The Productivity Commission 2014
Auto Report – A Critique
Phil Toner
Phil.toner@sydney.edu.au
Political Economy Department
The University of Sydney
Roni Demirbag
ronidemirbag@hotmail.com
1
Overview:
 Rationale for the PCs opposition to industry policy
 Modelling results and assumptions
 Criticism of the PC approach.
2
PC Arguments Against Assistance
 Misallocation of resources due industry specific
assistance.
 Dynamic efficiency losses: ‘dulls the incentive for firms
to improve productivity’ (PC 2014a:77)
 Crowding out: ‘one industry’s expansion usually results
in another’s contraction’ (PC 2012:26), ‘Tariffs do not
have any significant impact on the total level of
employment in the economy as a whole’ (PC 2000:22)
 Adjustment costs modest compared to the benefits from
reduction in distortions.
 All Industry specific assistance is measured by the PC as
a deadweight loss.
 Promotes rent-seeking behaviour
3
6 Common Arguments in Support
of Industry Policy
 Unemployed resources
 Distorted International Markets
 Increasing Returns
 Technological Spillovers
 Leontief Multipliers
 Excessive Exchange Rate Appreciation
4
Modelling Results -1
Table 1: Source of job losses
Passenger motor
Input-supply
vehicle manufacturing industries(a)
9 080
23 530
Model
Total
32 610
Assumed
Total
40,000
Source PC 2014b: Table C.4 (a) All industries supplying inputs to the domestic passenger motor vehicle manufacturing industry
(including automotive components suppliers).
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Modelling Results - 2
Table 2: Selected Main Aggregate Long-run Effects From 2020-21
Variable
Percent Change
Real GDP
0.1
Real gross national
0> <0.05
expenditure
Real exchange rate
-0.4
Export volumes
2.3
Import volumes
2.0
Terms of trade
-.3
Real unit labour cost
-.2
Source PC 2014b: Table 2.2
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Modelling Result - 3
Table 3: Selected Main Long-run Industry Effects From 2020-21
Variable
Percent Change
Employment
0 Held fixed by
assumption.
Value Added
Agriculture
0.8
Mining
2.4
Manufacturing
-1.6
Services
0> <0.05
Employment
Agriculture
1.3
Mining
2.5
Manufacturing
-1.2
Services
0> <0.05
Source PC 2014b: Table 2.1
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Modelling Assumptions
 Employment is fixed in the long run: ‘employment effects of a shock
to the economy are largely eliminated after 5 years’ (Dixon and
Rimmer 2002, [.205)
 Resource allocation based on neoclassical production function.
Capital is ‘malleable’ but labour is not. Different occupational groups
 Constant returns to scale: ‘’The model also does not capture factors
such as economies of scale or scope that change the commercial
viability of production units or lead firms to concentrate new
production at a particular plant or in a particular location’’
(Productivity Commission 2014b: 7)
 Unemployment floor is determined by the natural rate.
 High rates of substitution of domestic production for imports and
vice versa (High Armington Elasticities)
 High export demand elasticity with respect to prices of Australia’s
commodity exports. Australia has little influence over world prices of
the products they sell.
8
Lower level Assumptions for the
Car Industy Modelling
 Under-estimating the impact of passenger car industry:
Only direct and first round effects.
 After closure of the car industry at the end of 2017
$621m is reallocated as a lump-sum to households.
 Closure of the passenger car making industry and its
supply chain results in the unemployment of 40,000
workers and associated capital stock. ‘These initial
effects trigger changes in prices of products, labour and
capital which lead to output changes throughout the
economy’ (Productivity Commission 2014b: 12).
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Criticism
 Two approaches:
 Challenge the validity of the various parameters and
closures that are commonly accepted to be inherently
subjective yet very crucial in the results obtained from
the modelling.
 Investigate the broad theoretical framework of the
model and assess whether or not they support the bold
claims made by the PC.
 In this study we focus on the latter rather than the
former.
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MMRF Model
 Each state and territory is treated as a separate
economy.
 64 industries and commodities in each state
 8 occupation groups in each state labour market, labour
free moves interstate due to changes in 'occupationalspecific real wages'.
 A household sector in each state and territory
 8 state and territory governments
 the Australian Government
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Breakdown of 64 Industries:
 6 agricultural and related industries
 6 mining industries
 21 Manufacturing industries
 8 Utility Industries
 2 Construction industries
 4 trade, repair and food and accommodation industries
 8 transport industries
 9 finance, government and other service industries
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Production functions
 3 levels of nested production function.
