4
The costs of decline in manufacturing
4.1
Introduction
Manufacturing’s share of output and employment in the economy has fallen as
other sectors have performed strongly. The terms of reference instruct the
Commission to report on the costs to the Victorian economy of the
manufacturing sector continuing to decline relative to the growth of other
sectors, including services. The relative decline in manufacturing has given rise to
concerns that this deterioration may impose costs on the wider community.
This chapter provides an overview of the Victorian economy within the
Australian context; explores the extent and composition of structural change in
the Victorian economy; and considers the possible costs of the relative decline of
manufacturing.
4.2
The economic context: A picture of growth and
rising incomes
Globally, Victoria and Australia are not alone in experiencing a declining share of
manufacturing in the economy (see chapter 2). Indeed, in many countries the rate
of decline has exceeded that in Victoria. Chapter 3 discussed the key drivers of
the performance of manufacturing. Change in the manufacturing sector is
ongoing, driven by factors such as the exchange rate, strong global competition,
and the expansion of the mineral sector, which is drawing resources from other
sectors:
While manufacturing is important to our economy — and its activity levels have
not diminished in absolute terms — the reality is that its relative decline has
been integral to the marked increase in the living standards of Australians.
(Banks 2011, p. 12)
Overall, the declining share of manufacturing in the economy has coincided with
strong performance in the Australian economy as a whole, as indicated by
growth in national income, per capita incomes, population, and falling
unemployment.
Much of the growth over the last five years has been driven by the resources
boom, with strong demand from China and India. Recently, the mining industry
has increased its share of investment, output and exports, and has contributed to
an increase in Queensland’s and Western Australia’s share of the Australian
economy.
THE COSTS OF DECLINE IN MANUFACTURING
51
Even though Victoria’s economy is not well endowed with mineral resources, its
economic growth is close to the national trend, as shown in figure 4.1. 1 Victorian
GSP grew by 3.0 per cent per year over the last twenty years, slightly below the
national annual growth rate of 3.2 per cent. Also, Victoria’s income per capita
(growing at an average annual rate of 1.8 per cent) has largely grown in line with
the national trend (average annual rate of 1.9 per cent), as shown in figure 4.2.
This suggests that other sectors and forces have kept Victorian output,
employment and incomes growing, even though manufacturing’s relative
contribution to growth has fallen.
Figure 4.1
Australian Real GDP and Victorian Real GSP,
1989-90 to 2009-10 ($ billions)
1,400
350
1,200
300
1,000
250
800
200
600
150
400
100
200
50
0
1989-90
0
1993-94
1997-98
Australia (LHS)
2001-02
2005-06
2009-10
Victoria (RHS)
Source: ABS 2009c; ABS 2009d.
Real Gross State Product (GSP) and Gross Domestic Product (GDP) are based on a chain volume measure
and 2008-09 as the reference year. Per capita indicators measure the ratio of the chain volume estimates of
GDP and GSP to an estimate of the resident Australian and Victorian populations.
1
52
VICTORIAN MANUFACTURING: MEETING THE CHALLENGES
Figure 4.2
Australian Real GDP and Victorian Real GSP per
capita, 1989-90 to 2009-10 ($ per annum)
70,000
60,000
50,000
40,000
30,000
20,000
1989-90
1993-94
1997-98
2001-02
Australia
2005-06
2009-10
Victoria
Source: ABS 2009c; ABS 2009d.
There is, however, evidence that real weekly earnings in Victoria are lagging
behind the national average (figure 4.3).
Figure 4.3
Real Average Weekly Earnings, Australia and
Victoria, 1994-95 to 2009-10 ($)
1,000
950
900
850
800
750
700
1994-95
1996-97
1998-99
2000-01
2002-03
Australia
2004-05
2006-07
2008-09
Victoria
Note: Average weekly earnings expressed in average 2010 dollars; converted into real terms using the
consumer price index.
Source: ABS 2011b.
