The technical requirements of AUKUS, and the time strictures and innovation challenges laid out in the defence strategic review, all implicitly increase the demands on Australia’s defence industry. How can the government most effectively support industry in meeting those demands?

In my previous article, I noted that defence industry policymaking has fallen to the Department of Defence because Australia’s broader industry policy apparatus has withered over decades. Industry policy has been subsumed by Ricardian theories of comparative advantage, and technical industries have declined, outcompeted by better supported counterparts in other countries.

Even limited attempts to lean on the existing policy apparatus (such as situating the Centre for Defence Industry Capability in the Department of Industry, Science and Resources) have failed. And so, in the past five years, Defence has produced policies to support the growth of defence industry. Those policies have met with mixed success.

Given that limited success, the eye-popping demands on defence industry implicit in AUKUS and the review require a fundamentally new approach to industry policy. We must plan for the industry we need and design and deliver coherent strategies to stimulate its rapid and sustained growth.

Defence’s industry policy development capabilities are limited, which is fair enough—industry policy is not its core concern. As I advocated in the first article in this series, ideally government would create a powerful industry and trade department and cultivate strong and scalable policymaking capabilities within it, with economic planning powers and resources to back it up. But, if that cannot be, Defence will again forge its own path on industry development. How can it do that?

There are many ways to botch industry planning and policy. The objective may be a competitive and advanced industry, to be relied upon in the hour of need. But economic history is littered with poor outcomes and client industries and firms more expert at rent-seeking than innovating. There’s a high risk of wasting time and resources. But history also points to a consistently successful pathway.

Other countries, starting from a position of relative weakness, have attained greater technological advances and productivity gains than Australia through careful economic planning and well-designed and consistently delivered industry policies. South Korea is a signal example. In the 1970s, it had an economic profile akin to Guatemala’s. Today Korea, in the shape of Hanwha, is leading the development of Australian capability in Land 400 Phase 3 and is rumoured to be a potential acquirer of Austal. We should study how it got to where it is now.

Countries that have successfully transformed their technical capabilities have a common policy history. They have all:

• defined target capabilities (as in the defence strategic review and other reviews underway).
• established a web of preferment policies to grow firms in those target areas, such as concessional financing, tax concessions and preferred procurement
• shaped financial services to encourage the development of those sectors, moving the focus away from short-term profitability and excessive financial risk-aversion
• required supported firms to demonstrate efficiency and market awareness via exports
• allowed firms that fall short on exports to fail or compelled them to merge with better firms
• embraced selective public-sector co-investment with the private sector in producing assets.

There are two explicit Australian strengths, visible in other sectors, that Defence can harness when pursuing these policy prescriptions: exports and financing.

All countries that build highly capable technological economies from a modest base do so by supporting industries and firms that demonstrate export success. This allows firms to scale up past small domestic markets, and governments to validate the product development and financial and marketing capabilities of the supported firms. Defence and Austrade produced a defence export strategy in which I played a part. The idea was sound: to use our robust export culture and trade promotion infrastructure to grow defence exports. Yet the strategy lacks the focus and resources that truly reflect the centrality of exports to the rapid and sustained development of a nascent industry.

The alternative approach is to make all defence industry policy export-led—with lavish industry support available only to firms that are exporting, are scaling into export opportunities, or have an export-led business model. In other words, support fewer firms, but more generously. Back those with a chance of scaling up and rely on them to slot into Defence’s preferred capability areas when they are at scale and demonstrably efficient in the export market. That doesn’t preclude defence procurement from other firms that are incapable of exporting or unwilling to export.

Scaling up, whether organically or through mergers, requires finance. The economic history of successful rapid industrial development in other countries suggests that the financial services sector should be made the slave of industry via credit controls, widespread concessional lending, and the suppression of consumer welfare. That’s not appropriate here and now. Australia’s financial sector is larger and more sophisticated than Japan’s in 1950 or Korea’s in 1970, so that pathway is both inappropriate and politically unfeasible. But, given the strength of our $4 trillion private investment sector and our mighty domestic banks (themselves the products of active regulation and industry policy), it’s high time for Defence to develop a well-funded strategy to attract private financial investors into the defence industry sector.

For instance, Defence can capitalise private equity funds to build and shape manufacturing to its needs. Those funds can be mandated to deliver on required industry structures and scale through capability building within firms, organic growth financing, and consolidation through the financing of mergers and acquisitions. Likewise, Defence can empower venture capital funds to produce dual-use capabilities in a commercially sustainable way. Finally, it can partner with superannuation funds and infrastructure investors to extract better value from the defence estate. All of this requires the creation of a financial model that balances investor-return hurdles with Defence’s strategic objectives, which is achievable.

But, first, Defence will need to build out its own policy formation and delivery capabilities, with a focus on industry planning and direct investment both alongside and via private investors. That’s the subject of my next article.