 First level fixed proportion to output
 Second level is represented by the CES production
function.
 Third level is also represented by the CES production
function.
 The economy as a whole is represented by the Leontief
Production function
 Difference between MMRF5 and MMRF-Auto 14
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What is MMRF?
 Is it a general equilibrium model?
 Computable General Equilibrium (CGE) Model.
 Johansen 1960,
 Extension of the ORANI model
 Applied General Equilibrium (AGE) Models – Herbert
Scarf
 Velupillai (2006) AGE non computable.
 Why is the difference important?
 Assumption of full employment and Efficient resource
allocation.
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Capital Theory Debates
 Three key neoclassical parables:
1. An inverse, monotonic relation between quantity of capital
and rate of interest;
2. Return on capital is based on the natural or technical
properties of the diminishing marginal productivity of
capital; and
3. Distribution of income between capital and labour depends
on relative scarcity and marginal products.
 Wicksell effects – ‘reswitching’ and ‘reverse capital
deepening’ – Demand curve for capital is not always
sloped downwards.
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Samuelson concedes
 ‘The phenomenon of switching back at a very low
interest rate to a set of techniques that had seemed
viable only at a very high interest rate involves more
than esoteric technicalities. It shows that the simple tale
told by Jevons, Böhm-Bawerk, Wicksell, and other
neoclassical writers—alleging that, as the interest rate
falls in consequence of abstention from present
consumption in favor of future, technology must become
in some sense more “roundabout,” more “mechanized,”
and “more productive”—cannot be universally valid.’
(Samuelson 1966a; emphasis added)
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Two alternate paths
 Lowbrow: Admit the logical problems but challenge the
empirical significance.
 Highbrow: Admit the logical problems and move on to
General Equilibrium theory to avoid aggregation of
capital.
17
Lowbrow
 ‘The Crux of the matter is that economists may be
unable to make any statements concerning the relation
of production to competitive input and output
markets....I believe they can; but that is a statement of
faith...’(Ferguson, 1969, p.269)
 Solow: ‘I have never thought of the macroeconomic
production function as a rigorously justifiable concept. In
my mind, it is either an illuminating parable, or else a
mere device for handling data, to be used so long as it
gives good empirical results, and to be abandoned as
soon as it doesn’t, or as soon as something better comes
along’ (1966, pp.1259-60).
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Empirical verification
 Underlying accounting identity.
 Phelps Brown (1957)
 Shaikh (1974, 1980) – Humbug production function
 Herbert Simon: 'Fitted Cobb–Douglas functions are
homogeneous, generally of degree close to unity and
with a labor exponent of about the right magnitude.
These findings, however, cannot be taken as strong
evidence for the [neo]classical theory, for the identical
results can readily be produced by mistakenly fitting a
Cobb–Douglas function to data that were in fact
generated by a linear accounting identity (value of goods
equals labor cost plus capital cost' (1979, p.497).
 Can Neoclassical Economics afford to be roughly correct?
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General Equilibrium
 Arrow-Debreu General Equilibrium
 Disaggregated, all goods (including capital goods) are
treated separately.
 Hahn: representing the ‘invisible hand’
 Equilibrium was proven to exist (Arrow and Debreu)
 Was equilibrium Unique and Stable?
 Sonnenschein-Mantel-Debreu theorem (SMD): Anything
goes!
 Solow: ‘in the aggregate, the hypothesis of rational
behaviour has in general no implications (Arrow 1986,
p.S388).
 Income effect and substitution effect.
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General Theory of the Second
Best
 Lipsey and Lancaster (1956-1957)
 if the theoretically optimum cannot be attained because
of one Paretian condition being unattainable due to
constraints, then other Paretian conditions may be
attainable, but they ‘are, in general, no longer desirable’
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Dynamic Efficiency
 Static allocative efficiency (Neoclassical theory)
 Dynamic efficiency
 PC recognises the difficulty of dynamic efficiency but
ignores it in their analysis. Their model cannot capture
the dynamic change let alone quantify it.
 Ignoring dynamic change implies that PC is ignoring
productivity!
 Carveth Read ‘It is better to be vaguely right than
exactly wrong’ (1914, p.310)
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