THE COSTS OF DECLINE IN MANUFACTURING
53
Victoria’s population growth has also risen dramatically since the early 1990s,
averaging around 1.6 per cent over the past decade, while the national average
has been similar at 1.5 per cent (figure 4.4). Victoria’s population grew by 2.2 per
cent over 2008-09, the highest rate over the last two decades. Much of the
continued increase in Victoria’s population has resulted from its rising share of
national net overseas migration, which makes up two thirds of Victoria’s
population increase.
Figure 4.4
Population growth rate, Australia and Victoria,
1989-90 to 2009-10 (per cent)
2.5
2.0
1.5
1.0
0.5
0.0
1989-90
1993-94
1997-98
Australia
2001-02
2005-06
2009-10
Victoria
Source: ABS 2010c.
National and state unemployment rates have declined significantly since the early
1990s (figure 4.5). In the early 1990s, Victorian unemployment exceeded the
national rate. Since that time, Victorian unemployment has been broadly in line
with the national level (currently 4.9 per cent (ABS 2011e)), despite national
labour market conditions favouring employment in the mining and service
industries and manufacturing employment continuing to decline.2
Recent trends suggest that manufacturing employment in mining related firms is receiving a boost from the
expansion of the resources sector, while more trade-exposed parts of the sector are contracting under
pressure from the high exchange rate (RBA 2011c, p. 38).
2
54
VICTORIAN MANUFACTURING: MEETING THE CHALLENGES
Figure 4.5
Unemployment rate, Australia and Victoria,
1989-90 to 2009-10 (per cent)
14
12
10
8
6
4
2
0
1989-90
1993-94
1997-98
Australia
2001-02
2005-06
2009-10
Victoria
Source: ABS 2011e.
Overall, the decline in manufacturing’s share in Victoria’s economy over the past
decade does not appear to have significantly held back economic or employment
growth.
4.3
Structural adjustment
Underlying Victoria’s recent strong economic performance is considerable
change in the structure of the economy. Structural change occurs when
industries grow at different rates and the composition of the economy shifts.
These variations in output, employment and productivity growth among
industries, including the manufacturing sector, are part of ongoing economic
processes.
Figures 4.6 and 4.7 present structural change indices for Victorian output and
employment respectively.3 Where changes in shares are small, the value of the
index is small, indicating modest structural change. Conversely, where changes in
shares are large, the index is larger, indicating more extensive structural change.
This analysis suggests that the rate of structural change in the output of different
industries in Victoria decelerated over the decade to 2010, as depicted by the
average trend line (dashed line in figure 4.6). Similarly, rates of change in the
The methodology follows that of Productivity Commission (1998) and Connolly and Lewis (2010). See
Appendix B for a description.
3
THE COSTS OF DECLINE IN MANUFACTURING
55
industry composition of employment have fallen over the last decade, also
shown by the average trend line (dashed line in figure 4.7).4
Figure 4.6
Structural Change Index for Victoria – Outputbased, 1990 to 2010
3.0
2.5
2.0
1.5
1.0
0.5
0.0
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Note: dashed line represents an average trend.
Source: VCEC.
Structural change indices are sensitive to the level of aggregation underlying the industry classification and
time period.
4
56
VICTORIAN MANUFACTURING: MEETING THE CHALLENGES
Figure 4.7
Structural Change Index for Victoria –
Employment-based, 1990 to 2010
3.0
2.5
2.0
1.5
1.0
0.5
0.0
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Note: dashed line represents an average trend.
Source: VCEC.
The larger changes in manufacturing compared with other sectors have
contributed to this structural change. While the contribution of manufacturing
has varied considerably from year to year, on average manufacturing contributed
about 35 per cent of the shifts in employment in the economy, much larger than
its share in the economy (figure 4.8). Gary Banks remarked:
In Australia’s case, the decline of manufacturing has looked more pronounced
than elsewhere only because of its artificially elevated starting point —
underpinned by high protection. (Banks 2011, p. 5)
However, the trend lines for this time series, as for the other measures of
structural change, appear to have declined for Victoria.
