macro-engineering: an australian perspective

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r.&m&y &I society. Vol. 10, pp. 17-27 (1988) Printed in the USA. All tights reserved. 0160-719X188 $3.00 + .OO Copyright 0 1988 Pctgatnon Joutn& Ltd Macro-Engineering An Australian Perspective Nevde D. Chidgey ABSTRACT. Austrah is a large landmass with a smallpopulation. It has a history of mac- roprojxt deue/opment, implemented by the necessity to estabhsb its communications, product development, and trade. The concept of the modern, high/y intensive macro- project first impacted in 1964 with the development of iron ore deposits of the West Coast, close/y followed by the development of the coal deposits of the East in the 1970s. So far, Australia ‘z macroproject programs have not producedfaihre, but lessons have been Learned concerning the prudent application of limited recourse financing, the need for appropriate legal structuring, the complexities of government participation in private enterprise, and the manipuhion of resource-based projects for reasons of national inj?a- structure development. The vast improvement in labor productivity and the emphasis on tight national economic management in Australia in the Light of the currently depressed international commodity markets is discussed. In about 1908, observing the end of a long drought young Australian, Dorothea McKellar, wrote: on her family’s property, a . . . I love a sunburnt country A land of sweeping plains, Of ragged mountain ranges, Of drought and flooding rains, I love her far horizons, I love her jewel-sea, Her beauty and her terror- The wide brown land for me! . . . In thinking about macro-engineering, past and future, on the Australian main- land, it is hard to capture the environmental aspects more completely than Miss McKellar was able to do in a few words. Australia is a country of some 7.7 million square kilometers. By comparison, the Nevi//e Chidgey is Chairman of the Warren Centre for Advanced Engineentzg at the University of Sydney and Chairman of the Macroproject Pane/ in Australia.He is aho 0 Director of a private research organization and of a venture capitd company. Since 1963, he has been Chief Engineer Cons&ant to the Commonwedth Band of Austrak 17

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Page 1: Macro-engineering: An Australian perspective

r.&m&y &I society. Vol. 10, pp. 17-27 (1988) Printed in the USA. All tights reserved.

0160-719X188 $3.00 + .OO Copyright 0 1988 Pctgatnon Joutn& Ltd

Macro-Engineering An Australian Perspective

Nevde D. Chidgey

ABSTRACT. Austrah is a large landmass with a smallpopulation. It has a history of mac- roprojxt deue/opment, implemented by the necessity to estabhsb its communications, product development, and trade. The concept of the modern, high/y intensive macro- project first impacted in 1964 with the development of iron ore deposits of the West Coast, close/y followed by the development of the coal deposits of the East in the 1970s. So far, Australia ‘z macroproject programs have not producedfaihre, but lessons have been Learned concerning the prudent application of limited recourse financing, the need for appropriate legal structuring, the complexities of government participation in private enterprise, and the manipuhion of resource-based projects for reasons of national inj?a- structure development. The vast improvement in labor productivity and the emphasis on tight national economic management in Australia in the Light of the currently depressed international commodity markets is discussed.

In about 1908, observing the end of a long drought young Australian, Dorothea McKellar, wrote:

on her family’s property, a

. . . I love a sunburnt country A land of sweeping plains, Of ragged mountain ranges, Of drought and flooding rains, I love her far horizons, I love her jewel-sea, Her beauty and her terror- The wide brown land for me! . . .

In thinking about macro-engineering, past and future, on the Australian main- land, it is hard to capture the environmental aspects more completely than Miss McKellar was able to do in a few words.

Australia is a country of some 7.7 million square kilometers. By comparison, the

Nevi//e Chidgey is Chairman of the Warren Centre for Advanced Engineentzg at the University of Sydney and Chairman of the Macroproject Pane/ in Australia. He is aho 0 Director of a private research organization and of a venture capitd company. Since 1963, he has been Chief Engineer Cons&ant to the Commonwedth Band of Austrak

17

Page 2: Macro-engineering: An Australian perspective

18 Neville D. Chidgey

US has 7.4 and the subcontinent of India 3.3. Yet Australia has a population of only 15.5 million people and, at the turn of the century, it was only about 3.8 million.

