Achieving sustained economic growth

Here’s a paper of mine which I’ve often referred to but which wasn’t available on line. The paper was published in May 2006 by the Queensland Chamber of Commerce and Industry as an appendix to Des Moore’s paper The Role of Government in Queensland, to which I contributed. I am happy for  material from the paper to be quoted subject to attribution.

Achieving Sustained Economic Growth

ByMichael Cunningham

(formerly of Queensland Office of the Cabinet and Treasury, 1991-2004)

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Developments in growth theory are gradually eliminating the distinction between the fields of economic growth and economic development.  Sustained economic growth is everywhere and always a process of continual transformation.  The sort of economic progress that has been enjoyed by the richest nations since the Industrial Revolution would not have been possible if people had not undergone wrenching changes.  Economies that cease to transform themselves are destined to fall off the path of economic growth.  The countries that most deserve the title of “developing” are not the poorest countries of the world, but the richest.  (They) need to engage in the never-ending process of economic development if they are to enjoy continued prosperity.

– Peter Howitt, Conclusion, Growth and development: a Schumpeterian perspective, 2006.

 Introduction: understanding economic growth

The above extract from one of the leaders in economic growth theory emphasises that growth is about transformation, about change.  The main message of this paper is that policies which embrace openness, competition, change and innovation will promote growth.  Policies which have the effect of restricting or slowing change by protecting or favouring particular industries or firms are likely over time to slow growth to the disadvantage of the community.  While it is true that Queensland has had relatively rapid growth, labour productivity is only about two-thirds of US levels and is lower than in other states.  Queensland can clearly do better with more growth-supportive policies.

In addition, the rapid growth is in part due to transient factors such as the mineral resources boom.  It is better to improve the policy framework now rather than being complacent about the future.

Sustained economic growth is widely regarded by governments as a desirable objective.  Achieving this objective requires an understanding of the drivers of economic growth, and whether and how policy can influence them.  Policies developed without this understanding, and particularly those with mainly political objectives, are unlikely to be successful, and have often had serious negative consequences both economically and politically.  Recent examples include the failure of interventionist policies in Victoria, South Australia and Western Australia in the 1980s and 1990s, at high cost to those states, and government-backed projects such as the failed magnesium smelter in Queensland.

Over the last 20 years, variations in growth between regions and countries have increasingly been explained by “endogenous” growth theory, in which growth depends on characteristics of the economic environment rather than on exogenous factors.  Explanations with the clearest implications for policy come from “Schumpeterian” growth theory, based on the notion of “creative destruction.”  They stress the dynamic nature of modern economies and the importance of change – including firm entry and exit – in driving growth in productivity and national income.

An understanding of the implications of endogenous growth theory is critical to developing appropriate state government policies – not only policies which are clearly economic in nature, but also a wide range of policies which affect economic outcomes, for example in education and training, social welfare,  regulation and provision of infrastructure services.

The recent drivers of economic growth (DoEG) project of Queensland Treasury’s Office of Economic and Social Research (OESR) attempted to develop an explanation of growth as an aid to government policy in Queensland.  A Government website says that the 2003 paper Drivers of Economic Growth in the Smart State[1] “distils the key findings of this research and examines the Queensland Government’s current policy approach in the context of these findings. This paper outlines how the research findings provide theoretical support for the rationale underpinning the State Government’s Smart State vision and broader economic strategy.”

However, the policy implications drawn from that research have some basic flaws and are not consistent with theory, evidence and international best practice.  The fostering of higher economic growth, productivity and employment in Queensland should be based on a quite different approach that allows the private sector (which constitutes 80 per cent of the economy) to respond positively to changing circumstances.

While the approach as outlined here is based on a wide range of theoretical and empirical work, for purposes of this Appendix it draws mainly on the recent work of leaders in the growth theory field (Philippe Aghion and Peter Howitt, and their co-researchers) as well as the experience of the author.

Economic growth – creative destruction and competition

Contrary to the implication in the DoEG papers, the convergence of lower-productivity entities such as Queensland with those at the frontier (the high technology, high productivity, high income countries and states) is not automatic – the distance from the frontier merely provides an opportunity for catch-up and government policies can foster or hinder the catch-up process.