THE COSTS OF DECLINE IN MANUFACTURING
57
Figure 4.8
Contribution of Manufacturing to Structural
Change in Employment for Victoria, 1990 to
2010 (per cent)
60
50
40
30
20
10
0
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Manufacturing Contributions to Structural Change
Employment Share of Manufacturing
Note: dashed line represents an average linear trend.
Source: VCEC.
In the past, much of the structural adjustment has been driven by innovation and
improved productivity, against a background of reductions in industry assistance
and adjustment programs. More recently it has also been driven by the high
exchange rate. The inquiry heard that many Victorian manufacturers are
adjusting, or have already adjusted, to the new business environment
characterised by ongoing change and intense competition from other local and
foreign firms. Sutton Tools remarked:
The waves keep coming. We must learn how to surf, and keep an eye out for
sharks, and the occasional rip. (Bendigo Business Forum, April 2011)
Some other companies have increasingly moved their production activities off
shore, especially the price-sensitive activities. The Commission considers it is
possible, however, that reductions in manufacturing output and employment
may accelerate in the near term. This is discussed further in section 4.6.
58
VICTORIAN MANUFACTURING: MEETING THE CHALLENGES
4.4
The costs of decline
Notwithstanding Victoria’s overall strong economic performance and the
changing structure of the economy, it is important to consider the possible costs
of the relative decline of manufacturing. These include the costs of structural
adjustment long-term unemployment and loss of industries. AME Systems
argued that the continuing decline of the manufacturing sector in Victoria’s
economy could include employment, technology and strategic losses (sub. 13,
pp. 8-9). The Commission has adopted a community-wide perspective, which
involves assessing total social costs and benefits resulting from the decline of
manufacturing.
4.4.1
Costs associated with unemployment
The links between structural change and unemployment are not clear. Measuring
the effects on unemployment of structural change is beset by difficult empirical
and methodological issues (PC 2003a, p. 45). Different analytical approaches
have tended to provide different conclusions.
Over the long run, there does not appear to have been a strong relationship
between unemployment rates and structural change in the economy (PC 2003a,
p. xviii). Moreover, while there is evidence of short-term effects in periods of
major change before the GFC, in other periods structural adjustment in
manufacturing appears to have had weaker short-run effects on unemployment
(PC 2003a).
In Victoria, the strong growth in overall employment suggests that the relative
decline in manufacturing has not had a significant negative impact on aggregate
employment over the longer term. Nevertheless, pockets of manufacturingrelated unemployment may have caused significant personal and social costs (see
section 4.6).5 The social and personal impacts of long spells of unemployment
can be very high for those affected.
At a national level, Borland and Kennedy (1998) showed that individuals losing
their jobs in manufacturing had lower re-employment prospects than in other
industries owing to their age, education levels and location.6 This study is dated,
however, and the upskilling of manufacturing workers may have made the
study’s results less relevant today. The very limited recent evidence on the impact
Structural changes have affected the ability of workers to move between jobs and industries. Attributes such
as poor English proficiency, older age and low educational attainment are major indicators of increased risk
of unemployment (PC 2003a, p. xxiv).
5
Also see Borland (1996) and Borland and Foo (1996) for earlier research on the composition and dynamics
of employment in Australian manufacturing. Li (2011) reported that the number of manufacturing workers
leaving the workforce is considerably smaller than those shifting to non-manufacturing sectors.
6
THE COSTS OF DECLINE IN MANUFACTURING
59
of manufacturing-related unemployment in Victoria prevents a thorough
examination of this issue.
Nevertheless, changes in the structure of employment across regions affect
employment opportunities, rates of unemployment, levels of household income
and patterns of regional migration. The Commission has focused on the
movements in metropolitan Melbourne and regional unemployment rates, and
considered whether this coincided with areas where manufacturing employment
has been lost. Since the early 1990s, the regions have had higher rates of
unemployment and long-term unemployment than metropolitan Melbourne
(figures 4.9 and 4.10 and table 4.1). However, as noted in chapter 5, regional
Victoria has seen relatively stable manufacturing employment over the past
decade, which suggests that job losses in manufacturing have not been a major
contributor to regional unemployment overall, even though job losses may have
been relatively significant in particular towns. Nevertheless, some regions in
Victoria with a small number of major employers are more vulnerable to these
circumstances.
