Manufacturing has been a force for change in the world’s economy over the past two hundred years. The early industrial revolution in Britain’s textile manufacturing in the 1750s triggered the start. This soon spread throughout Europe, North America and beyond.

Today the issue that confronts many industrialised nations is the shift of manufacturing jobs offshore to low cost of labour countries. Of particular concern is the rise of China as an emerging powerhouse of manufacturing.

This is no different for Australia. For example, in a report issued last year entitled “A more competitive manufacturing industry”, the State Government of Victoria highlighted the importance of manufacturing and proposed strategies for its sustainability. This report identified several key barriers to maintaining a competitive manufacturing sector.

The first of these is a decline in the level of capital investment in Australian manufacturing over the past 20 years. This meant that new technologies were often not being embraced by local manufacturers. This trend is illustrated in the diagram below, which compares Australian manufacturing’s investment in capital against all other industries since 1991.

A second barrier is a lack of skilled technical trades’ workers. This involves the loss of “niche” skills in areas where there was a global demand, but only modest concentrations in Australia.

The report also noted that 95% of manufacturers are small to medium sized enterprises (SMEs). Such firms often lack the scale and scope economies needed to secure access to export markets. They also lack resources for investment in innovation and skills training.

Finally, the report noted that there was not enough collaboration and networking. Manufacturing requires connections to global supply chains not only for market access, but also to plug into technology and knowledge transfer corridors.

Does it matter if we don’t manufacture?

Some might argue that the loss of manufacturing is inevitable and that it does not really matter. However, a deeper analysis should be cause for concern. According to the World Economic Forum, manufacturing’s share of global value added has declined steadily over the past 30 years in contrast to the rising value of services. However, manufacturing has a higher multiplier effect than most services industries. Countries that manufacture and export tend to have greater bundles of accumulated knowledge and capabilities that they can leverage for competitive advantage.

To illustrate the value of investment in manufacturing we can look at the diagram above, which shows the relationship between the number of cross-border trademarks per capita for a range of countries, and the number of triadic patent families per capita (a triadic patent family is where a patent is lodged with the US, European and Japanese patent’s offices simultaneously). As can be seen, those countries that have high levels of patents and also strong international brands are the more affluent.

Of concern is that Australian manufacturing’s share of gross value added (GVA) has declined since the 1980s (GVA = GDP – Taxes less subsidies and ownership of dwellings). This is illustrated in the graph below, which shows the rise of services and the steady decline of manufacturing against other industry sectors.

According to the Industry Innovation Council report “Trends in Manufacturing 2020” from which this graph was sourced, despite these trends manufacturing remains important. It employs around 1 million people or 8.5% of the workforce, which is almost five times more than the employment contribution of the mining sector. Most of these jobs (79%) are located in Victoria (32%), NSW (29%) and Queensland (18%).

Manufacturing does matter for not only the jobs it creates, but the additional value it offers by way of import substitution and export revenues. It also adds the multiplier effects that can flow from intellectual property and accumulated skills and capabilities.

Manufacturing also holds a large proportion of the aggregate capital stock within the Australian economy. However, over the past five years manufacturing’s annual contribution to aggregate capital stock declined significantly. This constrasts with the trend in the mining sector. This is shown in the following graph, which is from the Productivity Commission’s 2012 report “Australia’s Productivity Growth Slump”.

This is in part a reason for the two-speed economy that Australia has been experiencing. While investment in the mining sector has been rising significantly, the level of investment in our manufacturing sector has fallen. According to an Australian Industry Group survey of CEO’s taken in 2011, 93% of manufacturing CEOs felt that their exports were becoming uncompetitive as a result of the high Australian-US Dollar exchange rates. Capital investment in this sector had fallen by as much as 28% and investment in R&D was declining as well.

So what can be done to revive manufacturing?

According to the World Economic Forum’s “Future of Manufacturing” report published this year at least seven major trends are likely to impact on global manufacturing over the next 20 years. These trends will require the efforts of government, business and the broader society.

The first trend is related to the need to build appropriate infrastructure to allow manufacturing industries to grow and develop. This relates to transport, telecommunications and the power and water supply systems that feed industry. Better infrastructure serves to enhance efficiency and lower costs of services.

The second trend is the need to compete for foreign direct investment to provide the funding needed for the renewal of capital stock and associated R&D. A third trend is the competition for commodities in particular scarce resources such as rare earth elements and specialist materials such as titanium. A fourth trend is the need for clean and affordable energy supplies, and the fifth and sixth trends are the need to innovate and to attract and retain talented human capital.

The final trend is the strategic use of public policy to enhance national competitiveness and address the needs of manufacturing. Some countries such as Germany, China, India and Korea have all taken steps to develop their manufacturing sectors so as to ensure they remain globally competitive.

In previous columns I have written about the need for Australia to invest more in infrastructure. This remains an important issue for our manufacturing sector. Attracting foreign investment into our manufacturing sector will require attention to be given to policies that encourage the modernisation of capital stock and boost innovation and R&D expenditure.

The federal government already has schemes in place such as the Steel Transformation Plan, Green Car Innovation Fund and the Automotive Transformation Scheme. These are administered by AusIndustry and are designed to stimulate such investment.

However, the Green Car Innovation Fund was cancelled last year by the government. This was done as a cost saving measure and to redirect funding to the Queensland flood relief. This decision triggered a warning from the nation’s large automobile manufacturers that it might risk the future of the car industry.

It is not clear how effective such schemes are or how they fit into the wider policy context of managing what has increasingly become an unbalanced two-speed economy.

As noted by the Victorian State Government’s report, the vast majority of Australian manufacturing firms are SMEs. Such firms need assistance in the face of high dollar exchange rates that impact negatively on their exports, and a flood of cheaper competitor products.

To succeed these firms need more assistance to innovate, attract and retain skilled employees, and develop their networks into global markets. It is a national challenge that has serious long term consequences if we fail to get it right.