In practice, increased innovation (and the likely resultant increase in total factor productivity) derives mainly from the threat of competition from the entry of new, higher technology firms rather than from technology spillover.  That threat leads to a structural shift towards better-performing firms, further improving average productivity and directing resources towards the more competitive firms and away from the poorer-performing ones.  In addition, industry deregulation (lifting barriers to entry etc) has a positive impact which is greater in the absence of restrictive labour-market regulation.[2]

There is considerable empirical evidence supporting the main Schumpeterian thesis that entry and de-licensing have a more positive effect on growth in sectors or countries that are closer to the technological frontier, and that exit can have a positive effect on productivity growth because it replaces less efficient firms or inputs by more efficient ones.  Empirical findings also go directly against the belief that national “champions” are best placed to innovate at the frontier and should be in charge of selecting new research projects for public funding.

Competition policy in Europe has been used as a mechanism to increase openness and integration rather than to increase competition per se.  The EU has policed anti-competitive behaviour among incumbent firms, but has paid little attention to the more important issue of entry.  The Economist identifies protection of existing interests as a major factor in the poor economic performance of EU countries, saying that “The only real options are to accept change now, or to defer it until economies get into such straits that change is forced.”[3]

Unfortunately, the section in the DoEG paper on Economic fundamentals ignores three critical fundamentals, for which there is supporting evidence covering all countries and known history – that competition is the main driver of innovation and productivity growth; that almost all wealth-generating innovation occurs in the private sector; and that investments which do not at least cover their risk-adjusted opportunity cost are wealth-destroying, not wealth-creating.

This failure of the Queensland paper leads it to emphasise policies which reinforce the role of the state rather than those which enhance competition and improve the environment  for business.  The paper claims that the papers in the supporting Treasury paper, Productivity and regional performance in Australia (PREPA) “highlight the extent to which Queensland’s future economic growth depends on increasing the productive capacity of the State’s industries and workers”, and that this “underlines the need for state-based policies that directly promote productivity growth, such as the fostering of innovation and improving the human capital base” (DoEG p 6).

The failure to acknowledge the value of competition and private enterprise leads the authors to totally misleading conclusions, such as that Queensland’s future growth depends “on increasing the productive capacity of the State’s industries and workers.”  Increases in productive capacity are of little use unless the states’ firms can compete successfully in state, national and global markets.  The output of expanded capacity has to be saleable at a profit; that is, the returns on the investment must exceed their opportunity cost (the return which could be obtained from alternative uses of the funds, including, in the case of government, cutting taxes).

Nor does account seem to be taken of the fact that increased “productive capacity” need not mean increased productivity, which is the basis for growth in incomes.

The main messages for the Queensland Government from the analysis of growth theory research and the above discussion are that –

  • competition is the main driver of innovation and productivity growth;
  • almost all wealth-generating innovation occurs in the private sector;
  • government policy should focus on promoting competition rather than on supporting particular firms or industries;
  • the failure of non-competitive firms is a necessary part of economic growth; and
  • relaxation of entry barriers may not succeed in promoting growth if not accompanied by other changes that are favourable to business development.

Economic growth – infrastructure

Queensland Treasury’s DoEG paper also claims that “the research shows that Queensland faces a unique challenge relating to the need to maintain higher rates of capital investment than other states.”  It notes that in 2002 80 per cent of fixed capital formation in the state was in the private sector, with a further 8 per cent in public corporations.  However, the policy issue relates less to the quantity of capital expenditure and more to how “smart” that investment has been.  The returns on assets of public corporations have been poor and there has been an undue emphasis for many years on attracting large capital projects. The provision of large subsidies and project-specific infrastructure for such projects suggests this policy has rarely been worthwhile.

For example, even with the offer of subsidies equivalent to 22% of the capital cost of the Korea Zinc smelter in Townsville, the company claimed during negotiations that the project was of marginal viability (although it subsequently went ahead).  This and similar projects are capital-intensive, and provide little employment relative to the size of the investment and subsidy.  Typically, the skills they require are not available locally, and skilled workers are bid away from other employers in the state and from interstate.  Much of the capital funding is from overseas, and almost all machinery and heavy equipment is imported.

In the case of the zinc smelter, Queensland Treasury modelling indicated that the gains from the project went predominantly to overseas suppliers of finance and equipment and to skilled workers from interstate.  The industry department’s alleged rationale for the subsidy was “technology transfer” – but any such transfer would be of little use given there is no scope in Queensland for a second smelter.

While as the main paper suggests there may be a lag in public infrastructure spending in Queensland, that does not justify the adoption of projects whose returns would not cover their opportunity cost.

