Embracing China as number one

Author: Shiro Armstrong, ANU

China is Australia’s most important economic partner. That is true now and it is only likely to become more so in the future.

In January Australia’s foreign minister Julie Bishop unexpectedly declared that ‘the United States remains our single most important economic partner. When you combine two-way trade and investment, it stands at over $1 trillion’. She is not alone in making this point and the Australian Department of Foreign Affairs website on the United States has made the claim since John Howard was Prime Minister back to July 2004. Back then there was a tussle deep within the ministry over the issue of America’s relative decline that spilled over into a debate about trade statistics and how important a trade and economic partner the United States was — only then it was compared with Japan (not China). How quickly the target has shifted!

How do the diplomats who advise Minister Bishop make the figures add up in that way when your average Australian citizen commonsensically thinks that China is now much more important on every economic measure they are familiar with? Maybe the punters are wrong? They sometimes are. But maybe there’s an inclination among some diplomats to manipulate the data? Certainly the earlier round of Japan deniers suggests a proclivity to massage the scale of American influence on the Australian economy.

The conclusion that the United States is Australia’s most important economic partner is supported by adding investment stocks to trade flows. But it actually makes little sense to compare stocks and flows in this way, let alone add them together as an indicator of relative interdependence. The correct way to construct a measure that included investment would be to add investment flows to trade flows as well as to take into account the whole range of other economic interdependencies (like migration) in gauging a partner’s economic importance.

By the correct measure, Australia’s trade and investment relationship with China is worth around $134 billion a year, $79.6 billion with Japan and $70.4 billion with the United States using the most recent data. By this measure, China is way out in front, and the United States is a far cry from the $1 trillion into which a bundle of other irrelevant data was clearly dumped.

China accounted for 21.1 per cent of all Australian merchandise and services trade in 2012–13. Japan is our second largest trade partner with 11.2 per cent, followed by the United States with 8.7 per cent. China bought $78 billion of Australian goods in 2012–13, or 31.3 per cent of all the goods that Australia exported, by far the largest buyer. Our largest supplier of goods is also China, accounting for 18.8 per cent of Australian imports in that year. The share of trade with China has been rising while trade shares with the United States have been falling. First, the United States was overtaken on this measure by Japan; now Japan and the United States have been overtaken by China. And that’s not to mention Hong Kong, now an integral part of the Chinese economy.

The United States is still the largest investor in Australia with $20.6 billion new direct investment in 2012–13, according to the Foreign Investment Review Board (FIRB), and a total accumulated stock of investment of $131 billion. Chinese investment into Australia has grown from a flow of close to nothing in 2007 to $15.8 billion of new investments in 2012-13. That was 11.6 per cent of Australian foreign direct investment and the third largest source last year. FIRB approved 6102 Chinese investment proposals compared with 264 American proposals.

Past investment in Australia is important but its effect on current interaction between the country of its origin and the Australian economy is indirect. It is difficult to reverse sunk investments by closing factories and close to impossible to pack up and take a mine back to America, Japan or China. Past investment is past investment and policymakers don’t have to lie awake at night worrying about things that are not reversible, so long as they keep the factors affecting current and future investment flows in mind.

What policymakers need to focus on is the flow of trade and new investment. It is quite easy to deter new investment coming from China and other sources by creating uncertainty in the investment approval process or making the investment environment less attractive by stalling on domestic reforms.

Similarly, a country’s economic health is better understood by looking at GDP — the ‘flow’ of new production in a year — and not its entire accumulated stock of capital and certainly not by adding together, one-for-one, a stock and a flow.

The Australian economy did not go into recession when the American economy did during the global financial crisis. It kept growing at 2 to 3 per cent when the American economy went backwards.

Nobody thinks Australia would fare nearly so well in a major Chinese recession.

Significantly, the Reserve Bank of Australia (RBA) uses trade weights to assess the overall value of the Australian dollar, underlining the importance of the relationship with China. Until the early 2000s, the RBA used to puzzle over the high correlation between Australian and US GDP. That focus has rightly shifted to the much higher correlation between Australian and Chinese GDPs. Australia may still catch a cold when the United States sneezes, but is likely to get pneumonia if China catches a cold unless Australian policymakers understand how they have to manage the shocks that will inevitably emanate from the country that is now our biggest economic partner. That’s the reason why Australia is often called everyone’s favourite short on China.

The United States is an important economic partner, and Australia has benefited from US investment and trade, and will continue to do so. As China’s economic rise induces major changes in the structure of regional and global economic relations, an instinctive psychological reaction by those who want to live in the past has been to double down on the US relationship. There is nothing to be gained by downplaying the importance of our largest trading partner, a major source of investment that is growing rapidly and our biggest source of tourists, students and new migrants.

The Australia in the Asian Century White Paper was about changing the nation’s mindset to prepare for the future in Asia.

Prime Minister Abbott recently credited Japan with developing Australia’s mining sector with foreign investment. It is now a new source of investment from China that is creating jobs, keeping our mining sector at the frontier as the world’s most technologically advanced, and opening new markets for Australian products and services in Asia.

The free trade agreement under negotiation with China would level the playing field for Australian agricultural produce and some services in China, where currently New Zealand and Southeast Asian producers get preferential access. It will also help correct some of the disadvantage Chinese investors face in Australia compared with US, South Korean and Kiwi investors enjoying a higher threshold before investment projects are screened.

But in the context of China as our number-one economic partner, and China’s importance in the regional and global economy, it’s only the first tiny step in getting the relationship with China into its proper perspective.

Shiro Armstrong is a Fellow and Co-Editor of East Asia Forum in the Crawford School of Public Policy at the Australian National University.

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