'Made in Australia' sounds good, but the reality is more complex

But, ironically, economists were big fans of what was probably the biggest ever industry policy implemented in Australia's history: Julia Gillard's carbon tax.

The carbon tax was industry policy under any definition. It was about reshaping the industrial landscape - rewarding businesses with low emissions, punishing businesses with high emissions and incentivizing the latter to become the former.

This suggests that industry policy isn't necessarily bad. It depends primarily on two things:

The carbon tax scores well on both counts. How does "Made in Australia" stack up?

We don't really know the details yet, but we can think about some hypotheticals.

If the rationale is simply that making things in Australia is better than importing them, then the rationale doesn't stack up.

Countries have scarce resources (workers, capital) with which to produce things, so we want to make sure we are producing the things that will earn us the most money.

Australia's strategy has (generally) been to leave it to businesses to decide what to produce, since they are the ones who put their money where their mouth is.

The result is that Australian businesses produce the things that are the most profitable and then we import the rest.

It's called specialisation: it's the same reason you work in a specific occupation and then "import" haircuts, plumbing and dentistry from people who specialise in those things.

Specialisation makes us rich. Diversification makes us poor.

The data backs this up. Real incomes and real wages have grown significantly since we started implementing this strategy from the 1970s.

If you look at the share of wages people must spend to buy things, almost every good and service (other than housing) has become dramatically more affordable.

If you worry about the decline of manufacturing jobs or the growth of the population or high rates of immigration - all of which occurred during this period of phenomenal growth in living standards - these facts should make you pause for thought.

By almost every measure, the good old days weren't that good.

Another argument that doesn't stack up is that specialisation has caused Australia to have too many eggs in one basket.

In fact, Australia's economy is highly diversified. It is only our export profile that is concentrated. Mining and resources, for example, represent 63 per cent of all our exports, but only 14 per cent of our economy.

Measures like the Economic Complexity Index are misleading because it only applies to exports, not the economy, and exports represent only about one fifth of our economy. The index also excludes services like education - a huge omission given it is Australia's third largest export.

There's also a big "so what?" problem with the economic complexity index.

It's true that Australia's export profile is concentrated around a few big industries, but is this a problem? Aren't these the industries that earn us the most money? Why would we want to divert resources away from these highly productive industries so we can make stuff that earns us less money?

The retort to this is the China Risk - that we don't want to be dependent on China for something in case they stop selling it to us for geopolitical reasons.

This is a legitimate concern, but it's sometimes overblown.

The Productivity Commission found that only 3 per cent of our imports came from highly concentrated markets from China - everything else we get from China we can get from elsewhere.

So, what are the rationales for making things in Australia that would be economically sensible?

In short, it makes sense for the government to seek to make something in Australia if: that thing is essential, it is only available from a single source overseas, new sources of supply couldn't be established fast enough, and it's not something we could simply stockpile to overcome any potential supply disruptions.

Then there's the question of how to do it. If the private sector isn't supplying something, we should figure out why. There might be a very good reason. Is it a regulatory barrier? Access to labour? Access to capital? No customers? No future for the industry? The government needs to diagnose the problems and tailor its response accordingly.

There are plenty of situations where industry policy makes sense.

As they teach us in economics 101, governments should tax things that have negative spillovers (like smoking and pollution) and subsidise things that have positive spillovers (like research and development and new technologies).

And there are all the things that the private sector won't supply or, at least, won't supply enough of - like roads, highways, infrastructure, defence and the social safety net.

Focusing on these things will help ensure that we get the biggest bang for our buck.

"Made in Australia" sounds good, but the reality is more complex. After all, our objective isn't to make more things in Australia, it's to increase the living standards of Australians. The former doesn't necessarily lead to the latter.