Reviving industry: How the Australian Government can be a better customer to the manufacturing sector

Executive summary

The Australian Government has emphasised the need for whole-of-nation uplift to support Australia’s defence and national security requirements since the release of the Defence Strategic Review (DSR) in April 2023.¹ They see civil society, public institutions, the private sector and, critically, the investment community as having key roles in underwriting Australia’s national security. In particular, the government recognises the strategic imperative to reinvigorate Australia’s manufacturing sector, which has suffered decades of decline. This imperative has been reinforced by Minister for Defence Industry and Capability Delivery Pat Conroy, who, in August 2024, pushed the need for Australia to not rely on “just-in-time manufacturing” but to position Australia for resiliency and redundancy in part by increasing and accelerating domestic manufacturing.²

This brief assesses the state of Australia’s manufacturing industry and argues that for the sector to realise Australia’s national security goals, the Australian Government needs to efficiently leverage private sector capital investment from both domestic and foreign sources. This includes mobilising Australia’s superfunds—the fifth-largest pool of assets under management globally—and incentivising foreign capital, such as allied venture capital and private equity, which can complement domestic efforts and strengthen alliance ties. Achieving this requires a deeper understanding of Australia’s macroeconomic conditions and the impact of government policies on the manufacturing sector and addressing barriers preventing its growth.

Policy recommendations

This paper makes recommendations for the Australian Government to inform engagement with the manufacturing sector and better align the private capital needed to finance its revival. The Australian Government should:

• Commission an independent review — ‘Manufacturing Review for National Security’ — to create a plan across all government departments and private sector stakeholders to arrest the decline of Australian manufacturing and to ensure that the manufacturing sector can sustain any new investments. Open engagement is needed to ensure the private sector can effectively respond to and strengthen the government’s strategic demand signalling through AUKUS³ and incentives like the National Reconstruction Fund Corporation (NRFC);⁴ and
• Establish an ‘Uplift Project Office’ (UPO) to help equip the government with the skills to better engage with industry, coordinating with efforts such as AUKUS and the NRFC. The UPO would work with the investment industry and manufacturing sector to co-develop a standard investment proposal process and contracting mechanisms for government ‘uplift’ projects to upskill responsible agencies in their ability to engage with sources of private capital. This type of collaborative and consultative engagement between government, private capital and industry is necessary to refine processes and practices, optimise decision-making, and better equip personnel to interface with investors and industry.

Demand from government

Australia’s 2023 Defence Strategic Review (DSR) is one of several recent landmark strategic initiatives sending new demand signals to Australian industry for increased sovereign innovation and capability development for national security. Notably, new investment priorities have been set via the AUKUS security partnership with the United States and United Kingdom, the establishment of the NRFC, the release of national strategies, such as the National Quantum Strategy,⁵ and the release of Sovereign Defence Industrial Priorities.⁶⁷ The release of the 2024 National Defence Strategy (NDS)⁸ and complementary Integrated Investment Program (IIP)⁹ lay out how the Australian Government proposes to deliver on its priorities.¹⁰ Notably, the IIP sets out the specific defence capabilities that will command an investment of A$330 billion between 2024 and 2033-34 to enable the NDS and provide a generational uplift in defence capabilities.¹¹ The speed and volume of these security initiatives under governments led by both parties speaks to a bipartisan recognition of the urgency for Australia to adapt to fundamental changes in its security environment.

Minister for Defence Industry Pat Conroy, Minister for Defence Richard Marles and Chief of the Australian Navy Mark Hammond during a press conference aboard the Australian Navy ship HMAS Canberra in Sydney, February 2024.Source: Getty

These high-level demand signals highlight priority areas of advanced capability development, such as hypersonic weapons, artificial intelligence, quantum technologies, autonomous systems, critical minerals extraction and processing, along with related value-adding activities.¹² Establishing a sustainable sovereign capability in these fields, or, at the very least, supply chain security for these fields, will require Australia to revive its domestic manufacturing base. However, this will not be possible without significant capital investment from, and coordination with, the private sector. This renewal will require both knowledge-based capital to innovate and operate and substantial financial capital to make it happen. As the DSR observes, this necessitates an increased level of flexibility and agility from the federal government, as well as a willingness to both modernise its approach to project risk management and work in partnership with sources of private capital.¹³ This modernisation is particularly important because the advanced capabilities identified by the federal government expand beyond the traditional defence manufacturing sector that supports the Australian Defence Force in areas such as missile production, shipbuilding and munitions, and includes newer dual-use sectors, such as advanced manufacturing, quantum, AI and biotechnologies, where the Australian Government is unlikely to be the primary investor nor the end customer.

