Saturday, August 23, 2008

Wasting our tax dollars on symbolism

Australian policy makers have an obsession with motor cars.  Australia, they say, should not only 'make things' -- as Kevin Rudd so simply put it during the election campaign -- but they should specifically make automobiles.

But Australia isn't very good at making cars.  Consider the evidence.  The Bracks Review into government assistance for the automotive industry indicated that the average fault per vehicle for Australian manufactured cars was well above the appropriate benchmark.  Furthermore, the proportion of domestic manufactured cars in the Australian fleet has declined over time.

But rather than face reality and allow the local automotive industry to survive or fail according to the dictates of the competitive market, the government is proposing more industry policy.

Industry policy has an entirely disreputable history with an appalling track record of failure -- it is amazing that politicians still think they can get away with proposing these sorts of winner picking ideas.  In essence it constitutes a supply side conspiracy of government and industry in order to collude against consumers.  As Adam Smith warned, "to narrow the competition must always be against [the public interest], and can serve only to enable the dealers, by raising their profits above what they naturally would be, to levy, for their own benefit, an absurd tax upon the rest of their fellow-citizens".


The failure of old-style industry policy is plain to see.  Governments have rightly shifted their tack a little -- we now have "new style" industry policy.  Here the government proposes building a culture of innovation, focussing incentives, and accelerating the take-up of new technology.  Rather than imposing tariffs and quotas or throwing money at specific products, government now throws money at research and development (R&D).  This is widely accepted as being appropriate expenditure of public money.

Certainly, standard economic theory suggests that markets will undersupply basic R&D and the market economy will be less innovative than is socially optimal.  Government, by subsidising basic R&D, can correct for that 'market failure'.  This is especially the case in environmental issues.  Here, apparently, there is a double market failure.  The Stern Report makes the argument that the "climate is a public good" and as in the case of basic R&D the market does not ensure the optimal allocation of consumption and investment in climate.  Solutions to climate change involve a substantial investment in R&D and so government can correct a double market failure by investing in green technology such as the green car.

At face value that is a plausible argument.  Unfortunately, it does not stand up to close scrutiny.  The climate is not a public good despite having the characteristics of public goods -- it is both non-rivalous and non-excludable.  The climate is not produced in a market, it is not bought and sold in a market, nor can government subsidise the production of the climate.  The first component of the double market failure is simply not correct.

The second part of the story is also problematic.  The benefits of publicly funded R&D are remarkably difficult to pin down.  Even the Productivity Commission has failed to find a clear relationship between R&D and productivity.  In 2003 the OECD published an official report into The Sources of Economic Growth in OECD Countries, and as part of that analysis, the OECD disaggregate R&D into a private and public component.  As expected there is a positive relationship between overall R&D and economic growth, and also between private R&D and economic growth.  In contrast there was a negative relationship between publicly funded R&D and economic growth.  In other words, it is not at clear that government should be financing or subsidising R&D.


Looking specifically at the Green Car fund, additional problems arise.  Australian political elites and large sections of the population have a low tolerance for wealth and income inequality.  As the late Nobel Laureate Friedrich Hayek explained, new products and services are often expensive and initially are viewed as luxuries for the rich.  Over time, the prices of these goods fall and the less affluent can access them.  Before new products can brought to the market, however, there needs to be sufficient individuals with sufficient disposable income to buy them.  Australia's brutally progressive tax system substantially reduces the disposable income that may be spent on new luxury goods.  All this means that there are fewer profitable opportunities for Australian firms to trial new products at home before exporting them.

In short, Australia is very unlikely to efficiently develop a viable green car -- the domestic market is simply too small.  There are, however, a number of overseas markets where such a viable vehicle could be developed -- the European Union or the United States are obvious contenders.  Rather than waste Australian tax dollars on a symbolic gesture, those Australians who would buy such a vehicle should simply import them from abroad.  To ensure the take-up of such vehicles the government should consider totally abolishing the import tariff on cars and, of course, the luxury car tax -- these vehicles are unlikely to be cheap.

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