Competing from Australia: The world is not flat

A CEDA research project maps out the Australian economy’s changing relationship with the rest of the world. By David Walker.

The most influential popular writer on world economics today is Thomas Friedman, columnist for the New York Times . Friedman's best-selling book The World Is Flat argues that technological and political forces are converging to level the global economic playing field - to "flatten" trade and investment. In Friedman's words, we now have "a global, Web-enabled playing field that allows for multiple forms of collaboration without regard to geography or distance".

The power of Friedman's book is that it ties together many recent trends in global trade and investment patterns of the past decade. The Internet, cheap telecommunications and business re-engineering are coming together to create giant global supply chains. Low-cost Chinese and Indian skills are creating ever-cheaper products and services for consumers in the "developed" world. Individuals are collaborating to grow new businesses and new business models and disseminate new knowledge at unprecedented speed. Transaction costs are lower; flexibility is greater.

But as Friedman himself acknowledges, the world is not yet flat. It is merely flattening. And Australia, as we are coming more clearly to realise, faces special challenges in responding to these latest changes in the world economy. We also possess some surprising advantages.

CEDA has started a new research project titled Competing from Australia. This project aims to understand how these changes will influence Australia's economy over the next decade,and to point the way to policies that make the most of the changing global environment.

This article sets out some key pieces of recent research that will act as the project's starting points.

Starting point 1: The Tyranny of Distance is real

Australia is 20 million people thousands of kilometres from any other large developed market. And no two cities in Australia with a population of over 1 million are closer than 600 kilometres. By way of comparison, California has a population of around 34 million in an area around one-twentieth of Australia's, with its population concentrated between San Francisco and San Diego - a distance of some 800 kilometres - with another 260 million people elsewhere in the US alone.

Work carried out by economists over recent years on "gravity models of trade" confirms that Australia's distance still matters in today's world. No matter what Thomas Friedman may claim in the title of his now-famous book, the world is not yet flat. There's not even clear evidence yet that it's flattening very much.

Calculations by the Macro Dynamics Unit of the Australian Treasury suggest that if Australia were placed where the United Kingdom currently is, our trade with the rest of the world over the past 25 years would have been around 50 per cent higher.

Concerns about Australia's trade performance were particularly strong in the 1980s. But by international standards, Australian remains a trade laggard: only 4 per cent of Australian firms are regular exporters. Among members of the OECD, the next lowest performer is Canada, at 16 per cent.

Yet according to the gravity models of trade, Australia actually trades slightly more with the rest of the world than our remoteness suggests we should.

Among the policy implications of trade model work is the notion that mining and agriculture will continue to be sources of competitive advantage for Australia. This work also suggests that Australia may have an advantage in certain areas of services trade. And the Macro Dynamics Unit also notes that distance confers a degree of natural protection on Australia's markets.

"It is unlikely that the costs of distance can ever be completely overcome," the Macro Dynamics Unit concludes. "Because of this, it is probably necessary that those characteristics that make Australia unique continue to be evaluated at a policy level."

Starting point 2: Specialisation

CEDA's research director Ian Marsh says new business models emerging in the past few years emphasise specialisation and collaboration as the factors that give individual firms an edge. Several studies confirm that as the world economy evolves, industry sectors are becoming more specialised and collaborative.

This rise in specialisation is potentially an important long-term development for Australian industries, which lack the ability to access huge economies of scale. In particular, a number of Australian businesses are showing an ability to complement world-leading overseas firms, providing specialist solutions.

Much industrial development literature of the past 15 years has stressed the importance of geographic "clusters" of industries, an idea that originated Michael Porter's 1990 book The Competitive Advantage of Nations. A series of state and federal government initiatives over the past 15 years have aimed to encourage the development of industry clusters in Australia. A number of industry policy experts, including Melbourne Business School's Professor Joshua Gans, argue that in the past 25 years Australian public policy and private sector initiatives have improved the status of Australian industry clusters, and that the strategy should be pursued more aggressively, particularly in Sydney and Melbourne.

However, it is not clear how many distinct genuine clusters exist in the Australian economy beyond the wine and minerals industries. As the No Simple Solutions report notes, "no major new sectors have emerged in Australia during recent decades." Some researchers consulted by CEDA speculate that as specialisation becomes more influential, geographic clustering may play a less important role in Australia's small and scattered economy.

Starting point 3: Multinationals matter

As Ian Marsh points out, in the past two decades the structure of global trade has shifted towards global supply networks centred on multinational corporations. Multinationals now play key roles in developing local technological capabilities and firm-specific advantages, he says. Multinational corporations represent a major part of Australia's industry base - but Australia has, by and large, been unsuccessful at using these MNCs to tap into the global economy. However, Australia's links with multinationals "remain underdeveloped", in Marsh's words. And this country suffers from the lack of major "platform" companies like Finland's Nokia, Sweden's Ericsson or Philips in The Netherlands.

The No Simple Solutions report argues that a number of successful Australian firms are choosing to be complementary to multinationals. "They take a lower-key approach and achieve success as either specialist providers internationally, and/or serving the Australian market - especially as service providers. In many cases, Australian firms 'learn while doing' and start to export these services."

In CEDA's work to date with policy experts and industry representatives, the role of multinationals in Australia has emerged as a key priority.

Starting point 4: Australia is using IT&T well

Among the most optimistic findings in recent Australian economic research is that Australia appears to have used IT and telecommunications (IT&T) to raise productivity. That may be reducing the effects of distance. "Strong uptake of [IT&T] in Australia in the 1990s ... in concert with restructuring of firms and production, has brought performance gains," notes the Productivity Commission's Dean Parham. Says the No Simple Solutions report:

A leading contribution to Australia's economic performance has arisen from implementing knowledge, and adopting and adapting technology, largely in resource-based, service and low-technology industries where innovation is focused on changing processes rather than on major products.

IT&T may be most important for the smaller-sized firms which are relatively over-represented in the Australian economy. "Constant supervision, constant communication and constant coordination are necessary to make small businesses grow," notes information economics specialist Professor Hal Varian. "But it is just these things - the ability to supervise, communicate and coordinate at a distance - that have become so much cheaper in the last 20 years. Big enterprises were the first to reap the benefits of this technological progress, but the impact of information technology on small and medium-size enterprises may yet turn out to have the most impact on the economy."

Starting point 5: China and India will compete - and complement

The rise of Chinese manufacturing has attracted particular attention in recent months as the local car industry confronts the challenge of low-priced Chinese components. But China's effects on Australia's economy over the next decade will go far beyond this.

Australian innovation expert Jonathan West argues that "the key to China's growth is not cheap unskilled labour, it is cheap skilled labour". The Chinese supply of low-cost skilled workers such as engineers appears to give China a powerful cost-structural advantage in a knowledge-oriented world economy. The same is true of India in some niches such as IT, and some services activities.

However, in most areas of economic activity, Australia's strengths are complementary to those of India and China. China is a commodity importer whose economy is centred on the production of manufactured goods; services make up around 34 per cent of its economy. In Australia, commodities such as iron ore and coal dominate exports, while services dominate the domestic economy, accounting for 56 per cent of GDP and three-quarters of total employment. Australia's strong existing bilateral relationship with China leaves us well-placed to benefit from that nation's re-emergence into the world economy.