The investment landscape

The processes of investment into the research, development and manufacturing of advanced technology are not new to capital markets. Technology investment involves identifying small-scale innovations and scaling them through capital markets to create sustainable, profitable businesses. Australia’s private equity markets — private equity being ownership or interest in a company that is not transacted in a public market — has grown sustainably in recent years. Assets under management in Australian-focused private equity funds have nearly tripled since 2010 to A$66 billion.¹⁴ While the private equity market remains much smaller than the public market, it reflects a positive trend for companies that need funding from sources willing to bet on typically new, small or riskier businesses, such as startups that have dual-use potential in the commercial and defence markets. These sources broadly include venture capital and buyouts, which differ from traditional funding sources such as bank financing or debt funding.

While this form of investment in nascent technology is reasonably mature, manufacturing businesses and the supply chains and investment they depend on are presently organised for a prior era of globalisation.

However, while this form of investment in nascent technology is reasonably mature, manufacturing businesses and the supply chains and investment they depend on are presently organised for a prior era of globalisation. Until recently, there has been less concern from both the public and private sectors about the national security implications of where commercial activities are located. Indeed, location decisions governed by the private sector have been based largely on business priorities such as the cost and availability of suitable labour; resources; energy and logistics; and the favourability of the regulatory and taxation environment of particular geographies. Therefore, if the Australian Government wants to onshore its manufacturing and bolster supply chain security — noting that the manufacturing capability needed to support contemporary national security needs expands well beyond the traditional base — there will need to be a review of the policies and economic disincentives that have discouraged this expansion from occurring organically. Government will need to engage with decision-makers in both the manufacturing and investment industries to ensure they can present projects that offer returns sufficient to justify the risks for investors.

Under the government’s current free market approach, Australia’s manufacturing industry is in decline. This is the result of high labour costs, increased corporate taxation and Australia’s growing demand for services as national income. At the same time, Australia has become reliant on the export of unprocessed raw materials to drive growth and prosperity, and has offshored most industrial activities higher up the value chain.¹⁵ The allocation of a budget of A$22.7 billion for the ‘Future Made in Australia’ Bill is a step towards a focused industrial policy that sees government act in closer coordination with the private sector, particularly in support of the clean energy transition. This momentum should be built upon to ensure that manufacturing industries critical to national security are also identified and benefit from prudent and targeted policy support. The challenge for policymakers is creating incentives that respect the open market but adequately guide private sector capital towards critical industries in support of Australia’s national security. Looking to incentives undertaken by close allies, notably the United States, via the Inflation Reduction Act (IRA) and novel models under the Department of Defense, can help provide a baseline for the types of approaches available to Australian policymakers.

Policy recommendation 1: Manufacturing review for national security

Australia does not have a mission-fit manufacturing capability. In fact, the sector has suffered a decades-long decline. Understanding the state of Australian manufacturing provides context for how the government can address impediments to the sector’s reinvigoration and the barriers preventing new investment.

Figure 1 compares the distribution of Australian exports by sector in 2004 and 2023. It indicates that the complexity of Australia’s output has declined, with the proportion of value-added products and services derived from manufactured products and services dwindling compared to primary industries. Data from 2023 indicates approximately 70% of Australia’s national income relies on demand-led exports from primary industries, which are then sent to overseas markets for value add. Manufacturing now accounts for less than half — and trending to a third — of the value of services. The data also shows that over the two decades, Australian manufacturing declined by more than 50%, while reliance on resource income increased by double. Data from the Economic Complexity Index (ECI), which measures the relative diversity and complexity of a country’s exports, confirms this trend. Harvard Growth Lab’s Country Rankings reveal that Australia’s ECI ranking has steadily fallen from being moderately complex with a ranking of 63 in 2000, to significantly less complex with a ranking of 102 in 2024.¹⁷ Australia’s AUKUS partners — the United States and the United Kingdom — have maintained a comparably steady ECI ranking between 6-14 during the same period. It is worth noting that during the same period China has significantly increased its ECI ranking from 41 to 18. These trends indicate that while Australia has always had a comparably lower ECI due to primary industries accounting for a large portion of exports, Australia, unlike both allies and strategic competitors, has not prioritised the growth or maintenance of its manufacturing sector, which is a significant contributor to economic complexity.