The question of whether “an expansion in the state’s infrastructure program would be an effective way to promote Queensland’s economic development and the role the [state] Government can play in bringing this about” was examined in a paper prepared for DSD (Argy et al, 1999).  The paper focussed on investments “which have the potential to produce relatively high ‘social rates of return’.”  While it argued that there were opportunities for viable capital expenditure in South East Queensland, the paper raised many caveats about the quality of the assessment process required.  It noted that the government would have to be “very selective in the choice of infrastructure investment”, with a “sound and rigorous cost benefit analysis framework.”  These requirements are generally lacking in Queensland.

A further message for the Queensland Government therefore is that –

  • investments which do not at least cover their risk-adjusted opportunity cost are wealth-destroying, not wealth-creating.

Economic growth – the role of education

Education and training also have the potential to be major factors in economic growth and productivity.  Productivity growth can be generated either by implementing (or imitating) the frontier technology or by innovating on past technologies, with the relative importance of innovation increasing as a country or region moves closer to the technology frontier.  However, different types of spending underpin the different activities.  In particular, higher education investment should have a bigger effect on a country’s ability to make leading-edge innovations, whereas primary and secondary education are more likely to make a difference in terms of the country’s ability to implement existing (frontier) technologies (AAZ 2002).  Of course, different industries in a region may be at different levels of technological development.  In Queensland, industries such as mining which face intense international competition tend to be the most technologically advanced.

As a country moves closer to the technological frontier, tertiary education should become a more important influence on growth than primary/secondary education.  However, investing in higher education in a lower-tech state may simply induce emigration to a more frontier state with higher productivity and wages.  This is what happened in Queensland in the 1990s, when about half of IT graduates found work outside the state. Declining tertiary enrolments at smaller institutions suggest that Australia may have over-expanded tertiary education relative to the opportunities to profitably employ graduates.

Economic growth – sustainability

Queensland Treasury’s DoEG paper refers to “sustainable” economic growth without defining the term.  The issue arises from the proven economic concept that an extra unit added to any production process will have a marginal return less than that of the preceding unit, with the return tending to zero.  With such diminishing returns, economic growth would also tend to zero, which is observably not the case.  The economic growth theory referred to above thus seeks to explain how growth can be sustained in the face of the theory of diminishing returns.

The DoEG paper states that economic growth based on increasing inputs “has attracted criticism because it is considered unsustainable.”  It is true that some forms of input-driven growth have limits (e.g. a shift of workers from low-productivity agriculture to high-productivity manufacturing), but that does not mean that they are not worthwhile.  Growth based on increased workforce participation will also have limits in terms of numbers employed, but the human capital embodied in each worker can be increased.  Capital inputs are not inherently finite.  The confusion of the Queensland paper’s approach to sustainability is indicated by the statement that “Sustainable economic growth provides the foundation to support the further development of the State’s industries and regions” (p2, para 4).  What on earth does that mean?

One concept of “sustainability” in connection with economic growth tends to convey that the form of economic growth should not be at the expense of future generations, whether in reducing their ability to maintain similar rates of growth or in severely damaging the environment so as to irremediably damage their quality of life.  The concept is very nebulous and seems to imply that, although the world has made great gains over the last 250 years from innovation and technological advance at an increasing pace, it will be unable to do so in future.

“Picking winners” – always a bad policy

Commercial businesses and investors thrive or fail on their capacity to correctly identify and pursue profitable opportunities.  The skills required for this are highly valued and are in great demand, particularly by firms and investors who operate globally.  If there is a profitable opportunity available in Queensland or elsewhere, it is unlikely to be overlooked.

Nevertheless, governments and public servants with little relevant expertise frequently think that their capacity to identify and pursue viable commercial opportunities exceeds that of the businessmen whose livelihood depends on that capacity.  In practice this almost invariably leads to poor investment choices at great cost to the state concerned.  A classic example is Queensland’s light metals project, the Australian Magnesium Corporation (AMC).

The possibility of a light metals industry in Queensland had been considered for more than 20 years without attracting serious commercial interest.  Despite this strong indication that it would not be viable, the Department of State Development  vigorously pursued the project.  A major user of magnesium metal is the motor vehicle parts industry, and DSD’s preferred client for the metal was Teksid, the world leader in metal automotive parts.  Teksid analysed the opportunity and said that a light metals industry would never be viable in Queensland  At the same time, Queensland Treasury undertook detailed economic and financial analyses which came to the same conclusion.  This analysis was never challenged or faulted.