The Australian continent is geologically ancient. Dorothea’s ragged mountain ranges are well eroded, providing, generally, little obstruction to the atmospheric systems which control the climate. The continent as a whole, therefore, is rela- tively dry, with 50% of its area having a minimum annual rainfall of less than 300 millimeters and 80% having less than 600 millimeters.

The land is sensitive to excessive cultivation or stocking. Dorothea’s flooding rains can cause irreparable and permanent damage to poorly managed or over- stocked country. Inland rivers meander and dry up in poor seasons.

On the one hand, it is a delicate land, full of environmental challenge. On the other, it has provided the basis for a few significant macro-project systems that have changed the ancient craggy face of the country in order to provide a unique but rewarding quality of life for its peoples.

The first of these macro-projects on which the nation built its character and early wealth had its origins in the post-Napoleonic demand for woolen goods in Europe. A few Australians took up the challenge to supply the mills of Yorkshire with fine wool. Intensive research and the genetic development of the merino sheep lifted the wool yield from 1.4 kilograms per sheep in 1860 to four kilograms by 1730. Construction of a national rail network, haul roads, and strategic ports- built sometimes under conditions of extreme hardship and aggressive financial planning-produced the early infrastructure necessary to maintain productivity, so that, by the turn of the century, the colony became the world’s leading supplier of fine wool.

When the six independent colonial states were federated to become the Aus- tralian nation in 190 1, the wealth and future of the new country had already been substantially underwritten by the fine wool industry.

Prior to 1900, the wheat industry had been a labor-intensive industry, suffering the hazards of the dry, harsh climatic conditions. Again, a few hardy pioneers sup- ported the genetic development of a unique strain of wheat that was capable of

accepting these conditions. Others set about the design and manufacture of broad-acre tillage equipment that was suitable to the hard ground. These massive plant and equipment changes proved to be the keys to the establishment of a new industry, which eventually rivaled the wool industry in export earnings, while Australian methods set the pattern for productivity improvement in the industry worldwide.

Each of these projects grew out of the recognition by a few hardy entrepreneurs that a market existed, and that new genetic strains were required. Innovative tech- niques, equipment and machinery were necessary to service the emerging indus- tries. Development was progressive over a long period, so that, in that sense, these efforts were different from the modern-day macro-project. Nevertheless, by the first half of the 20th century, these two projects had built a substantial nation. And each was the result of entrepreneur-driven industry which challenged scien- tific barriers.

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&cm-Engineering: Australtb 19

The Macro-Project Record, 19GFl98S

The concept of the modern, highly intensive, pre-planned and coordinated macro- project as a tool for regional industry development had its first impact on Australia in 1964. It arose as a result of the government’s lifting of a long-term embargo on the exporting of iron ore. This led to the immediate exploration and rapid devel- opment of extensive haematite and limonite deposits in the Pilbara region in the northwest area of Western Australia. Four major joint-venture groups quickly es- tablished modern mining operations and a heavy, rolling-load railway infrastruc- ture. Three new ports and four major towns were constructed.

By 1975, the Pilbara region was the world’s largest exporter of iron ore products to specification. Each of the four joint ventures had satisfactorily completed macro- projects designed to meet exacting market requirements and to develop the social and commercial infrastructure of the region.

In the 1980s, the Pilbara region also supports the development of a major off-

shore gas field. This North West Shelf project will ultimately supply liquefied natural gas to eight Japanese gas and utility companies with service areas that encompass 90 million people. The completed cost of the LNG program is in the order of $10 billion.

Pilbara has been developed from a desolate, remote region into a thriving, profitable industrial metropolis as a result of a planned series of macro-projects.

By way of definition, the term “macro-project centres” is used to describe regional developments involving multiple fast-track industrial projects which, by their size and complexity, have impacted on the social, environmental and indus- trial development of Australia and on her global markets. Coal will complete the quartet of multiple macro-project experiences which have had the deepest effect on Australian thinking and planning for the future.

