Economists say Bracks tariff modelling is wrong

JOINING car manufacturers, unions and others in criticising the recommendation that tariffs should continue to fall in Australia, the Federation of Automotive Products Manufacturers (FAPM) has this week argued that there was a major technical error in the Productivity Commission’s modelling on industry assistance which the Bracks review used to reach its conclusions.

The federal government-appointed commission advised the Bracks panel on the economy-wide effects of future assistance options for the automotive industry and found that proceeding with the planned tariff cuts – due to fall from 10 per cent to five per cent in 2010 – and scaling back of the current Automotive Competitiveness and Investment Scheme (ACIS) to the point where it is removed altogether in 2015 would have positive economic outcomes of around $500 million per annum.

Backed by leading economist Peter Dixon, who was one of the architects of the economic modelling in question, FAPM is adamant that these outcomes are incorrect and “massively overstate the investment effect that lies at the heart of the commission’s optimism over cutting tariffs further”.

The chief executive of the peak representative body for the car components sector, Anna Greco, has told GoAuto that maintaining tariffs and ACIS assistance at current levels would have a negligible impact on the economy and that the federal government must now re-evaluate the tariff issue before making its anticipated policy response, which will be to proceed with the cuts if it acts on the Bracks review’s recommendations.

“What Professor Dixon, who developed the model that they (the Productivity Commission) used, has found is that they calculated things wrongly … and that by having the assistance, and by keeping tariffs at the same level, there is no real cost to the economy when you take into account all of its various benefits – it isn’t a drag on the economy,” Ms Greco said.

“In making any decisions on tariffs, the government really does need to re-look at the modelling in making a decision. Otherwise you can end up with the wrong decision based on the wrong data.” The Productivity Commission found that the proposed tariff and ACIS cuts would yield a 0.06 per cent gain in both annual national output and in the community’s “economic welfare” (as measured by real adjusted GNE, or gross national expenditure).

Although these percentages are small, the commission said they equated to around $600 million and $500 million per annum respectively, accruing each year in perpetuity.

Ms Greco (left) told GoAuto that Prof Dixon had studied the commission’s calculations and found that “in fact, you’re actually increasing the cost to the Australian economy if you cut tariffs further”.

“There is no benefit to the Australian economy, or what economists call ‘Australian welfare’, by reducing tariffs. There is an optimal tariff level, and that’s been set about 10 per cent.

“Reducing the tariffs any further doesn’t assist the economy – all it does is actually increase costs in the economy.

“So we don’t understand on what basis you would then be cutting tariffs – because it’s certainly not an economic argument.

“Then, if you look at it from a trade perspective, why would you do it, because it means that we’ve got nothing left to leverage in any trade negotiations.” Mr Bracks made it clear that the Productivity Commission’s recommendations were crucial.

“We did take into account, significantly, Productivity Commission recommendations. I found them enormously valuable, and the panel did. And if you look carefully at the recommendations, you see that largely they have been adopted,” he said at the report’s launch last Friday.

“I think their report was telling. It was commissioned. The government sought in the terms of reference for the panel to commission that.” Ms Greco acknowledged that the Bracks review was comprehensive and took a holistic approach that went well beyond tariff walls.

She welcomed the recommendation that the federal government double the Green Car Innovation Fund to $1 billion (and that the components sector be eligible for grants) and the setting aside of between $60 million and $80 million in restructuring funds for the parts industry, which would assist smaller companies to merge, to make R&D investments and to help with redundancy payouts as required.

However, the FAPM chief sounded a cautious note on the $2.5 billion (2010-2020) grants program that would replace the ACIS scheme – about 45 per cent of which should be directed to component manufacturers, according to the Bracks review.

“We are still working through a lot of the detail, and I know the car-makers are doing likewise, to understand what the changes to ACIS mean from a dollar perspective because there’s some detail in there that (makes the benefits) not immediately evident,” Ms Greco said.

“The other area that hasn’t been taken into account by this report, and you can understand why, is the carbon pollution reduction scheme and the additional costs that are going to have to be borne by industry.