Figure 4.9
Unemployment rates for Melbourne and
Regional Victoria, 1990 to 2011 (per cent)
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
1990
1993
1996
1999
Melbourne
2002
2005
2008
2011
Regional Victoria
Source: ABS 2011e.
60
VICTORIAN MANUFACTURING: MEETING THE CHALLENGES
Figure 4.10
Long-term unemployment rates for Melbourne
and Regional Victoria, 2000 to 2011 (per cent)
2.5
2.0
1.5
1.0
0.5
0.0
2000
2001
2002
2003
2004
2005
Melbourne
2006
2007
2008
2009
2010
2011
Regional Victoria
Source: ABS 2011e; ABS 2009a.
The differences between unemployment rates in Melbourne and the other major
statistical regions in Victoria are provided in table 4.1. In the late 1990s,
Gippsland’s unemployment rate was, on average, 2.8 percentage points higher
than Melbourne’s. More recently, higher rates of unemployment (on average 2.2
percentage points) are evident in the Central Highlands-Wimmera region, which
includes Ballarat.
THE COSTS OF DECLINE IN MANUFACTURING
61
Table 4.1
Unemployment rate differential between
Melbourne and major Victorian statistical regions,
1993-2010 (percentage points)
Barwon-Western Central Highlands- Loddon-Mallee Goulburn-OvensWimmera
Murray
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Average
-0.5
0.6
1.2
0.6
2.5
1.1
1.4
1.3
-1.2
-0.4
0.1
2.0
1.6
1.7
0.4
-0.9
0.2
0.5
0.7
2.9
0.8
0.2
0.6
0.6
1.6
0.9
0.8
0.7
1.4
0.8
2.4
1.4
3.4
2.6
2.3
0.5
2.4
1.5
1.3
1.4
0.6
-0.1
1.1
0.6
1.4
0.9
1.9
-0.1
-0.7
2.2
1.7
1.7
0.8
1.2
0.2
1.6
1.0
-3.2
-2.3
-1.9
-1.8
-1.7
-0.3
-1.6
0.4
-1.0
-0.3
-1.6
-1.1
0.7
-0.0
-1.4
0.3
-0.4
1.3
-0.9
Gippsland
2.7
2.4
-0.3
1.1
3.3
3.7
3.3
2.7
2.0
2.1
0.7
1.6
2.8
0.0
1.3
0.1
-1.0
0.4
1.6
Source: ABS 2011e; ABS 2009a.
4.4.2
Loss of industries
Another potential cost of structural change is the loss of a strategic industry or
skill. It has been suggested that, once an industry falls below a minimum size, it
can reach a tipping point below which the whole industry is lost. For this to
involve costs in addition to the adjustment costs noted above, there must be
external benefits associated with the existence of the industry which are lost once
it has gone. The Australian Council of Wool Exporters and Processors expressed
the concern that, if the current wool processing plants were lost, there would be
flow-on effects and broader costs to the industry (sub. DR52, p. 6).
Similarly, the Federation of Automotive Products Manufacturers (FAPM)
pointed out that, in the case of the automotive industry, the threshold level of
activity is primarily driven by the production of locally manufactured vehicles.
62
VICTORIAN MANUFACTURING: MEETING THE CHALLENGES
The loss of volume in local vehicle production would likely have a significant
impact on the businesses and trades associated with the industry, such as the
tooling industry, raw material suppliers and the services sector (sub. DR60,
p. 10). Toyota Australia also acknowledged that the local automotive
manufacturing sector is a strategic industry, and is at risk if volumes continue to
decline while operational costs continue to rise (sub. DR64, p. 10).