Figure 2 compares the share of output by sector over the same period. The 2023 data shows that mining and services are Australia’s largest economic outputs. A focus over the two-decade period shows that mining has increased by approximately 330% while manufacturing has reduced by 50%. The other sectors have remained relatively stable, although health and education grew by 20%, due to increases in demand for aged care services and the National Disability Insurance Scheme. Manufacturing is now just over 5% of Australia’s total economic output. While construction, finance and education are strong, the opportunity and need for these sectors to engage with the manufacturing sector will have naturally declined as manufacturing in Australia has declined. Therefore, Australia’s skill set in engaging with and educating in areas needed to support a strong manufacturing sector will be limited. The declining know-how in manufacturing across sectors only adds to the already uncompetitive environment for Australian manufacturing businesses to grow, let alone in highly advanced areas such as emerging technology and defence manufacturing.

Any whole-of-nation effort to arrest these trends needs to start with the government adjusting policy barriers to make the environment less hostile to manufacturing. The DSR acknowledges this, stating that “defence strategy and policy supporting whole-of-nation strategies” needs to be a priority.¹⁹ Policy review should occur before private capital is pursued and deployed to avoid directing new investments into an environment that is not conducive to manufacturing revival.

Productivity issues

The Productivity Commission’s 2021 submission to the Senate Economics References Committee Inquiry into the Australian Manufacturing Industry offers an effective baseline assessment of the sector. This submission made recommendations for how best to support Australian manufacturing.²⁰ It found that the Australian manufacturing industry tended to receive a disproportionately high share of government assistance compared to other sectors.²¹ The submission notes that, as a structural shift towards a services-dominated economy is a trend across advanced economies, it is difficult to determine how much of an impact Australian policy has had in driving this process.²² However, the submission acknowledged that assistance has failed to produce sustained impact and the gradual reduction in tariffs and other forms of assistance likely contributed to Australia’s declining manufacturing sector, as evidenced by the continued decline in manufacturing as a share of Gross Domestic Product (GDP).²³

The submission’s six recommendations can be used as a starting point of reference for a future review of industry policy. They help to assess whether relevant policies are acting effectively to shape a more competitive environment for manufacturing. These recommendations include:²⁴

1. Reducing impediments to research and development
2. Reducing impediments to domestic and foreign investment
3. Managing government supply chains and facilitating firms’ ability to manage the many risks that affect their supply chains
4. Ensuring that government procurement is streamlined, cost-effective and maximises the wellbeing of all Australians, with governance to avoid undue influence from sectional interests
5. Formulating trade policy that enables Australian trade, and fosters cooperation in promoting global trade to achieve the gains from trade
6. Formulating education and training policies that foster the skills and capabilities needed for people to participate effectively in society and the economy

Given that both Australia’s capability objectives and economic security are largely dependent on a revival of Australia’s manufacturing sector, ensuring that all related policies and initiatives improve the viability of sovereign manufacturing is key. For private sector capital to respond to the demand signals for investment across high-priority industries in support of initiatives like AUKUS, their economic environment must be conducive to a return on investment. This brief’s recommended ‘Manufacturing Review for National Security’ builds on the 2021 submission’s recommendations, with the added emphasis on the capability needs of the changed strategic environment that Australia finds itself in, as acknowledged in the NDS.²⁵ The ‘Manufacturing Review for National Security’ should include a specific focus on defence and national security priority initiatives such as AUKUS, which signal an increased need for government industrial policy, and increased government appetite for collaboration with private sector capital since the 2021 submission.

Policy recommendation 2: Upskill government for engagement with alternative sources of capital

In conjunction with policy levers that improve the economic viability of Australia’s manufacturing sector, greater emphasis needs to be placed on enhancing the effectiveness of government engagement with private industry to mobilise their capital in support of national security objectives — namely the strategic revival of Australia’s manufacturing sector.

