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French submarines and Australia’s 21st century economy



9 August 2016 15:47

The politics behind the decision to build the Australian Navy's new French-designed submarines in South Australia have been analysed to death. But what about Prime Minister Malcolm Turnbull’s claim that the high-tech program will play a key role in boosting the economy’s competitiveness and growth?

The government is subsidising the local construction the highly advanced French submarines partly in order to secure high-tech jobs, training, and expertise that, it argues, will have applications outside naval shipbuilding and will foster the development of high tech manufacturing and services.

These ‘spillovers’ are central to Turnbull’s argument that the submarine project will make an important contribution to future economic growth. However, the same money could have been spent on more conventional policies to boost research and development and innovation; policies such as increased tax breaks for R&D that would leave business and ‘the market’ to decide where the money should be spent. The prime minister’s decision to nail so much of the government’s innovation strategy to the submarine project will incur a high opportunity cost that can be measured in terms of the potentially more valuable R&D foregone.

The Turnbull government’s desire to encourage R&D and innovation, including in manufacturing, is understandable. Economists agree that technological progress is the most important driver of economic growth. Yet the very spillovers that spread the gains from research and innovation also act as an invisible tax on investment in R&D. They mean the benefits from R&D investment cannot be fully captured by the original investors and, in the absence of government financial support, there would be too little investment in R&D and innovation.

However, if there is a case to expand that assistance for R&D, it should go where it will do the most good for the economy.

The Productivity Commission argues that technology spillovers are more likely if high-tech activities such as R&D are conducted in Australia. It warns that the local assembly of high-tech defence components that have been developed overseas is likely to yield less in the way of spillover benefits.

Tax breaks for R&D also are a more direct way of encouraging the research and innovation that economists agree is crucial for growth. Moreover, because they are aimed at the activity rather than particular industries, and the R&D investment decisions are made by business as part of the competitive process, the R&D subsidy is more likely to find its way to where it will do the most good. Like any other investment, spending on R&D should be driven by the expected rate of return.

Anyone listening to the prime minister's could be forgiven for thinking that R&D and the high tech jobs of the 21st century are all in manufacturing. In fact, mining spends almost as much as the manufacturers on R&D, and the service sector spends far more. Of course, some of that service sector spending will be outsourced research for manufacturers, but the finance sector alone spends three quarters as much as the manufacturers. The construction industry also is major user of R&D.

One sector where government R&D spending probably should be higher is agriculture. Reduced government spending on agricultural research has been a prime suspect in the decline in agricultural productivity growth. But with the emergence China’s middle class, agriculture and its research are set to become more important.

In the name of creating jobs for the 21st century, the Turnbull government is spending billions of dollars to expand an inherently uneconomic submarine-building industry. We are forcing ourselves to make our own weapons at a large cost to the economy. Australia is in effect doing to itself what we and the other western nations did with our arms embargoes to the apartheid regime in South Africa. 

A more promising strategy would have been to have the submarines built more cheaply in France, and use the money saved to directly fund business R&D and more basic research in our universities and the CSIRO. That almost certainly would have generated more research and innovation, and in industries that can make more effective use of it.

Another possibility would have been to share the savings between the navy (which might have got, say, another submarine) and R&D.

Then there would have been more truth to the prime minister’s assertion that the submarine decision marked a great day for both the navy and Australia’s 21st century economy.

Photo courtesy of Australian Defence Image Library

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