A Tale of Two Contracts: Infrastructure and Australian Jobs

26/09/2016 10:43 AM AEST | Updated 26/09/2016 10:43 AM AEST

Economists agree public infrastructure investments will be critical to Australia's economic adjustment to the downturn in mining. Capital spending by private companies is falling fast. Consumers, meanwhile, are tapped out with record debt, and can't boost their own spending until the labour market improves.

Infrastructure projects by all levels of government thus take on a double importance. They directly address the need for improved public facilities, in all kinds of areas: transportation, education, health care, utilities, and more. But they also help fill the economic void left by the contraction in mining investments.

A dramatic illustration of the importance of public investment was provided in the latest GDP statistics from the Australian Bureau of Statistics. Adjusted for inflation, public capital spending grew over 15 percent in the June quarter, up $2.7 billion. But overall GDP grew only $2.2 billion. In other words, without the expansion of public investment, Australia's GDP would have shrunk – and the country's 25-year streak of recession-free growth would be in jeopardy. Private capital spending, in contrast, trended lower for the tenth quarter in a row.

So the emphasis on infrastructure spending makes strong economic sense. But to get the most bang for the buck, governments must be deliberate and strategic in allocating infrastructure dollars. Of course, they must ensure the money is spent efficiently: so projects are delivered on-budget and on-time. But they must also target the greatest possible economic spin-offs from infrastructure spending for the broader Australian economy. Since a key goal of infrastructure spending is now to stimulate macroeconomic activity, it is crucial that investments be targeted for maximum stimulative effect.

In this regard, two recent contracts for public passenger rail equipment provide a study in contrasts. Last week Victoria announced the state's biggest-ever contract for new trains: $2 billion for 65 new high-capacity trains, with delivery beginning in 2018. The trains will be assembled at an upgraded plant in western Melbourne, generating over 1000 jobs in direct assembly, and many more in related functions. Domestic content will account for at least 60 percent of the total value, and the state government was clear from the outset that Australian content was a key criterion in bid selection. Other state rail contracts in the last two years have also gone to facilities in Ballarat and Dandenong.

At the other extreme, the New South Wales government recently signed a similar-sized contract for taxpayer-funded passenger rail cars. But stimulating new employment and economic activity in New South Wales – or anywhere else in Australia, for that matter – was not a priority in bid selection. Instead, the state government fixated narrowly on minimizing the bid cost.

So the $2.3 billion contract was awarded to a consortium led by the Korean industrial giant, Hyundai. The 512 cars will be assembled in Korea, incorporating Japanese-made powertrain and traction equipment. Australian employment spin-offs will be limited to maintenance work – and even that is not guaranteed, because the Korea-Australia Free Trade Agreement allows Hyundai to bring unlimited numbers of Korean workers to Australia to perform any specialized work related to the contract.

NSW Transport Minister Andrew Constance claimed that sourcing the equipment from Korea was "the best outcome for taxpayers," citing unspecified "benchmarking" to argue it would cost 25 percent more to do the work in Australia. His claim of a cost premium for domestic work is not convincing: research by independent experts (including Deloitte Access Economics) has shown that better coordination of the flow of domestic rail procurement could attain savings of 20 percent or more on Australian production.

But even if Australian-made cars were 25 percent more expensive, that still doesn't imply that offshoring the work is the "best outcome" for taxpayers. I recently completed a quantitative study of the direct and indirect economic effects of railway equipment manufacturing in Australia. The industry directly employs about 5000 workers, at facilities in several states (including NSW). It supports 7000 more jobs through its direct purchases of Australian-made parts, supplies, and services: everything from fabricated metal products, to electronic equipment, to transportation and financial services. Finally, downstream consumer spending by railway manufacturing workers (and those employed in the industry's supply chain) supports an estimated 5400 additional jobs.

Remember, government needs a vibrant economy to generate tax revenues to fund public services: including infrastructure. This is especially true at times – like the present – when the economy is held back by inadequate purchasing power and persistent unemployment. By offshoring high-tech, taxpayer-funded economic activity to Korea, wh9ile tolerating high unemployment at home, the NSW government undermined its own fiscal base, and that of other governments in Australia (including the Commonwealth, which after all provides over 40 percent of the state's revenues).

The manufacturing portion of the NSW contract (excluding maintenance costs) is worth about $1.3 billion. A 25 percent made-in-Australia penalty, even if true, would add $325 million. But offshoring the manufacturing work will reduce national GDP by $1.4 billion, and cut all government revenues by $455 million. In other words, lost public sector revenue from buying the cars from Korea will more than offset the purported (but unproven) cost penalty for doing the work in Australia. The NSW government is being penny wise, but pound foolish.

At a time of chronic unemployment and sluggish growth, government has a responsibility to use all of its powers to maximize the opportunities of Australians. Upcoming investments in public infrastructure – including $30 billion in railway equipment over the next three decades – have enormous potential to snap the national economy out of stubborn stagnation. But a blinkered obsession with buying as cheap as possible will squander that opportunity and reinforce Australia's deindustrialization.

Read the full report on the consequences of offshoring rail procurement here.

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