Nevertheless, with strong support from the federal and state governments, the project went ahead.  Even with $300m in grants from the Queensland and Commonwealth governments, AMC could not attract commercial support.  The State Government therefore developed a scheme to attract small investors to invest in the project.  The smelter subsequently collapsed with losses of around $450 million – borne by the promoters, the two governments and the investors – but no minister lost their job.

Another relevant factor in the attempts to attract large metals processing projects is the state’s policy of subsidising metals processing plants through reduced royalty rates.  Queensland’s Administrative guidelines for royalties pertaining to base and precious metals provide that “where mineral is processed within Queensland to 95% contained metal, royalty discounts will apply as follows: copper – 20%; lead – 25%; zinc – 35%.”  There are two issues here.  First, if the minerals were not processed here, they would be exported with full royalties – there is a loss of State revenue from the discounts.  Second, overseas processors who buy Australian ore can compete while paying full royalties plus freight for the ore.  If royalty discounts are required for firms to operate in Queensland, it implies that they are not internationally competitive.  That is, the State is fostering the development of non-competitive industries rather than letting market forces direct resources to viable industries.  If the industries can, in fact, operate here profitably without subsidies, then there is no need for them.  Either way, there are long-term costs to such distortionary policies which tax viable companies to fund those favoured by the Government, and a query as to whether government infrastructure which supports them is worthwhile. 

Queensland Treasury’s analysis in 2002 of the Government’s $700m Paradise Dam irrigation water supply project in the Bundaberg hinterland showed that it had no prospect of a positive rate of return – even the smallest and least costly water supply option examined was unlikely to be viable.  The project went ahead even though Treasury’s criticism became publicly available.  The Suncorp Stadium in Brisbane was redeveloped by the Government at a cost of $300m.  Servicing this capital cost alone would require charges of perhaps $120-150 per seat if the stadium were filled 30 times a year.  In practice, the stadium has lower occupancy rates at prices as low as $10-30.

There will be continued failures of the kind outlined unless proposed government capital expenditure on large projects or subsidies to private projects are subjected to proper published cost-benefit analysis.  The imperative for Queensland is not to spend more but to spend more wisely.  The magnitude of capital spending should be determined by the availability of opportunities for investment with a risk-adjusted expected rate of return at least equal to that of alternative opportunities.

By contrast with the Beattie Government’s approach, the economic development strategies of both the Goss and Borbidge governments recognised that there was no merit in “picking winners.”  They adopted market facilitation strategies which accepted that the role of the state government in economic development was to provide an environment which enhanced the opportunity of the private sector to identify and successfully pursue profitable opportunities.[4]

However, the discredited “picking winners” interventionist approach continues to have excessive influence in Queensland, particularly through the Department of State Development.  Although interventionist policies are based on the view that a government can obtain better economic results by direct intervention in the economy rather than by facilitating markets, there is little or no evidence to support such an approach.[5]  The Soviet bloc countries were strongly interventionist with extremely negative results.  A recent World Bank report concludes that since the break up of the USSR, the economic well-being of the former Soviet bloc countries has been directly related to the extent to which they have opened up to trade and embraced pro-market capitalist policies (World Bank 2006).  Within Australia, interventionist policies in three states around 10-25 years ago led to significant losses.

Queensland’s recent economic growth has been in spite of, rather than because of, government intervention.  A major factor has been booming world markets for minerals and metals, over which the Government has no control.

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Advice to Ministers:  Be sceptical of any public servant who brings to you a “wonderful” investment opportunity which has not been pursued by commercial investors.  Your first question should be: “Have you mortgaged your house to invest in this wonderful opportunity?”  Unless the answer is a resounding “Yes!”, go no further.

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“Regulatory innovation” – a new name for “picking winners”?

The present author’s extensive experience in competition and regulatory issues in Queensland’s Office of Cabinet and Treasury suggests that, while Queensland has a highly pro-regulatory stance, its record in determining what to regulate and in designing, administering and reviewing regulations leaves a good deal to be desired.  Any policy which depended on a subtle, rigorous and unbiased approach to regulation, and a willingness to amend or repeal regulations as required, is unlikely to succeed in the prevailing environment.

In one of his papers for the DoEG project, Professor John Foster (2003) argued for an increased role for the state government in reducing uncertainty for “emerging” industries.  He suggested that “protective and facilitating regulations may be required in emerging industries that would be highly inappropriate in mature industries.”  This is expanded in Treasury’s DoEG paper, which argues for “a focus on ‘regulatory innovation’, as distinct from deregulation” (p 10).