In 1965, Australia mined 30 million tons of coal. By 1984, that figure had been raised to 120 million tons. All this significant increase came from the east coast coal fields of New South Wales and Queensland. In 1965, the Queensland fields sold 1.5 million tons. By 1984, the figure had reached 66 million, 40 million of which were exported. Total sales to overseas countries again increased strongly in 1985, and will approach existing mine plant capacity in 1986. Coal sales are now Australia’s largest single export earner.

The New South Wales fields are largely served by existing infrastructure, which had only to be upgraded to service the larger capacity imposed upon it by the in- creasing volume of the export trade, but, in Queensland, a whole new industry- including infrastructure -needed to be provided in the area of the Bowen Basin.

This area lies inland from the Great Barrier Reef, a coral reef and lagoon area of great environmental sensitivity and national value, which reaches some 1,400 miles along the Queensland coast. Five major ports with land-backed stockpiling and loading facilities were constructed within the environmental impact area of the reef. Loading structures, reaching up to three kilometers offshore, were con- structed to handle the largest coal carriers in the high tidal-range which prevails.

Currently, distribution of Australian coal of varying specifications is about 60%

Page 4: Macro-engineering: An Australian perspective

20 Nevile D. Cbidgey

into the Pacific Basin and about 40% to European destinations. The European fraction is increasing, so low-cost bulk handling and production efficiency are essential in view of the increasing importance of the longer haul distance to Europe.

About $10 billion has been spent on capital works since 1965 to establish 18 mines and the necessary infrastructure on the North Queensland coal measures, and about $5 billion has been spent in New South Wales. These expenditures will continue to increase, but at a lower rate as new mines are added to cope with the increasing demand after 1986-87. Each of the project sponsors, as is usually done in Australia, has financed its own share of mine, mine plant, and infrastructure development. The largest fund-raising by an individual project sponsor in this area was about $1.1 billion.

Macro-Engineering: Lessons from Past Experience

Some of the lessons which senior practitioners have seen as significant in the Aus- tralian experience are surprisingly simple.

For instance, international coal marketing is invariably a highly competitive business. Overall, on the Bowen Basin, transport represents about 33% of FOB costs, excluding the capital charges of rail and port facility funding. In this scheme, the construction costs of the port facilities and rail links were advanced to the government in the form of a security deposit by each of the producers. The government, with the backing of the producers, arranged contracts for design and construction, and this worked quite well for the most part. The government was permitted, however, for sound reasons, to take title to the rail and port facilities

and to charge rentals to the producers, based on pre-agreed tonnage, less a sum calculated to repay the security deposit. This scheme leaves the producers vulnera- ble to excessive charges which could adversely influence their competitive capabili- ties, particularly when delivered tonnage is down.

On the one hand, the scheme had merit, as the funds accumulated could be used by the government to support less profitable rail sections. It also, however, placed the coal measures in a potentially less competitive free-market position than the iron ore producers in the Pilbara region, who control their own rail and port loading systems. It raises the vexing question in regional macro-project plan- ning of how to best allocate all the charges for infrastructure development.

In general, it seems that-where international markets are involved-transport is such a significant sector of production cost in these industries that the producer of the future should seek to achieve as much leverage as possible in early negotia- tions with the government and bite the bullet on the initial capital cost. It should be borne in mind, right from the start, that the need to demonstrate long-term de- livery cost-minimization is a very desirable feature in competitive negotiations for international period supply contracts, particularly when large tonnage is involved.

Toward the latter stages of the Bowen Basin coal program, some of the private- sector macro-projects put into place to construct mine plants encountered the full impact of the banks’ marketing strategies for selling fully financed, capital works

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Macro-Engineering: Austrah 21

packages on limited or non-recourse bases. At the front end of project planning, these packages seemed most attractive to some operators. So, a few mines that were established on highly geared, limited-recourse packages are now facing up to higher on-going finance charges in the face of coal prices that are lower than those projected by the owners and the participating banks at the time of their commit- ment to the project. There is little prospect of relief from this situation by price improvement in the short term.

