HERE'S a cautionary tale for anyone who is tempted by the argument that the Abbott government can accelerate the economy's future growth by picking Australia's future winning industry sectors.
When the Productivity Commission was asked by the Treasurer, Joe Hockey, to investigate the cost pressures on Australian dairy manufacturers, what it found was an industry infected with a new enthusiasm: attractive government intervention to create a New Zealand-style "national champion" dairy manufacturer.
That enthusiasm owes a great deal to work by the management consultants, McKinsey, for the Business Council of Australia which cited New Zealand's dairy in its argument for the government to "develop specific sector growth strategies, with urgent action needed for the mining and LNG, agriculture and food production, and energy sectors, which are critical to driving Australia's wealth and enabling growth".
McKinsey concluded Australian dairy was at a 20c per kilogram of skim powder milk disadvantage to the New Zealanders because of its lower scale processing. It suggested that "purposeful market design" by the Australian government might be warranted to "unlock the underlying export potential of the dairy industry".
However, the Productivity Commission appears to be less impressed than the BCA with the McKinsey analysis.
It says New Zealand's dairy industry structure is of limited policy relevance to Australia. It points out that drought, the strong Australian dollar, and the mining investment boom play an important part in explaining the less impressive export performance of Australian dairy.
"While the resources investment boom in Australia drew resources away from dairy and toward higher returning industries, relatively low returns to many non-dairy agricultural industries (such as sheep and forestry) in New Zealand led to a high rate of land conversion towards dairying," the commission says.
As for New Zealand dairy's scale economies, the commission argues that Australian manufacturers already are taking advantage of scale economies where that is profitable. It reminds readers that achieving higher scale can increase other costs: "Where the density of raw milk production in the collection area surrounding a plant is relatively low... the transport costs associated with raw milk collection can limit the case for increasing dairy manufacturing scale. Evidence provided to the commission suggests that these costs could often outweigh the benefits from consolidating dairy manufacturing plants in Australia."
The commission also argues that Australian dairy manufacturers are as capable as Fonterra of developing a distinctive national brand but it points out that Australia is a relatively small global supplier of dairy products and warns that the belief that a single dairy company could exert market power "is not consistent with market realities".
On the commission's more detailed analysis, it seems the idea that the government can turn the dairy manufacturers into a national export champion does not stack up. Identifying the factors that explain the strengths and weaknesses of an industry obviously is difficult; accurately predicting the sources of the economy's future comparative advantage is harder still, and it is dangerous.
While the government keeps prioritising specific sectors, it is creating the political framework for successful rent seeking. When the growth centres prove to be not enough, the favoured industries will use the government's own words to demand greater preferment. And while they enjoy the material benefits of their official priority, other activities that could also have an important role in Australia's future growth will not be so blessed.
As Abbott stressed in his dealings with Australia's unsuccessful industries, assistance to one industry imposes costs on others.
The issue is the government trying to pick future winners. Many of the individual reforms outlined in Abbott's industry agenda – from cutting unnecessary red tape to better education and training – are fine, as long as they are properly executed.
The mistake is to bias the reform process in order to favour industries judged by the government to have a special place in the nation's longer-term future.