While some groups have argued for special treatment to avoid loss of particular
industry, it needs to be recognised that changing industry structure is a normal
part of economic growth. There is also considerable debate about what is (or is
not) a strategic industry, what the broader net benefits to the community of
supporting such industries are and whether, in practice, it is possible for
governments to override broad market trends. This is discussed further in
chapter 6. Whether there is evidence of the loss of training capacity for key skills
is discussed in chapter 9.
4.4.3
Costs from structural adjustment
Adjustment costs arise when labour and capital in contracting parts of the
economy do not move readily at low cost to those parts of the economy where
they can earn a competitive return. These costs may include re-skilling displaced
employees, under-utilised capital and unused assets. Some level of adjustment
costs is inevitable. The challenge is to minimise them and reduce the impacts on
individuals, households and communities. In fully employed economies with well
functioning markets, adjustment costs are usually low.
The Commonwealth Treasury details an example of a Victorian community
successfully making such a structural shift and facing the challenges of
adjustment (box 4.1).
THE COSTS OF DECLINE IN MANUFACTURING
63
Box 4.1
Geelong – adapting to change
Founded in the 1830s, Geelong became one of Australia’s premier port towns. In the
second half of the 19th century, it shipped the agricultural exports of western
Victoria around the world. In the 20th century, rapid advances in technology and the
advent of mass production techniques provided a new economic opportunity for
Geelong. A strong manufacturing sector emerged, providing work for Geelong’s
growing population. Large firms, such as Ford, also spawned a wide range of related
and supporting industries.
In the early 1990s, the recession and the collapse of the Pyramid Building Society hit
the Geelong region hard. Mirroring events in the broader economy, jobs were also
lost in textiles, clothing, footwear and leather manufacturing. The population
declined and the region was under pressure. Some firms opted to relocate or close.
Developments in technology also meant that certain occupations became redundant.
Yet new technologies and a competitive economic environment provided new
opportunities and generated improved living standards. Many manufacturing firms
abandoned traditional, labour-intensive modes of production. Firms, including those
in the growing biotech industry, switched to capital-intensive and knowledgeintensive approaches. These firms focused on research and development and
required workers with design, engineering and science skills. While manufacturing is
still a large employer in Geelong, employment in services (across a range of areas)
has grown considerably over the past decade.
Source: Commonwealth Treasury 2011a, p. 31.
In the past this adjustment has often been accompanied by government
programs to facilitate change and reduce its impact on communities. Ai Group
suggests that state government assistance programs, such as the Industry
Transition Fund (ITF) and other national programs, are important in assisting
the manufacturing sector to adjust to structural change (sub. DR55, p. 23). More
specific to the automotive industry, the FAPM pointed out those programs that
aimed to facilitate structural adjustment, such as the Automotive Industry
Structural Adjustment Program (AISAP), did in fact assist the industry (sub.
DR60, p. 7). Toyota Australia recommends a broad approach to setting
appropriate policy settings to allow a transition through the current challenging
market (sub. DR64, p. 10).
The arguments around structural adjustment assistance are complex. If poorly
applied, or in inappropriate circumstances, such assistance can have a range of
problems (including distorted incentives leading to protracted adjustment, rent
seeking behaviour and difficulties in ceasing the assistance once granted) and
may adversely affect other industries by reducing employment prospects
elsewhere in the economy.
That said, the case for government action is clearest when industry closures have
a significant impact on local workers who need assistance to retrain or move into
alternative employment. In this case assistance is provided for a very specific
64
VICTORIAN MANUFACTURING: MEETING THE CHALLENGES
purpose and for a defined period of time. Business, however, sometimes claim
that assistance is also warranted in other circumstances.
For example, during a temporary economic downturn some may claim that
assistance is needed so that vital skills and business capacity are not lost when the
business would viable in the long term. This was part of the justification for
changes to the Victorian Industry Participation Policy (VIPP) in (see chapter 12).