In the past decade of project financing in Australia, competition between banks to advise, lead, co-lead or join in syndicated financing of macro-projects-mainly in the resource industries- has reached an intensive level. Non- and limited- recourse, fully financed packages were offered on competitive bases by the banks to the project sponsors. All the banks have prudential lending policies, and these were not breached, but rates and fees were cut and-perhaps more important - the information memoranda prepared by the banks in support of the loan pack- ages took on some aspects of a sales document, rather than a balanced assessment

of prospects. The frenzy has now died down, apparently without damage, as there is no evi-

dence that any projects have failed as a result. Nevertheless, it is timely to draw to the attention of the banking industry, as a whole, the need to keep its project ana- lytical capacity in good shape, to participate early in the project planning phase, and to examine without bias as a final measure of project viability. Project gearing should be fearlessly assessed by the lead banks, who should keep in mind the assessed long-term capacity of the project to participate profitably in international markets.

It is widely recognized that an undoubted reputation for individual profit-ori-

ented macro-projects as a financeable package can only be won by the presentation of excellence in engineering planning, project implementation, and establishment in a sufficiently stable sociopolitical environment. Yet some concern has been ex- pressed that legal constraints might affect the timely application of new engineer- ing-indeed, the best engineering, in some cases. Fairly thorough investigation by the Warren Centre has yet to come up with any well-documented cases, but some recommendations can be made as a result of the Australian macro-engineering experience, namely:

l Specify clearly the codes of practice and national technical standards to be fol- lowed throughout the project very early in the planning stage, particularly on projects which are located in developing countries.

l Highly qualified, experienced practitioners in specialty services are sometimes deterred from involvement in macro-engineering, due to a high assumed level of responsibility under the law of tort, relative to fee received. These specialists should be offered carefully drafted, effective, limited-liability contracts, whereby the owners accept contractual liability above a reasonably insurable professional indemnity sum. Public risk and third-party liability cannot, of course, be limited.

l Assume that complex macro-projects disputes cannot be settled satisfactorily by the courts. Specify clearly and seek early clarification of issues. Assemble all the data relative to potential disputes and be prepared to negotiate.

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22 Nevilie D. Cbidgey

l Specify appropriate law for projects in remote jurisdictions. l Adopt international model law where appropriate and encourage trends toward

the future development of international standardization.

Finally, on the subject of the learning curve, Sir Charles Court was the responsi- ble Minister in the Government of Western Australia during the Pilbara develop- ment and Premier of Western Australia from 1974 to 1982. He participated in the Warren Centre project on macro-project implementation at Sydney University in 1985. Some of the points made at the Centre with respect to specific project expe-

rience on the Pilbara were:

Dreamers are essential, but “dreaming” must have a finite end. Macro-projects will only be transformed into reality if they are viable. Leadership is vital - right from the start. Teamwork can only be achieved by

strong, purposeful and dedicated leadership. Disciplines imposed by the private sector, share-holders, banks, and financial institutions eventually produce more reliable analysis than does the government sector. Have a clear and detailed statement and understanding of objectives. There will

be no concessions from government or unions after the commitment to pro- ceed. Clarify issues early. Set firm milestones for key decision points. Evaluate each sponsor’s ability to abandon the project at key points, if prospects deteriorate. The concept of a “one-stop government shop, ” under the direct control of a

responsible minister of state, can ease regulatory delays and frustrations. Erect sensitivity curves early and direct viability studies to critical areas on the curves. Product price, production and quality and project completion on sched- ule can be more significant than completed capital cost.

Macro-Engineering: The New Challenge

Recently, the Warren Centre has examined and reported in depth on the chal- lenges of the macro-engineering future in Australia. This discussion is more gen- eral, and is meant to complement that work and to discuss the future from an entrepreneurial viewpoint. After all, without the vision, wisdom and courage of the sponsoring businessmen, there would be few- if any-giant projects in the

commercial sector in the future. Overall, Australia is currently spending at the rate of about $4 billion per

annum in the private sector on capital works concerned with major projects. About 65 % of this expenditure is in the mining and resources industries, while the balance is credited to the manufacturing sector. While this is still a creditable rate of activity, it is to be compared with $7.54 billion per annum in 1982-83, of which about 43% was taken up in the manufacturing sector.