“That being the case, then the $1.5 billion in assistance that we’re talking about, unless there’s additional assistance in some other way – and we don’t see it at the moment because the industry is not going to get concessions under the current proposed scheme – that $1.5 billion will be fast eroded and it doesn’t really compensate for the additional costs from increased energy, increased transport and increased input costs (raw materials) as a result of this scheme.” While the local car manufacturers have argued that parts makers should only receive grants in conjunction with vehicle programs, Mr Bracks highlighted the importance of independent exports.

“There has been, of course, some rationalisations of (the component parts) industry already and there will be further rationalisation of industry. That is the nature of it. That does not mean the industry cannot grow,” Mr Bracks told the media last Friday.

“Embedded in the recommendations are proposals that the component parts sector not only provide component parts for the three Australian producers, but they also seek to export, as some already do.

“That increases their volume, reduces their cost base to Australian producers as a result of that. And there’s some incentives built-in for the component parts sector to get larger, to seek to have greater volume, and to seek to have exports as well, in the whole supply chain.

“So, whilst there might be rationalisation, there’s also a strong case and a strong possibility that some component parts sectors could get larger as well. And that's just a natural move as part of a mature industry which is more competitive worldwide.

“This is all about having a base case in Australia for a greater global competitive industry in the future.” Ms Greco said this vote of independence for parts makers was “critical to their future”.

“If they are to survive, and to open up export markets, they need to keep investing in innovation … that distinguishes their product,” she said, emphasising the importance of green-fund dollars being made available to parts makers.

“So long as there is a strategic benefit to Australia, whether it’s a car-maker or a components manufacturer, then they should equally have the opportunity to go after it.

“In some cases in the past, for whatever reason, the market here might have rejected some new technology – and for it to become established, a component maker has had to sell it overseas. Then (later) it’s become part of mainstream car-making.” Federal industry minister Kim Carr said the Bracks report drew attention to the fact that, of the 200 major component manufacturers in Australia, “maybe as many as a third are in a distressed state”.

“This is a pattern that I have observed in a number of countries – in the US in particular, this parallel situation,” Senator Carr said.

“In recent times, these questions of the capacity of the supply chain to actually meet the demands of an advanced manufacturing sector have placed the industry very much at risk.

“This is not just a question of tariffs. I’ve always said that tariffs are very much a second order issue these fundamental questions are about management, about being able to diversify in terms of export markets, about ensuring that the Australian supplier base is locked in, not just to our three major manufacturers here, but into the German automotive industry, and the Chinese, and the Americans.

“We’ve got a highly innovative component sector, some major new technologies are coming on stream, which will improve fuel efficiency to an extraordinary level.

“We’re seeking, as part of this process, to have new technologies introduced to the Australian market by 2010 where we can have up to 25 per cent fuel savings for Australian-produced cars. But to get the economies of scale, we need to ensure that our suppliers are tapping into the international supply chains.” According to FAPM, Prof Dixon found that that the Productivity Commission’s technical error has the same effect as around $400 million materialising from nowhere at no cost to fund increased investment.

He also believes the Productivity Commission used an implausible specification of industries’ elasticity of substitution between capital labour.

The size of the investment response that remains after substituting a more plausible specification is one-third of the result otherwise obtainable.

Correcting for the first problem reduces the Productivity Commission’s estimated effects of automotive tariff cuts from an annual gain of between $570 and $510 million to somewhere between $66 million and minus-$26 million. Correcting for the second problem produces net losses in all relevant scenarios of somewhere between $14 million and $92 million.

“Now we know that the Productivity Commission’s modelling supports leaving tariffs where they are,” said leading economist Nicholas Gruen.

“Given that it is the basis on which industry and trade policy decisions could be made, the Productivity Commission should immediately acknowledge the problems and rerun its modelling to better inform government decision-making.

“This would bring the Productivity Commission back to the fold of evidence-based policy-making.” Dr Gruen is the CEO of independent consultancy Lateral Economics. He was involved in the development of the Button Car Plan and sat on the Industry Commission (the precursor to the Productivity Commission) from 1994 to 1997.

Prof Dixon is recognised as Australia’s foremost academic practitioner of computable general equilibrium modelling.

He has been involved with the Productivity Commission and its predecessors in modelling of the Australian economy almost from the outset of the Industries Assistance Commission more than 30 years ago.

He also directed the construction of the model the Productivity Commission used in its simulations for the Bracks review.

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