There are two serious concerns here.  The first is that although Foster draws on the Schumpeterian paradigm outlined in this paper, his policy prescriptions are not optimal either in terms of the paradigm or in the light of empirical evidence on these issues (see earlier discussion).  The second is that the Queensland Public Service does not have, and is never likely to have, the capacity to devise and implement Foster-style policies in a manner which advances the public interest.  In effect, “regulatory innovation” is dressing up the traditional, failed, “picking winners” approach in new language, once again assuming that public service bureaucrats know better than private sector investors how to identify “emerging industries” which will succeed on world markets.

Foster states that his approach “requires the development of an endogenous capability to anticipate the future direction of economic evolution in particular cases from current and past tendencies.  To do this requires an understanding of where, in their particular growth trajectories, firms and industries lie.”  To say the least, this is a tall order that would never be realised in practice.  Even if it were accepted as a valid strategy, the history of the Department of State Development, its predecessors and related agencies scarcely suggests a capacity to understand such factors let alone apply the strategy.

In reality, “regulatory innovation” would protect certain firms or industries – chosen by state bureaucrats rather than market entrepreneurs – from competition.  As such, it is inherently flawed.

Regulation should be a last resort used only when certain conditions are satisfied, namely

  1. There is a clearly identified and serious issue of public interest to be addressed.
  2. There is an expectation of a clear net public benefit from addressing the issue.
  3. This benefit can not be obtained by enhancing the operation of market forces or other non-regulatory mechanisms.
  4. The regulation proposed is demonstrably the minimum required to obtain the objective, is clearly defined, well-targeted, efficient and effective.
  5. Any costs and secondary consequences of the regulation do not exceed the expected benefits.
  6. There are clear and effective mechanisms to amend or repeal the regulations as circumstances change.

In my experience these criteria are rarely met in practice.  Most often, they are not even given attention.

Market failure and government failure

Markets are very efficient devices for providing and processing information, for organising production and distribution of goods and services so as to allocate resources to their highest valued use and thus maximise community income.  Their superiority to central planning is well attested.

There may, however, be cases where markets do not produce the most efficient outcome, where there is “market failure.”  This tends to arise in particular circumstances, for example when there is a natural monopoly, where externalities are not taken into account, where there is information asymmetry or in the case of public goods.  (There is extensive literature on the issue for those who seek more detail.)

The identification of market failure alone is not, however, sufficient reason for government intervention.  There can be no presumption that governments outperform markets: indeed, “government failure” is more common.  The World Bank advised that “the countless cases of  unsuccessful intervention suggest the need for caution.  To justify intervention it is not enough to know that the market is failing; it is also necessary to be confident that the government can do better.”[6]  A Bureau of Industry Economics paper assessing the 15 major interventionist policies of the Commonwealth Government from 1970-85 found no positive outcomes: 13 had negative returns, while for two the net outcome was unclear.[7]

Should the cost to the community of market failure be significant, government should first see whether it is possible to improve the workings of the market.  If not, it must assess its capacity to produce a better outcome, and the costs and benefits of any intervention.  Given that a number of studies have found administrative costs of around 15-50 per cent in government industry support programs, the prospect of a net benefit from intervention must be considered doubtful.

Within the Queensland system, the term market failure has rarely been used in its true economic sense.  It tends to be shorthand for “We think that certain opportunities for which there is no commercial support should in fact be pursued, with government funding.”  That is, picking winners again.

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Imperfect government:  “The skills of government in addressing market failure are often exaggerated.  Government intervention must overcome three formidable difficulties:  the tendency of regulated firms to “capture” their regulators, weak incentives for efficiency within the public sector, and missing information (where markets lack it, governments are likely to lack it as well).  …  The record of intervention is poor … history suggests that the burden of proof should lie with those who would extend the government’s role.”  The Economist, 17/2/96.

An holistic approach

As indicated above, the success of growth-oriented policies in one area, such as competition policy, is often dependent on complementary and supporting policies in other areas, such as light-handed regulation of labour markets.  A persistent failing in Queensland policy development is that policies in different areas tend to be developed in isolation from, and ignorance of, related or opposed policies in other areas.  There is no unifying principle, no comprehensive strategic oversight of how policies interact.  This has been referred to as the “silo” mentality.