The submission by the Australian Manufacturing Workers Union, the Australian
Workers Union and the National Union of Workers argued that unfavourable
movements in the currency exchange rate are a justification for assistance:
There is no economic justification for sitting on the sidelines and
watching unless the policy authorities have a very high degree of certainty
that the terms of trade and the dollar are fixed at these high levels for a
decade or more and that structural adjustment and the allocative efficiency
function of markets must therefore be left unfettered to redistribute
capital and labour to their most efficient uses. The precautionary principle
and considerable expert opinion suggests the high dollar is unlikely to be
with us for a decade or more that case for intervention is strong to secure
those capabilities that would otherwise be lost. (sub. DR58, p. 28)
Others have argued that in some cases the rate of change and investment needed
to revitalise or restructure industry is beyond the capacity of the affected
industry. They argue that government assistance to support the transition would
avoid massive adjustment costs. In such cases it has also been argued that the
risks of significant adjustment costs are particularly acute when the vulnerable
businesses are part of a broader supply chain and the closure of a few businesses
puts the whole supply chain at risk. In this regard the FAPM suggested that
automotive companies are seeking government assistance to help them with
internal restructuring and diversification, and that previous grants under the ITF
had encouraged automotive supply chain consolidation (sub. DR60, pp. 7-8).
Supply chain issues were also raised by Toyota:
It is important to note that a continued decline in the manufacturing sector will
lead to the eventual loss of the local automotive manufacturing industry. The
flow on effects of this would impact the entire automotive supply chain, as well
as service providers to the industry. (sub. DR64, p. 3)
Toyota argued that automotive manufacturing requires appropriate policy
settings to allow a transition through the current challenging market situation
including:




automotive Component Supplier specific policy and programs to facilitate:
accelerated consolidation and rationalisation of the auto components sector
assistance to develop diversification opportunities
access to debt finance. (sub. DR64, p. 9)
THE COSTS OF DECLINE IN MANUFACTURING
65
Due to the complexity of each of these issues it is important that they are
carefully considered on a case-by-case basis to ensure that the benefits of any
proposed assistance outweigh the costs. In assessing those costs and benefits it is
also necessary to demonstrate that:



the problem that the assistance is intended to address is expected to be very
temporary or a one-off permanent restructuring is needed that would result
in a viable, and competitive industry
the industry would be viable in the long-term without further assistance
supporting the industry would not be at the expense of the competitiveness
of other sectors.
The Commission has not undertaken such an assessment on the assistance
programs offered to the Victorian manufacturing sector. However, the
Commission agrees in principle with the value and appropriate role of
adjustment programs, properly defined and focused. The Commission’s views on
the appropriate role for government programs are discussed later in this report
(see chapter 6).
4.5
Social costs of decline
Decline in manufacturing can lead to businesses closing permanently or moving
to another location. Unemployment is one possible outcome, or workers move,
seeking employment in another region.
While this process is economically efficient, and may benefit Victoria in the
longer run as average incomes and levels of welfare are higher, individuals and
communities may incur significant costs which should not be ignored. Watts and
Mitchell argue that ‘the majority of commentators agree that sustained
unemployment imposes significant economic, personal and social costs that
include’:









66
loss of current output
social exclusion and the loss of freedom
skill loss
psychological harm
ill health and reduced life expectancy
loss of motivation
the undermining of human relations and family life
racial and gender inequality
loss of social values and responsibility. (Watts and Mitchell 2000, p. 5)
VICTORIAN MANUFACTURING: MEETING THE CHALLENGES
4.5.1
Costs to individuals
As noted in section 4.4.2, unemployment — especially long-term unemployment
— can impose significant costs on individuals, beyond loss of income. Burgess
and Mitchell note that:
Unemployment has been linked to family break up, substance abuse, alienation,
discrimination, illness and death, truancy and non-completion of schooling, and
poverty. (Burgess and Mitchell 1998)
In addition, unemployment not only affects the direct well-being of the
individual but also their ability to enjoy the rights and privileges expected by
other members of the community:
In the context of human rights it is important to emphasise the loss of freedom
associated with unemployment. Without access to labour income the
unemployed have to rely on social and/or family transfers, non-labour income
or savings. For many of the unemployed there is no pool of savings, no nonlabour income and no family transfers. Being without an income severely
restricts the ability to participate in the market economy. (Burgess and Mitchell
1998)
4.5.2
Impact on communities
Decline in local manufacturing industries can affect community strength and
resilience — especially in regions where there is a single major employer. As well
as leading to pockets of unemployment, major business closures or contractions
can break up communities, as workers leave to find employment elsewhere.
