documented and experimented successfully with options to do more than liberalize the economy in the 1980s. However politicization of key functions under successive governments then prevented this happening. For example, it resulted in four economic strategies from 1988 to 1997 being seen as political statements. This prevented them being an opportunity for networks of civic leaders to learn enough about their challenges and opportunities - which could have accelerated development of the real economy.

In practice the knowledge and skills required to successfully manage strategic change were eliminated in the name of Public Service 'reform', and Queensland's traditional economic tactics were continued - ie seeking to 'recruit' (industrial era) projects through low taxes and support for major investors, and provision of government 'assistance' to fill market gaps (which obstructed economic development).

3. Unsatisfactory Economic Outcomes

As always these tactics resulted in the rapid growth of low productivity sectors, because (in the absence of the complementary knowledge assets to provide a local basis for competitive advantages) investments can not usually be in functions which are highly productive, and the community generally can have little scope to capture significant value added. Because traditional tactics were continued and the requirements for competitive success had changed, the capabilities needed for prosperity were often not created and the result was overall under-performance and adverse impacts on many regions and individuals - leading to inequality and political instability.

Queensland has not effectively developed its economy, despite its 'success' in the rapid growth of poor quality economic functions. Economic under-development is indicated by: (a) the growth of mainly low productivity industries (eg tourism with low average wages and returns; and capital intensive resource extraction and basic mineral processing which have typically achieved poor corporate returns for two decades, and frequently have very narrowly concentrated effects); (b) relatively low and declining per-capita incomes; and (c) the existence of marginal rural, metropolitan and coastal regions whose communities have been unable to cope with economic change and have been transformed from productive contributors into virtual 'welfare' cases.

Many thus experienced the social symptoms resulting from under-employment and unemployment. The One Nation phenomenon was incubated by this failure.

However this is not just a state problem, and the split between the 'haves' of the knowledge economy and the 'have-nots' of the rural, coastal and metropolitan margins is now recognised nationally.

That the nationwide problem is similar to Queensland's is shown by an analysis commissioned for Victoria's Parliament at the request of the independents who held the balance of power after the demise of the Kennett Government ( Birrell B., Dibden J. and Wainer J. 'Regional Victoria: Why the Bush is hurting', Centre for Population and Urban Research, Monash University, January 2000). It suggested (in effect) that the problem lies in relative economic underdevelopment in 'the bush', compounded by the selective effect of inter-regional migration. The latter refers to the fact that those with limited economic contributions and limited means migrate to 'struggling' regions because living there is cheaper (particularly for housing costs), while those with strong potential contributions move to where there are opportunities - and in so doing they further weaken the 'struggling' regions.

Nationally the problem is also shown by: (a) the need for ongoing devaluation to price enough people into jobs; (b) a (dangerously?) high current account deficit (representing a structural gap between national spending, and the (lower) income derived from such spending); and (c) political demands which distract governments from forward looking policies (the latter according to the Business Council of Australia - see Taylor L. etal 'Howard lacks vision, laments bosses', Financial Review, 5/4/00).

Australia's (so called) 'miracle' economic performance in recent years in the face of the Asian financial crisis reflects some progress, but the benefits were not universal, and (to oversimplify somewhat) the 'miracle' also reflects (a) strong economic performance and the growth of an asset 'bubble' in the USA which has boosted world growth and (b) large de-valuation of the nation's production which made it easy to achieve rapid productivity 'growth' - while its prior value was simply being restored.

Amplification (added September 2004)

See also Debating the Impact of Economic Liberalism in Australia  and Does Productivity Growth confirm Queensland as the Smart State? (Incomplete)

Unsatisfactory outcomes were partly due to the difficulty of the challenge (eg changed fortunes of resource-based and capital intensive industries; and the standards now required for high productivity enterprise). However, as the basic challenge has been recognized since the early 1980s, poor outcomes must also be blamed on those who 10 years ago did not take seriously the need to adopt new economic management tactics in the face of clear limitations on traditional tactics.

Much better outcomes could have been achieved if (a) economic management tactics were shifted from a focus on external investment in areas of comparative advantage, onto a focus on knowledge assets (ie knowledge, organisation, scope for initiative) as the basis for competitive advantage and (b) the apolitical entities which must lead in implementing such tactics had been encouraged to do so.

Amplification (added January 2006)

The imperative for new initiatives to boost productivity growth increased when it was recognized at the 2006 World Economic Forum that challenges are merging to economic globalization. Job creation and increasing real wages have slowed in the mature, industrialized economies as the Internet has changed the way business is done. Previously rich countries would lose market share in manufacturing but this was not a serious threat because they had many highly-educated knowledge workers in services. This distinction is now disappearing. Gains in the developing world are increasingly at the expense of the developed world. [1]

September 2000