For example, there is evidence of a relationship between education levels and productivity and economic growth.  But this is not a simplistic relationship.  It does not mean, as the State Government seems to have assumed, that forcing those who prefer to leave school early to complete Year 12 will lead them to more skilled jobs and higher wages and will boost productivity and growth.  The driving force here is the opportunities for profitable investment and business growth in Queensland, and extra schooling for students at the lower end of the spectrum will not significantly change this.

Education and training was discussed earlier in the context of economic growth theory, as regards the impact of different levels of education in economies at differing technological levels.  However, this is not to deny the importance of focusing on early education, including pre-primary education.  US Nobel Prize-winning economist James Heckman strongly supports an holistic approach to policy.  He argues that in evaluating a human capital investment strategy, it is crucial to consider the entire range of policy options together.  Early investments in education are effective, while more expensive later interventions can not compensate for poor early learning.  Learning is a dynamic process, and it is most effective when it begins at a young age and continues through adulthood. 

Heckman also provides evidence that private training programs are more effective than public ones and develop more marketable skills.  His view is that it is better to promote private sector training, while using public resources to provide wages subsidies for older workers.  Such workers would gain more from this than from training, and there are social benefits from moving low productivity workers from unemployment into work with such assistance.  This is particularly relevant in Australia where, compared to other OECD countries, the minimum wage is a very high proportion of the average wage, making it harder for low-productivity workers to find employment.

Heckman also finds evidence that additional spending on public school quality tends to be inefficient, and that reforms in the administrative structure of education and infusion of incentives and competition are far more likely to be effective.  This accords with the emphasis in the main paper of government school funding being applied to support students in private schools, which face greater competition and incentives, as well as public schools.

Outside of the education system, Heckman argues – in line with this paper – that policies which promote capital formation (that is, that encourage and reward entrepreneurial behaviour) are very effective in raising wages growth and economic efficiency.  They also provide incentives for individuals to undergo relevant training.  This illustrates how policies outside the field of education and training can affect outcomes in that field, reinforcing the need for an holistic approach.

The DoEG project paper on human capital (Draca et al 2003, drawn on in the Government’s DOEG paper, pp 16-17) claimed that differences in human capital, as measured by education completion rates, explained 87 per cent of the difference in GSP per capita between Queensland and NSW.  This claim is hard to believe.  As Draca et al note – in line with the present paper – relationships between educational attainment, economic growth, increasing real wages and productivity are highly complex.  While in earlier discussion the authors acknowledge that no clear links have been demonstrated (pp 155-159), they still proceed to use the growth accounting results to advocate “explicit policies for encouraging human capital formation” (p 170).  But the material cannot support such policy conclusions.

Equally, the authors’ estimate that Queensland would have been $15 billion better off in 1996 with similar completion rates to NSW is simplistic.  It is a huge step to surmise that increased educational attainment alone would lead to the implied 16 per cent increase in Queensland’s per capita income.  Indeed, Draca et al give the game away when they say that their results are “contingent upon the development of appropriate industries in which to employ human capital” (p 168).  As argued throughout this paper, the development of particular industries in Queensland depends on many factors, primarily on the identification by commercial investors (not by government) of profitable opportunities.  Increasing education levels alone will not generate such opportunities.[8]

While this section uses education as an example, the broader point is that –

  • policies across many areas must be coordinated, complementary and well-founded to be successful.

Market enhancement and a competitive environment

One of the major problems with government in Queensland is the limited comprehension of the value of markets and competition to the community as a whole.  While Premier Goss helped to initiate the process which led to National Competition Policy, implementation in Queensland was based on minimum compliance to obtain Commonwealth funds rather than being seen as an opportunity to make changes with long-term benefits.  Competition is not seen as a factor, let alone the predominant factor, in driving innovation and productivity growth.  Indeed, State Development and other agencies all too often seem to see long-term agreements as economic development even if they are anti-competitive.  For example, the 2000-2001 Timber Industry Taskforce (headed by DSD’s deputy director-general) extended by a further 25 years existing 25-year anti-competitive arrangements for timber access.

Part of the problem is reflected in the adoption in Treasury’s DoEG paper of DSD’s view on “competitive advantage” and “comparative advantage” (p 10).  Competitive advantage is the ability of a firm to make higher returns than its competitors (cf John Kay 1996).  DSD (and hence the government) use the term to support investment and intervention in areas which commercial investors and enterprises consider non-viable.  The magnesium smelter is a typical example: we have ore, we have energy, therefore Queensland has a competitive advantage and if business can’t see it, it’s up to DSD to bring it about; Queensland has a wide range of flora, therefore we have a competitive advantage in biotechnology, and so on.