This engagement must not be restricted to large industry participants and superannuation funds. While these sectors play a significant role in scaling large projects, fostering innovation and engaging with start-ups — key drivers of exponential progress — there must be representation from all sectors of the economy. This should include a review and analysis of lessons learned from AUKUS partners and beyond.

The opportunity in technology and advanced capabilities

Typically, large-scale research and development and the commercialisation of high-tech products is viewed by government as the domain of the private sector. However, government can, and should, play a pivotal role in their markets, especially at the formative stages.

Though venture capitalists are generally comfortable with the “fail fast” risks associated with software development, the incubation of hardware and deep tech is somewhat more problematic, and a place where government can step in. Government participation in technology policy and investment has already begun to increase²⁶ as technology-driven strategic competition between the United States and China has intensified and conflicts in Europe and the Middle East underscore the changing capability demands of war. The Australian Government could, for example, minimise the issues associated with the limited availability of partners for venture capital funds willing to allocate capital to largely illiquid investment portfolios over an extended period.

In Australia a starting point should be more innovative government engagement with private sector capital investors to understand which guarantees, policy signals and/or investment conditions are needed to make the deployment of private capital more tenable

Interestingly, these specialised investments are usually in the technologies that will most benefit defence, such as quantum and AI. In this instance, government has an opportunity to step up in its support for defence capability innovation, R&D and production, helping mitigate some of the risk factors for investors seeking to support innovators that specialise in strategic dual-use technologies. This does not necessarily mean government has to foot the entire bill. Indeed, the strain on existing defence budgets and the repeated call from Australian officials for private capital to help alleviate some of the government financial burden in certain areas is well known.²⁷ Instead, in Australia a starting point should be more innovative government engagement with private sector capital investors to understand which guarantees, policy signals and/or investment conditions are needed to make the deployment of private capital more tenable, as will be explained below.

The role for government

Australia has a vibrant and burgeoning start-up community that is more than capable of competing on the global stage. The question for policymakers is whether Australia is simply an acquirer of advanced capabilities from its international partners, or whether the Australian Government has the ambition and willingness to back domestic innovators and create the conditions for participation in the development, production and global economic success of these indigenous capabilities with industry partners.

If the federal government wants Australia’s defence strategy to succeed in a meaningful timeframe and ensure the economy flourishes beyond primary industries, it must leverage its limited direct taxpayer funding and attract private investments. This is essential given the small scale of Australian manufacturing and the nearly non-existent high-tech manufacturing sector.

Australia has a vibrant and burgeoning start-up community that is more than capable of competing on the global stage.

To leverage private capital and enterprise, the government must embrace its role as a customer in its engagements with private sector partners to co-develop its priorities with manufacturers. The government should clearly communicate to the investment community the commercial opportunities that can arise from these priorities, and if necessary, ensure that projects allow private investors to meet their institutional and regulatory risk management requirements. Nascent examples of this are already occurring in Australia, such as Westpac’s partnerships with Export Finance Australia (EFA) to provide capital solutions and expertise to sovereign defence companies.²⁸ Announced in 2023, the partnership has been successful in its initial stages of implementation by creating a pathway for Australian SMEs working with defence primes to receive capital. The partnership is a positive indication of growing government risk appetite for creatively addressing national security investment needs. Importantly, the EFA’s partnership is not limited to Westpac, and other large financial institutions could establish similar deals if the partnership demonstrates financial returns.²⁹

By taking a bold step forward from the traditional model of direct government investment into individual projects, the opportunity exists to act asymmetrically, deploying a relatively small amount of public funds in a highly strategic manner to seed and stimulate the creation of a whole new class of hardware, deep tech and manufacturing centric venture funds in Australia. This should build on existing initiatives, such as the NRFC, and involve inviting capital from friendly nations and occur alongside the ‘Manufacturing Review for National Security’ to ensure the investment can grow and rebuild Australia’s manufacturing foundations to support national security goals.

