Who says Australian politicians never discuss policy? Rather surprisingly, our national debate is currently absorbed by one of the oldest debates in the policy book: industry policy.

What is industry policy? Very simply, industry policy is the funding and regulation of various industries by the government. It includes things like tariffs, which are special duties levied on foreign imports, as well as subsidies for various activities, like making cars, clothes or Air Warfare Destroyers.

Once upon a time, Australia had one of the most protected manufacturing sectors in the rich world. High tariff walls were erected in the 1930s, and they stayed high for half a century. This was protection: the purposeful cosseting of certain industries in order to keep jobs at home, even at the cost of more costly goods and lazy manufacturers.

But in the 1980s and 1990s, the Hawke, Keating and Howard governments dismantled the tariffs barriers, opening Australian industry up to foreign competition. The result was a wholesale structural change in the nature of our economy. Many businesses failed, and job losses in the recession of the early 1990s were particularly severe in the former industrial heartlands of Melbourne and Adelaide. However, in the wake of the savage restructuring, Australia emerged into a long boom. Jobs were lost in manufacturing, but more jobs were created in the growing services sector: nurses, teachers, financial planners, personal trainers and the rest.

Now industry policy is back on the national agenda. There’s no secret why. Manufacturing in Australia is struggling. Our manufacturers are suffering weak demand and are competing against cheap international imports, made cheaper by the high Australian dollar. As a result, the sector may actually be shrinking. "I think manufacturing is effectively in recession", NAB economist Alan Oster told Lateline Business back in June, and things have only deteriorated since then.

Manufacturing matters because the sector employs around a tenth of the workforce. It also represents some of the key inputs to broader economic activity, from cement, steel and bricks to the more complex, so-called "elaborately transformed" goods that modern life depends upon, such as electricity turbines and mobile phones.

Of course, Australia has long been a nation that imports the bulk of our manufactured goods. We can’t compete with Asia when it comes to laptops or shoes, and for the most part we no longer try. Successful Australian manufacturers tend to be those that retain a technological edge, such as the Cochlear corporation or biopharmaceutical giant CSL.

But for the many Australian businesses that have to compete on price, times are lean indeed. According to Heather Ridout of the AI Group, trading conditions for manufacturers right now are "stressful". The AI Group mentions "weak demand fuelled by global uncertainties and rising interest rates (which are arguably already too high); rising labour costs which are not backed by productivity gains; rising electricity and other input costs; and a high dollar which has pulled the ground out from below our export and import competitiveness."

Union leaders are worried too. The AWU’s omnipresent national secretary Paul Howes has been vocal about the issue for some time. Last Monday, when the BlueScope lay offs were announced, he issued a media statement arguing strongly for a policy response to the problems in the sector. "We’ve got to face the reality of the manufacturing crisis that’s before us," Howes said. "We can’t accept job losses as the norm and we can’t rely on imported goods in our strategic sectors."

The BlueScope job losses and the broader problems of local manufacturing represent the background for yesterday’s well-publicised meeting between the government and industry leaders over the future of the sector.

At the meeting were Prime Minister Julia Gillard and Industry Minister Kim Carr and representatives from two of the country’s biggest manufacturing unions, Dave Oliver of the AMWU and Paul Howes from the AWU, as well as Heather Ridout, long one of the government’s favourite industry lobbyists (the ACCI, for instance, get rather frostier treatment, given that group’s strident criticism of the government’s carbon policies).

Ridout and the union bosses want the government to announce a policy inquiry into the sector, geared around providing a new plan for restoring sustainability. Though they didn’t say it publicly, the unspoken assumption was that some new money from taxpayers should also be found.

Howes and Oliver seem to have something like the Bracks review into assistance for car manufacturers in mind. "That was a short, sharp inquiry," Oliver told reporters after the meeting. "[It] came out with some significant recommendations which I know had secured the future of the automotive industry in this country."

But the reference to handouts to carmakers shows the problems in trying to prop up uncompetitive industries. Over the last two decades, Australian governments have given billions of dollars to multinational automobile corporations, even while the industry itself has continued to shrink. The most notorious example of this was of course the hundreds of millions given to Mitsubishi to keep its plants in South Australia open. Mitsubishi took the money, and closed the plants anyway.

It’s no wonder most economists think industry policy is a bad thing. As Paul Krugman wrote all the way back in 1997, "for 170 years, the appreciation that international trade benefits a country whether it is ‘fair’ or not has been one of the touchstones of the professionalism in economics." This remains especially true of the boffins working in the key policy institutions like the Treasury, the Reserve Bank and the Productivity Commission, who almost universally think that industry policy is a bad thing.

After all, supporting local industries in the face of stiff international competition is a form of protection, and protection is a economic concept that finds few supporters today. As the University of Sydney’s Evan Jones put it in a 2006 paper, "the conventional economic wisdom is oriented to austere macroeconomic policy (budgetary surplus, anti-inflationary monetary policy) and eradication of impediments to free market operation (‘microeconomic reform’)."

Perhaps that’s why Minister Carr promptly ruled out an inquiry.

"We’re in the business of acting, (so we’re) not having another inquiry," he told ABC Radio. The government is apparently of the belief that its commitment to economic rationalism casts it in a positive light.

Unfortunately, the argument that Australian governments should not "pick winners" by industry is not backed up by the facts. The problem with arguing against picking winners is that governments do it all the time. According to the Productivity Commission’s Gary Banks, the total spend on industrial assistance by the federal taxpayer was around $15 billion in 2008, and "state and territory assistance programs, which are less transparent, would add a few billion on top of that". The special treatment comes in all shapes and sizes: from fossil fuel subsidies such as the diesel rebate for mining and primary industry, to the Australian government’s wholly owned naval manufacturer, the Australian Submarine Corporation.

The point here is not to argue that all industry policy is inefficient, but rather to point out that Australia is still a long way from being a paragon of micro-economic reform. Indeed, one way to think about industry policy is that it is another way of structuring the economy for the benefit of citizens, rather corporate shareholders.

In the end, the issue comes down to whether you think Australia needs to maintain a manufacturing base, and whether spending taxpayers’ money is the best way to promote future employment outcomes. Rather than propping up money-losing steel-makers and car makers, a better industry policy may well be to follow the recommendations of Terry Cutler’s 2008 innovation review, which recommended that Australia increase federal spending on research and development to boost us to levels comparable to trading partners like Germany and Japan.

A forward-thinking government would take the opportunity represented by the current manufacturing malaise to ramp up Australia’s investment in innovation, creating new opportunities in new industries that will stand us in good stand for the coming century. The Australian Research Council, for instance, still only supports around one-fifth of its applicants. That figure could easily be doubled without any risk of supporting "useless" research.

Of course, investing in innovation is expensive. It means spending more taxpayers’ money. And that’s something else politicians and economists currently oppose.