After joining the Queensland Public Service in 1991 the author experienced this approach on many occasions.  For example, at that time, it was said that Queensland was going to be in the top 3 or 4 in the world in many IT categories – even though no one had given serious consideration to potential markets or overseas competitors.  This failed approach continues to dominate, in part because of the lack of adequate post-intervention assessment.

While the DoEG paper also refers to “current and emerging areas of comparative advantage” (p 10), it overlooks those areas of relative strength in the economy, as typically indicated by export and import performance, e.g. in mining and agriculture.  It is an extension of the Government’s mistaken “competitive advantage” view, that areas which are not currently internationally competitive – but “should be” because of their perceived (by DSD) merits in the Queensland economy – can readily be identified.

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Evaluation of business assistance programs:  In 1997, the author noted in a Queensland Treasury memo that there was little effective evaluation of industry assistance.  Such evaluation as was done was ad hoc and of a partial nature and did not permit comparison between programs.  The memo proposed that Treasury’s Microeconomics Branch, which had an expert in program evaluation techniques to hand, develop suitable evaluation tools in order to determine the effectiveness of programs and to improve accountability and transparency.  To date, no such tools have been developed.

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Market enhancement also requires a change in attitude to regulation so as to free the entrepreneurial spirits on which innovation and new businesses depend.  Governments with a tendency to central planning and “command and control” policies use what is known as “heavy-handed” regulation, greatly limiting the freedom of companies and individuals in an attempt to force patterns of behaviour favoured by the government, perhaps for ideological reasons.  The alternative, where government has more faith in individual choices and market-based outcomes is often referred to as “light-handed” regulation.

This paper strongly commends the adoption of “light-hearted” regulation.  This would acknowledge that government understands its limits and accepts that the members of its community have the capacity to make decisions which promote communal welfare without the need for a regulate-everything-that-moves approach.

Productivity in Queensland

The major source of growth in incomes is growth in productivity, and the approach advocated by the main paper and this appendix is designed to increase productivity.  The main measures of productivity are labour productivity, e.g. real output per hour worked, and total factor productivity (TFP), which measures the productivity of both labour and capital.  Labour productivity in Australia is much lower than that in the leading country, the US – productivity averaged less than 83 per cent of US levels from 1990-2005, with the latest estimate under 80 per cent[9] – and productivity in Queensland is below the Australian average.

The Statistical Appendix contains data on labour productivity in Australia (Table 11 and Figure 2).  The table below shows that productivity in Queensland is well below that in most states, although in recent years it has caught up somewhat with NSW, which has had relatively low growth in labour productivity.

Labour productivity in Queensland as a percentage of that in other states –

                  NSW       Victoria        WA                 SA                  Tasmania

1997-98      78             85                     80                     88                     95

2003-04      85             85                     82                     96                     107

2004-05       83           84                     82                     93                     105

To some extent differences in productivity are due to differences in industry structure – for example, a major factor in WA’s relatively high productivity is that the high-productivity mining industry accounts for a relatively large portion of the state’s economy.  The industry structure of each state tends to reflect both local characteristics, e.g. availability of minerals, attractiveness to tourism, and historical factors, and it is not easy to bring about a major shift to higher productivity industries.

What these papers aim to do in part is encourage non-discrimnatory policy settings which will make Queensland more attractive to high-productivity businesses and which accept that increasing economic growth and productivity will involve a decline in low-productivity industries and firms.  Continuing to protect the latter from change will lock in low productivity and low incomes, and will limit the opportunities for new firms.

Concluding remarks

The Treasury paper on growth concludes that the research underpinning the paper “provides intellectual support to the Government’s current policy approach.”  This Appendix suggests that the research is flawed and does not accord with currently accepted economic views.

If Queensland Government policy is to foster sustained economic growth, it must be based on an assessment and understanding of the implications of decisions for the Queensland economy and society as a whole, not simply for some particular sector or group.  That understanding requires a recognition of the merits of change and the disadvantages of protecting existing business, industries and jobs.  Change is inevitable and the policy framework should seek to create an environment most likely to help business and the community to adapt to changing circumstances.  This means flexible policies such as light-handed regulation, fostering competition and accepting a greater role for the private sector in, for example, provision of infrastructure, education and health services, avoiding long-term anti-competitive contracts which limit opportunities and leaving commercial investment decisions to the market.