Unemployment and social exclusion can also lead to direct problems in local
communities. For example, Burgess and Mitchell argued that:
… social and economic exclusion facilitates anti-social behaviour and fosters the
growth in illegal activity as a means of generating income. (Burgess and Mitchell
1998)
From a wider perspective, social exclusion and population loss can reduce social
capital and weaken community connections. Social bonds in communities are
important, as noted by Vinson:
… we have strong factual evidence, based on a sample of more than 37,000
residents of Victoria, that areas characterised by strong connections between
people, and residents’ involvement with their community, are localities protected
from the most harmful consequences of social conditions like unemployment,
low income and limited education. (Vinson 2007, p. 3)
The loss of social bonds and connections as a result of declining industry,
unemployment and population loss can weaken the community protections
envisaged by Vinson, potentially exacerbating the impact of decline and
population loss.
THE COSTS OF DECLINE IN MANUFACTURING
67
These community impacts are not just social. The Productivity Commission
identified that social capital (embodying, among other things, high levels of trust
among people and strong social networks) — an outcome of strong communities
— can enhance competitiveness and improve economic performance by:

reducing transaction costs
facilitating the dissemination of knowledge and innovations
promoting cooperative and/or socially minded behaviour

through individual benefits and associated social spin offs. (PC 2003b, p. 15)


The transaction costs of personal and business dealings can be more efficient in
strong communities because of personal networks and high levels of trust among
community members (PC 2003b, p. 15).
The loss of social capital as a result of a declining manufacturing in some areas
— most notably in regional Victoria but also in parts of metropolitan Melbourne
— may impose significant social costs on individuals as well as on their families
and communities.
4.6
Future costs of decline
It can be expected that structural change will continue in the future; indeed, this
is desirable as it leads to a more competitive and productive economy. As noted
by Banks:
The longer-term trends — the relative rise of the services sector and decline of
the manufacturing sector — are all a manifestation of the process of advanced
economic development, which are observable in most OECD countries. (Banks
2011, p. 5)
Moreover, future structural change is no more likely to be associated with
long-term unemployment than it was in the past two decades, even if
manufacturing’s share of output and employment continues to decline.
The Commission considered a number of projections of growth of output and
employment in the Victorian manufacturing sector. Goodman Fielder and Visy
jointly commissioned a report, The Future for Manufacturing in Victoria (SG
Heilbron Economic & Policy Consulting 2010). The report used input-output
(IO) analysis, and suggested that the ‘collapse of the Victorian manufacturing
industry would result in significant economic and social costs’ (sub. 9 p. 5). The
report estimated that 587 000 jobs would be lost in Victoria, along with 27 per
cent of household income and 24 per cent of Gross State Product (GSP) (SG
Heilbron Economic & Policy Consulting 2010).
However, the partial equilibrium methodology used to reach this conclusion has
inherent biases that significantly overestimate the negative economic impacts.
The IO analysis assumes there is a complete shut-down of the manufacturing
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VICTORIAN MANUFACTURING: MEETING THE CHALLENGES
sector and adds the flow-on effects to, for example, industries that supply
manufacturers. The predicted outcomes are unlikely because:
 The complete loss of manufacturing is an extreme scenario. It is inconsistent
with recent history where some areas of manufacturing are growing even with
high wages and an appreciating exchange rate.
