Economic gravity works: Can China and Australia stand together?
October 24, 2012, 2:24 pm

What really lies at the heart of Australia’s China challenge? One of China’s leading economists explains

Australia and China have got closer and closer in the last decade. China has now become the most important export destination for Australia, and Australia ranks the eighth largest trade partner for China. Bilateral trade increased at an average annual growth rate of 26.8 per cent since 2001.

China’s overseas direct investment in Australia also boomed. Apart from Hong Kong and tax havens like the Cayman Islands and British Virgin Islands, Australia is the largest recipient of China’s overseas direct investment. The annual growth rate of China’s overseas direct investment to Australia was above 200 per cent from 2007 to 2010.

Economic gravity works. It is China’s rising that has pulled Australia closer. The last three decades witnessed a rapid economic expansion in China at an average annual growth rate higher than 9 per cent. In China, a growth rate below 8 per cent is viewed as recession. This unprecedented growth miracle has lifted hundreds of millions of people out of poverty, and also created a massive middle class with a huge consumption appetite. Herein, Australia is well positioned to thrive. It is lucky to be at the right time and the right place, with the right neighbour.

Now let’s take a closer look at the China-Australia economic relationship.

China-Australia ties

Firstly, bilateral trade between China and Australia is uneven. Most of China’s import from Australia is minerals, which accounts for 78.7 per cent of the total. Just over 15.1 per cent of China’s import of minerals comes from Australia. 37.6 per cent of China’s export to Australia is machinery and electrical equipment. As a result, China has a trade deficit with Australia, reaching 50 billion USD by the end of 2011.

This is an Australian version of the Leontief’s paradox: an advanced economy like Australia exports primary commodities, while a developing economy like China exports capital goods, just the contrary of textbook economics. The implication of this puzzle is that Australia’s impressive export performance to China is not the result of hard won competition. It’s basically a mining story.

Secondly, the huge demand for Australia’s minerals is unsustainable. Industrialisation and urbanisation in China has helped much in pushing up the commodity prices, especially the ore price. These two historical progresses are incomplete, but the growth curves will become flat anyway. And quicker than we predicted.

After the global financial crisis, Chinese government announced a 4 trillion CNY stimulus package in 2008. Most of the investment flew into infrastructure building and the housing market. It boosted growth immediately, and drove up commodity prices dramatically, but caused more chronic diseases like mounting local government debts and non-performing loans in the banking system. It’s unlikely the government will repeat the same mistake by having a second round stimulus.

Although recently the National Development and Reform Committee (NDRC), the most powerful government department in China, has approved a batch of investment projects amounting to 2 trillion CNY, the central government has traditionally been reluctant to spending its own, asking local government to shoulder the burden. Local governments, are however, already staring at the torrent of red inks. The result: China’s demand for minerals is going to slack further. My guess is that, China’s iron and steel industry has just encountered the chilling wind in autumn, not yet the freezing winter storm. Let me be blunt-what is unsustainable is unsustainable.

Thirdly, structural reform in China is more of a challenge for Australia. We have talked so much, for so long, about China’s structural reform, with so little progress. It has been frustrating. However, hope seems to be around the corner. Recently, some “green shoots” emerged, showing signal of transformation and rebalancing. Investment in heavy industrial sectors is weak, but investment in high-tech, finance, and other service sectors is strong. Geographically,  investment in the middle and western areas is greater than that in the coastal areas, for the first time.

This silent revolution cannot be credited to government policy. It should be attributed to more fundamental factors like the rapid change of demographic profile. With a sluggish overseas market and a sharply increasing labor cost, Chinese manufacturers, even those in labor-intensive industries, are investing eagerly to upgrade their products. They strive to use less energy, and fewer raw materials and workers. At the same time, demands for services like health care, education and tourism, and goods like high quality agricultural produce, high-end manufacturing products will increase with the rise of middle class.

Is Australia ready?

China’s rebalancing provides a good opportunity for Australia to end the “two-speed” economy. Service sector, which accounts for over 70 per cent of Australia’s GDP, is well placed to benefit. But there are no more low-hanging fruits. For export of minerals, no one can compete with Australia. In the service sector, however, there will be fierce competition.

Education and tourism will thrive, but certainly they will face constraints. Australia’s financial sector is most advanced in this region, but it still lacks deep Asian connections. Imagine ANZ Bank having to compete with the Citi Group or Goldman Sachs, or the Australia National University competing with Harvard or Stanford. Competitive edge, not the geography, can help Australia. The question is, is Australia ready?

To project its influence better in this region, Australia has to be more creative, and play a far more important role in facilitating regional dialogue and cooperation. That is the “value-add” for Australia to Asia. Australia’s engagements outside Asia can have an impact on its battle in winning the heart of Asia. The case in point being- Australia’s defence agreement with the United States.

A more shrewd strategy, as ANU strategic analyst Hugh White has proposed, would be for Australia to have a more independent position, vis-a-vis US supremacy claims. Also, amidst threats of facing a likely backlash of globalization, Australia should firmly support trade liberalisation and investment liberalisation. That should be the path for Australia to traverse to become Asia’s dependable voice on global issues.

Getting closer is not good enough for Australia-Asia ties. Two hedgehogs will only hurt themselves by getting closer. Australia and China should stand together and support each other. Asia is not just a foreign environment that Australia needs to adopt. Australia is an endogenous factor in the unfolding dynamics of Asia.