The need is for a much less interventionist and more open role than that previously adopted by the Beattie Government, and an acceptance that the competitive, market-driven approach is likely to be the most successful in driving economic growth.

Postscript 2010

The intention of this paper was to foster improved economic policies in Queensland, policies based on clear principles, evidence and understanding which serve the public interest.  I was informed that immediately after the release of the paper, there was a flood of e-mails amongst senior officials in Queensland Treasury.  Sadly, but unsurprisingly, none of the e-mails were concerned with such improvement.  Given that they could not counter the arguments in the paper, the Treasury officials’ e-mails were concerned only with how they could cover their backs and avoid adverse fallout.  It would appear that they were successful in this.

_________________________________

Michael Cunningham was a senior economic policy advisor to the UK, Australian and Queensland governments, including with the UK National Economic Development Office and the Office of the Economic Planning and Advisory Council (EPAC).  The author provided the analytical basis for the economic development strategies of both the Goss and Borbidge governments.  He also headed Queensland Treasury’s Microeconomics Branch.

The author’s work has covered a wide range of economic issues, with emphasis on factors driving economic growth, including competition policy and innovation.

References

Acemoglu, D, Aghion, P & Zilibotti, F (2002), Distance to frontier, selection and economic growth, NBER WP No 9066

Aghion, P, Boustan, L, Hoxby, C & Vandenbussche, J (2005), Exploiting states’ mistakes to evaluate the impact of higher education on growth, mimeo, Harvard

Aghion, P & Howitt, P (2005), Appropriate growth policy: a unifying framework, paper presented to the Annual Congress of the European Economic Association

Argy, F, Hollingsworth, P, Lindfield, M & Stimson, R (1999), Infrastructure and economic development, paper prepared for DSD Queensland.

Draca, M, Foster, J & Green, C (2003), Human capital investment and economic growth in the Australian economy, in Williams et al (2003)

Foster, J (2003), New growth theories and implications for state government policy makers, in Williams et al (2003)

Heckman, J (1999), Policies to foster human capital, NBER WP No 7288

Howitt, P (2006), Growth and development: a Schumpeterian perspective

Kay, J (1996), The business of economics, OUP

Lattimore, R, Assessment of Commonwealth industry assistance policies, BIE seminar paper, 1986 (unpublished)

Queensland Government/Treasury (2003), Drivers of economic growth in the Smart State, referred to in this paper as “DoEG”

Vandenbussche, J, Aghion, P & Meghir, C (2004), Growth, distance to frontier and the composition of human capital, mimeo, Harvard-UCL

Williams, C, Draco, M & Smith, C (eds) (2003), Productivity and regional economic performance, published by OESR, Queensland Treasury, in conjunction with Queensland Government/Treasury (2003)

World Bank (1991) (p 131), World Development Report: the challenge of development, OUP, Washington DC

World Bank (2006), From Disintegration to Reintegration: Eastern Europe and the Former Soviet Union in International Trade.


[1] Queensland Government/Treasury (2003), Drivers of Economic Growth in the Smart State (DoEG)

[2] AB 2005, ABGHP 2005, ABGHP 2004.

[3] Editorial, The Economist, 23/3/06.

[4] Queensland – Leading State (1992) and State Economic Development Strategy (1998).

[5] A rare exception is Singapore’s rise from third world to first world incomes.  However, the policies which helped a tiny authoritarian country to catch up are proving less successful now that Singapore has a modern economy, and are not relevant to Queensland.

[6] World Bank (1991) (p 131), World Development Report: the challenge of development, OUP, Washington DC

[7] Ralph Lattimore, BIE seminar paper, 1986 (unpublished).

[8] I sent Mirko Draca a draft of this paper.  He fully accepted my criticisms of his work.

[9] Graeme Davis, Treasury (2006), Productivity level: how far can Australia catch up?

2 thoughts on “Achieving sustained economic growth

  1. Truly enlightening, Faustino.’ Regulatory innovation,’ er isn’t that as
    contradictory as ‘state innovation’? While I was reading on picking
    winners I kept thinking of Nassim Taleb and Philip Tetlock re ‘experts’
    and certainty in ‘The Black Swan,.’ (

  2. I’d like to say something relevant to the above excellent article, particularly as regards the picking of winners.

    “Ashes to ashes, dust to dust…if Johnson don’t get you…”

    A bit cryptic, I’ll grant you. Hint: Black Swans=WACA=MJ=unregulated innovatory bowling=Cook is cooked.

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