The national infrastructure builders, the wool and wheat industries, together with the more recently developed coal and iron ore centers now contribute about

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Macro-Engineering: Austrahiz 23

40% to Australia’s export income. Productivity and technological efficiency are high in these sectors, but the manufacturing sector has fallen off from about 5 5 % contribution to 45% during the 1980s. This sector deserves attention. Old indus- try may need to be reconstructed or retired. R&D to lead to new industries should be encouraged and supported.

The devaluation of the Australian dollar has helped export manufacturing and the primary product producers. A little-too-buoyant domestic economy should stabilize soon, as it is the policy and aim of the economic planners to maintain a fairly tightly controlled monetary policy until inflation is convincingly on a steady downward trend.

In the past decade, much has been said in the world’s commodity markets con- cerning Australian industrial relations. Mostly, comment is related to the hostile environment which developed in the late 1960s on the wages front. In 1974, 6.3 million working days were lost to industrial disputes. yet, by 1985, this figure had been reduced to about 1.2 million. This dramatic improvement resulted primarily from the endorsement by the government in 1983 of a prices and incomes accord which was acceptable to the council of trade unions. One of the provisions of the accord indexed wages to movement in the Cost Price Index, thereby almost elimi- nating the major single cause of recent industrial disputes.

Principally as a result of the reduction in the number of working hours lost due to disputes and the improvement in labor morale in general, the real Gross Non- farm Product (GNFP), which rose by only 0.5 % in 1982-83, improved by 3.3 % in 1983-84 and by 5.2 % in 1984-85. In the same period, inflation fell from

11.5 % to 6.0% per annum, and the real cost of labor, after allowing for the resul- tant productivity gain, improved by a dramatic 17 % .

The trend in real labor costs throughout the decade is shown in Fig. 1. The sig- nificant steepening of the gradient of the curve in 1982-83 reflects the commence- ment of negotiations to set up the accord and the resultant improvement in labor’s sense of job responsibility and industrial morale. The tabulation of working days lost per annum through the decade, given in Table 1, together with Table 2, dem- onstrates the strengthening trend in productivity gain in the later stages of the decade.

This strong underlying performance and the continuing success of the accord has placed Australia in a sound position to continue a sustainable rate of growth

into the future. The sponsoring companies, design terms and constructors who have been in-

volved in the macro-engineering programs of the past two decades are used to working and competing in the international arena. These firms will continue to seek to make a contribution on the world scene, not only in the design and con- struction area, but also in the field of project recognition and definition and in financing. Moreover, Australian banks with the necessary project experience are already engaging in project analysis, underwriting and funding the capital works sectors of projects in the wider field.

Onshore, in the resource-related industries, the emphasis has moved to produc- tivity improvement to sustain competitivity in both price and quality and in reli- ability of supply.

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24 Nevibe D. Cbidgey

TABLE 1. Industrial Disputes - Australia (1974-1984)

Number of Workers Year disputes involved

1974 2,809 2,004,800 1975 2,432 1,398,OOO 1976 2,055 2,189,900 1977 2,090 596,200 1978 2,277 1,075,700 1979 2,042 1,862,900 1980 2,429 1,172,800 1981 2,915 1,251,800 1982 2,060 722,900 1983 1,788 470,000 1984 1,965 562,300

Half year to Aug 1985 1,350 434,100 Y/e Sept

Source: Derived from statistics obtained from ABS.

Number of Average number man-days of days lost1

lost striking worker

6,292,500 3.1 3,509,900 2.5 3,799,200 1.7 1,654,800 2.7 2,130,800 1.9 3,964,400 2.1 3,320,200 2.8 4,192,200 3.3 2,158,OOO 2.9 1,641,400 3.4 1,307,400 2.3

779,900 1.8 1,242,200

TABLE 2. Causes of Disputes-Australia (1974-1984)

Working days lost (96 of total)

1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984

Wages 88.3 77.6 24.4 25.3 27.1 52.5 36.0 46.7 48.7 12.2 24.6 Hours of

work 0.2 1.0 1.9 2.7 3.8 3.0 7.5 24.8 20.5 5.0 5.9 Managerial

policy 5.1 13.8 41.2 39.0 36.1 12.9 22.9 15.5 16.6 43.5 32.5 Workirig

conditions 1.6 2.6 18.4 19.9 18.9 3.9 5.5 4.0 7.0 31.5 16.2 Trade

unionism 2.6 4.9 9.6 8.9 9.8 2.5 3.4 2.0 3.5 3.3 8.7 Other 2.6 0.9 4.5 4.2 4.3 25.1 24.7 7.0 3.7 4.6 12.1

Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Source: Indushr;lr/ Disputes, ABS 6322.0.

