Measuring contributions to the Australian economy: the benefits of a fast-growing motor vehicle and parts industry

Economic Papers (Economic Society of Australia), March, 2004 by Peter B. Dixon, Maureen T. Rimmer

The contribution of an industry to the economy is often measured by an out-put calculation showing labour used directly in the industry and indirectly via the production of intermediate inputs for the industry. This paper demonstrates an alternative approach based on simulations with a dynamic computable general equilibrium model. Rather than measuring contribution in terms of resources used, we look at the potential contribution of an industry in terms of the effect on economic welfare of improved performance. We apply our methodology to the Australian motor vehicle industry by simulating the impact that this industry could make if it were to achieve higher productivity growth, higher export growth and the production of cars of greater appeal to Australian consumers.

Key words: Industry contribution, Dynamic CGE analysis, Input-output analysis, Motor vehicle industry

JEL Codes: C67 and C68

1 Introduction

In our role as consultants, we often respond to tenders from industry associations and large firms seeking quantification of the contribution of their industry to a national or regional economy. Normally the potential client has some form of input-output computation in mind and is looking for a multiplier that will inflate the apparent level of employment and output associated with the industry. (1) The usual objective envisaged for the analysis is to impress governments during negotiations for assistance or to impress the public in a general awareness-raising campaign.

In effect, what the client is asking for is an estimate of the implications of eliminating the industry of interest from the regional or national economy. Implicitly, the client wants this estimate made under the assumption that resources used by the industry, directly and indirectly, would be lost to the economy (through unemployment or emigration) if the industry were closed down. The problem is that both the question and assumption are unrealistic. There is no real expectation by the client that the industry will close down, and the assumption that all the people who work in the industry and the people who supply inputs to the industry would emigrate or be unemployed without the industry is unsupportable. On the contrary, clients are usually optimistic about their industry's future, and even if their industry were to close down, at least part of the released resources would flow to other industries in the regional or national economy.

To us, the contribution that an industry can make to the economy is not measured by employment in the industry and in its suppliers. Employment is an indication of what the industry takes out of the economy. Apart from short-run adjustment issues, the decision by an industry to employ more people is a decision to impose a cost on the economy which must be compensated by increased output.

In the long run, an industry's contribution to the economy should be measured by improvements in the industry's ability to make productive use of the economy's resources. In other words, the main contribution that an industry can make is to improve its own productivity.

To estimate an industry's contribution to the economy, we need a technique for answering realistic questions concerning the implications of changes in the industry's performance under realistic assumptions concerning the opportunity costs of the industry's resources. In our view, the best technique currently available is computable general equilibrium (CGE) modelling. Unlike input-output models, CGE models can provide answers to a wide variety of questions on the effects of changes in production methods (technology) and other aspects of industry performance under plausible assumptions on inter-industry factor movements. In this paper we illustrate the application of CGE modelling to the contribution issue by using MONASH simulations in an analysis of the motor vehicle and parts (MV&P) industry. (2) Section 2 sets out the simulation question. Section 3 lists our underlying assumptions. Sections 4 to 7 report results and Section 8 contains concluding remarks.

No knowledge of MONASH will be required to understand our results. They are justified in Sections 4 to 7 through back-of-the-envelope calculations involving familiar economic mechanisms.

2 Simulation Question: the Contribution of a Faster Growing MV&P Industry

Table 2.1 contains forecasts for the Australian economy generated by MONASH under business-as-usual assumptions. These forecasts show average annual GDP and employment growth over the next five years of 2.9 and 1.3 per cent. However output and employment growth in the MV&P industry average only 1.0 and--0.9 per cent. Output growth in MV&P is restricted by relatively rapid growth in MV&P imports allowing the import share of the domestic market for MV&P products to increase from 42 per cent in 2001 to 46 per cent in 2006. Employment opportunities in the MV&P industry are restricted not only by slow growth in output but also by productivity growth.

How could the MV&P industry make a contribution to the Australian economy? Would it make a contribution by exceeding its business-as-usual forecast rate of growth? Here we use MONASH to quantify the benefits to Australia of an MV&P industry that grows by about 20 per cent over the next 5 years rather than 5 per cent (3.6 per cent per annum rather than 1.0 per cent).