 The IO analysis assumes that all people and capital employed in
manufacturing would remain idle if manufacturing businesses closed. As
Victoria’s and Australia’s economies are growing and many of the skills
employed in manufacturing are in demand in other sectors of the economy,
the decline in manufacturing would tend to be offset as these people and
other resources moved into other activities.
For a discussion of concerns with this methodology, and the advantages of
competitive general equilibrium modelling as an alternative approach, see
(Layman 2002) and (VAGO 2007a).7
The Department of Business Innovation commissioned KPMG to develop
projections of the Victorian manufacturing sector (KPMG 2011b). KPMG used
a computable general equilibrium model that is designed to take account of flowon effects and adjustments in the economy.8
The results for a set of ‘business as usual’ assumptions — where major drivers of
domestic economic growth such as productivity, population and world growth
continue in line with current trends and there are no major shifts in government
policy — indicate that Victorian manufacturing output is expected to grow
slowly in the next ten years (+1.0 per cent per annum), before accelerating to a
higher long run average annual growth rate (+1.8 per cent per annum) owing to
stronger downstream business investment (particularly mining) and projected
depreciation of the Australian dollar (KPMG 2011b, p. 27). Employment in the
industry is expected to contract over the long term, declining from approximately
305 000 jobs in 2010-11 to 279 000 jobs in 2030-31 (KPMG 2011b). This reflects
the shift away from labour intensive to more capital intensive production
processes due to the competition from overseas with lower cost labour intensive
imports (KPMG 2011b, p. 27).
In addition, Ai Group modelled the potential impact of a further decline in the
manufacturing industry on the regions. This analysis showed significant declines
in regional gross domestic product for two scenarios — a 10 per cent reduction
in food manufacturing export demand, and a cumulative 10 per cent reduction in
The Victorian Auditor-General compared alternative modelling techniques for estimating the economic
effects of the 2005 Australian Formula 1 Grand Prix.
7
8
For full description of the model see KPMG (2011b).
THE COSTS OF DECLINE IN MANUFACTURING
69
the level of total factor productivity of the manufacturing industry over 10 years
(sub. DR55, pp. 36-38). Regional manufacturing is discussed further in chapter 5.
4.7
Conclusion
Overall, the Australian and Victorian economies have performed well in recent
years, with significant changes in their size and composition and in the
distribution of activity and resources among firms, industries and regions.
Although manufacturing has been a significant contributor to structural change
in Victoria, the rate of structural change appears to have been decelerating.
However, there may be some acceleration in this over the course of the next few
years as the resources boom (along with high terms of trade and an appreciating
exchange rate) accelerates this process.
Structural change is an inevitable part of a growing economy, and there will
always be a need to adjust. The costs of adjustment can be large if there are
unemployed resources, particularly labour. Because of the personal and social
costs of unemployment, the community is particularly concerned when structural
change results in job losses, and the affected employees are unable to quickly reenter the workforce or alternative pathways such as re-training. Therefore, at the
state level, skills and training policies are particularly important.
The Commission concludes that the net costs of the relative decline in
manufacturing have not been large from an economy-wide perspective, although
the personal and social costs of unemployment, and losses accruing to owners of
enterprises that have become uncompetitive, can be significant for those
affected. To the extent that the relative decline in manufacturing has been
associated with productivity growth and innovation, it is likely to have generated
net benefits for the community.
A key aspect of the costs of decline in manufacturing is the risk that future policy
settings will not be amenable to a high-productivity, dynamic and flexible
economy. Government policy is unlikely to be able to reverse the relative decline
in manufacturing; to the extent it could, this would have very high direct and
indirect costs.
The subsequent chapters of this report focus on how to give manufacturing the
best possible chance to succeed in a challenging environment. Manufacturers will
have some specific needs regarding education and skills, for example, but policy
interventions should operate in a non-discriminatory, broad-based way that
enhances productivity and competitiveness and provides the appropriate policy
settings for all firms. If future productivity growth is lower because, for example,
policy prevents adjustment, or discourages innovation or the development and
application of skills, this would undermine manufacturing’s long-term
competitiveness.
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