There is also an understandable desire to go to the progressive accumulation of added value by on-going materials processing. For marketing reasons, however, raw materials are normally processed for export to a stage where a mutually accept- able commodities contract can be agreed upon with the end user, who also needs to accumulate a reasonable share of the added value from the deal. Nevertheless, secondary processing will be undertaken when:

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Macro-Engineering: Austraha 25

i

I 1177

I I 1179 1181

OUARTERS

I 1183

I i/a!

FIGURE 1. Index of Real Unit Labour Costs 1980 = 100

i

It seems to offer a marketing advantage.

Special processing techniques have been developed, as in the case of zircon ceramics. Marketing advantage can be gained by lower-cost processing, as in the case of aluminum production, where cheaper power in Australia provides a cost- reduction opportunity.

Is this enough to sustain a healthy rate of growth for a virile young country into the future? The answer of the professional firms and project-sponsoring com- panies- who have undertaken and completed the macro-engineering round of the past two decades in Australia and who have met and considered the question in the Warren Centre at Sydney University-is that it most certainly is not.

The sponsoring companies which initiated, planned and implemented the Aus- tralian resource industries now have a proven track record in specific technical and management skills. They have earned the confidence of the international financial

115

110

105

100

95

90

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2G Neville D. Chidgey

industry and are supported by experienced scientific, engineering and legal ptacti- tioners. These teams will continue in their established directions, but it is also to be expected that they will include, in their corporate plans for the future, the initiation of new industries, as they have done in the past, but possibly in new and different directions.

An indicator to some of these new directions is given by the Commonwealth Scientific Industrial Research Organization, which is Australia’s primary strategic research organization. Its currently designated growth areas include:

l The application of information technologies l Development of technologies widely applicable to the manufacturing sector l Development of a space industry l Development and application of biotechnology techniques

Metallurgical techniques are not included, but concerned sectors of industry have this area under active examination.

The Warren Centre project on Advanced Surface Mining has recognized the need for a mine plant manufacturing industry based on Australian surface mining experience for much the same reasons of productivity improvement and lowering of down-time in the field that led to the establishment of the great broad-acre tillage-equipment manufacturers, who were critical to the success of the wheat industry in the early part of this century.

Of singular significance, in the light of the Japanese experience and other national experiences, the federal government has undertaken to provide legisla- tion in 1986 for a 150% tax concession to be applied to incorporated companies’ expenditures for the cost of approved R&D carried out in Australia. The aim is to accelerate the rate of higher technical development in the country, and the scheme

will operate initially for six years. This provision will mean that the actual cost of $100 million in approved research and development to a company which can claim the full R&D tax benefit will come to only about $27 million.

So an incentive for new business has been created. There is the opportunity for financial institutions to gear up well-planned industrial R&D, provided that

clearly defined commercial development is the end aim. Also, there is the oppor- tunity for international organizations to take part in this new activity, whether they have an Australian tax commitment or not, if they are able to participate in specific new product development of a substantial nature in a technical or other meaningful way.

For those companies in the international sector, such as the computer main- frame suppliers and defense and aerospace contractors, who have offset credits with Australia, the opportunities are even more attractive.

Industry, more particularly the companies experienced in macro-engineering developments, are therefore being challenged to recognize new projects, pass them through the research and development stage -using the financing which the tax concession will generate- and build new industries. In reality, this is not

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Macro-Engineerihg: Australia 27

greatly different from the establishment of the great resource-based industries of the i96Os. It requires courage, meticulous planning, and an ability to cooperate technically, as well as the will to trade competitively on the international market.

If, then, as seems likely, aggressive new product development is to achieve a higher perspective in the macro-engineering industry, society needs to respond with mature and stable labor policies, good laws, top-flight educational facilities, and intelligent, far-seeing and sound economic planning by government. This is the path on which Australia is bound.