Britain’s Secretary of State for Defence Grant Shapps and Australia’s Deputy Prime Minister and Minister for Defence Richard Marles tour the Osbourne Naval Shipyards in Adelaide, March 2024. Source: Getty

Drawing on the efforts of allies to address similar challenges would also be beneficial. For instance, the Office of Strategic Capital (OSC) in the United States, which sits under the Department of Defense, is designed to develop and implement strategies and partnerships to accelerate and scale private investment in critical supply chain technologies needed for national security. Established in 2022, the OSC’s first step to approach the challenge of increasing investment in technologies critical for national security has been to solicit public comment from companies and financial institutions on contemporary market activity, capital requirements, and where OSC-provided loans and loan guarantees can support investment in critical technologies.³⁰

The Uplift Project Office

To achieve this, the Australian Government should consider forming an ‘Uplift Project Office’ (UPO) that coordinates engagement between the investment community and the government departments tasked with executing strategies that support the whole-of-nation efforts required to meet national security goals as outlined in the DSR.

The UPO should sit under the Minister for Defence to ensure that national security priorities are embedded in the UPO’s ‘bottom-up’ activities and align with complementary top-down efforts under the IIP and NRFC. Though the IIP and NRFC are relatively nascent, their establishment indicates that Australia is moving to revitalise its industrial policy. They would benefit from active coordination with defence and national security priorities. An advisory council should be established, comprising senior individuals actively working across Australian, US and UK investment communities to assist in overseeing the UPO.

The UPO key mandate should include:

• Prioritising manufacturing investment opportunities based on those that directly support national security priorities, as outlined under the DSR.
• Acting as a ‘front door’ for private sector capital looking to make national security-related investments across a wide range of portfolios.
• Coordinating with investors to ensure that existing government initiatives such as the NRFC, which provides debt and equity for businesses, can be leveraged to incentivise greater private capital investment in priority areas.
  • The UPO should also assist the government in amending or implementing policy incentives that improve access to these structures so that they are available to investors from wholesale markets all the way into retail markets through platforms such as the Australian Stock Exchange (ASX).
• Working with existing government-adjacent investment vehicles, such as The Future Fund investment process.
  • The Future Fund is Australia’s sovereign wealth fund, and its investment mandate can act as a template for deciding what national security-aligned opportunities can be taken to the investment community in a way that is suitable for the projects to go through the bottom-up investment processes of superannuation and other investment funds e.g. venture capital and private equity funds.
• Establishing a timeline for success, key investment milestones and key performance indicators, to ensure that Australian manufacturing receives adequate capital to meet the national security goals as outlined under the DSR.
• Building on the findings of the ‘Manufacturing Review for National Security’ to conduct future planning and strategic assessment of how to mitigate known risks to Australia’s manufacturing sector. Notably, talent pipeline and skilled workforce challenges in advanced manufacturing and technology sectors. This includes ‘brain drain’, and high labour costs making Australia an uncompetitive ecosystem for SMEs.

Next steps for Australia

Australia is navigating an era of intensifying strategic competition in advanced technologies. The outcome of that competition will determine the balance of power in the region. In the face of potential future conflict, the security of critical supply chains essential to Australian peace and stability is also crucial. Australia’s defence policies aim to coordinate with allies to best protect Australia’s national interests. Growth in Australia’s manufacturing sector is key to enabling and sustaining initiatives such as AUKUS. The revival of sovereign manufacturing will require private sector capital. As long as demand signals are effectively communicated and efforts are made to resolve challenges in the policy environment that impact the success of investment, private sector capital will continue to step up to the challenge. Australia needs to act in a concerted and coordinated manner with the private sector to secure national security priorities.

The private sector does not lack an interest in investing in Australian manufacturing or national security more broadly, but greater efforts to fine tune engagement are necessary.

It is key that the Australian Government understands how its policies impact the competitiveness of the manufacturing environment, and reduce as many barriers to investment as possible, while at the same time upskilling government to meaningfully work with private capital.

The private sector does not lack an interest in investing in Australian manufacturing or national security more broadly, but greater efforts to fine tune engagement are necessary. This paper proposed two methods to facilitate this. Delivering on these recommendations will help to ensure that Australia is able to achieve its national security goals, as outlined in the NDS, and ensure Australia is able to effectively participate in and leverage partnerships such as AUKUS.