Australia has paid a high cost for
its faith in the benefits of free trade.
We could learn from the
Asian economies, writes Gregory Clark

Time to challenge the fantasy of free trade
THE AGE Saturday, July 13, 1996

THE coalition has sensibly challenged the myth that unlimited immigration from Asia will turn Australia into a multi- cultural paradise. It should also take a much closer look at the myth that says unlimited free trade with Asia will transform Australia into a manufacturing miracle.

Obviously, free trade per se is a good thing - provided it is between competitive economies. Between Australia and New Zealand, for example, it allows both nations to gain larger markets, economies of scale and specialised production.

But if there is a large competitive gap, as there is between Australia and Asia, genuinely free trade is impossible. The weaker partner ends up with a trade deficit, which causes its currency to depreciate, which in turn has exactly the same protective effect as the tariffs and subsidies so despised by anti-protectionist economic rationalists.

Against Japan, for example, the value of the Australian dollar has fallen from 400 yen to less than 90 yen in the past 25 years. Even allowing for Japan's lower inflation rate, this means that Australian car manufacturers have gained exchange rate protection equal to more than a 100 per cent tariff. The much-debated cuts in car industry tariffs are almost meaningless in comparison.

Seen from Japan, this failure to realise the highly protectionist effects of currency depreciation is one of Australia's greater mysteries. Obviously, Australia has had to adjust to Asian competitiveness. But it had a choice of means and timing. It could have chosen a mix of exchange rate protectionism and tariff/subsidy protection. Even better, it could have relied on interventionist industry policies to protect or gain the industries it needed while getting rid of the industries it did not need.

But laissez faire, free trade dogma closed off those options. Australia has had no choice but to go the exchange rate protectionist route, which in many ways is by far the most harmful form of protectionism. It provides equal protection to the efficient and the inefficient. Many of the gains go to foreigners via worsened terms of trade. Production costs rise since the prices of producer goods rise in parallel with prices of consumer goods.

Tariffs and subsidies can be far more selective. Most of the gains accrue to Australia rather than to foreigners. Ideally most of the targeted goods are consumer items that Australia could in any case try to produce competitively if protected under sensible industry policies.

Another particular problem for Australia is its high minerals exports and high interest policies, which mean that the Australian dollar tends to be constantly overvalued. So currency depreciation is always too little and too late, after the industries that needed protection have already collapsed. A vicious Latin American-style circle of delayed depreciation, more industry collapse, more depreciation, more collapse ... can easily develop.

New Zealand was fortunate in that weak minerals exports allowed its currency to fall quickly and hard. The massive exchange rate protection that it gained as a result allowed the Kiwis to make their comeback. Even so, their lack of an industry policy leaves them vulnerable to exchange rate fluctuations.

Australia should take a leaf from the Asian book. The Asians kept their currencies devalued, using artificial means if necessary. They gave key industries the tariff or subsidy protection they needed. That, combined with low wages, allowed them to quickly match us for competitiveness.

If they advocate free trade today that is because they want other people's free trade polices allowing them to expand exports of their own goods into other people's markets while keeping their own markets closed. Or else, like Japan, they wait till their own economy is rock-solid and then embrace free trade.

One of the ironies of Western comparative advantage, 'free trade' theory is its claim to be internationalist. In fact it originated in the racist 19th century belief that despite our higher wages we in the West could easily retain competitiveness because of our inherent superiority in manufacturing technology and infrastructure gave us unlimited comparative advantage.

Free trade and free markets would encourage us Westerners to further upgrade that comparative advantage, and allow the Asian masses to move more quickly into the industries we had abandoned. By exchanging our technology-intensive goods for their labor-intensive goods trade balance would be achieved automatically. It never occurred to anyone that those inferior Asians could match our technology and infrastructure advantage.

Canberra's naive 1980s belief that free trade would see inventive Australians flooding Asian markets with hi-tech manufactured goods was a direct descendent of those 19th century theories. In fact the Asians have long had a work, social and study ethic just as good, if not better, than ours. Their technicians are just as clever as ours. And their economic managers are not shackled by textbook theories about open markets and free trade. Throwing open our markets to them was a form of manufacturing suicide.

"If they advocate free trade today that is because they want other people's free trade, to expand exports of their own goods."

We may have balanced our trade, but only through harmful exchange rate protectionism and Asian demand for primary or processed goods. Instead of hi-tech wonders, we have had to become hewers of wood and drawers of water. How to adjust to the reality of Asian competitiveness? Aggressive action to push the dollar lower would help. But the first priority should be an industry policy that will allow Australia to hold on to some of its remaining import-competing industries and develop new manufacturing industries. Some tariff protection and subsidies to selected industries may also be needed. Australia still has one major advantage over much of Asia, namely a large domestic market hungry for a range of mid-tech consumer goods. If Malaysia - with a much smaller domestic market than ours, but relying on intelligent industry policies and the Japanese/Korean hunger to invest abroad - has managed to end up with a largely competitive, home-based car industry, how much more could Australia do once it gets rid of its "free trade" obsessions?

Gregory Clark is president of Tama University in Tokyo. He joined the Australian diplomatic service in 1957 and was a policy adviser to the Whitlam Government in the 1970s.