The weather was awful outside the WTO Ministerial Conference in Geneva last week, but there was some sunshine within the convention centre.

Russia acceded as a member, along with Samoa, Montenegro and Vanuatu (the club still attracts new members, and as one minister said: ‘as far as I know, nobody has asked to leave’).

The Plurilateral Government Procurement Agreement was revised — after 10 years of negotiations — further opening up procurement markets to give foreign economies better access. China is also en route to joining, having agreed to do so on its accession to the WTO, after further negotiations took place.

But there were some strange decisions, like giving countries the option to waive most favoured nation (MFN) provisions, so as to allow least-developed countries preferential access to services markets. It is not yet clear how this will happen or how it would help resolve constraints in developing countries, which hinder reforms in their own service sectors. There were some non-decisions as well. No conclusion was reached on a set of principles for food security, for example, although the WTO’s Director-General rebutted a protectionist report from a UN official.

Why the lack of progress at this year’s Ministerial Conference? Here are five suggestions.

One factor is that ‘development’ has been mixed with trade. On the face of it, having a ‘development round’ seems positive, but lumping these two areas together complicates the process, and introduces new items for debate. The WTO should remain focused on the resource allocation gains from international business.

Another reason for the lack of progress is that the WTO cannot deal with the barriers that have now become relatively more important to business. This includes the rules and processes affecting international business which are not managed at the border. These barriers create significant rents — and those who currently gain from the arrangements resist their removal. Analytical work on these barriers is more and more important.

The third factor involves the uncertainties faced by policy makers when removing such barriers. Some were put in place for genuine public policy purposes, and policy makers are not confident about the likely consequences of their removal. Capacity building programs focused on this issue could help address the problem, and the EU and APEC, in particular, could work well together on this.

Fourth, the use of preferential agreements does not make the process any easier. Rents are created for local business, which are then shared with a state’s ‘favourite partners’ when preferential trade agreements find a way of allowing market access. In this way, the grand bargain once represented by the WTO has been diminished.

The US is the fifth reason why progress has stalled, although the US would likely say that other leading members were the problem. The US wants to create more domestic jobs — and good ones — which it associates with more market access, especially in countries like India, China and Brazil. These economies are not offering enough, and the US is therefore pursuing other options like the Trans-Pacific Partnership, or negotiations with the EU, to flush out some response from recalcitrant members. Meanwhile, this tactic promotes the use of FTAs and depreciates the political capital available to the WTO.

What will happen now?

Within the WTO, fundamental principles including MFN provisions and the ‘single undertaking’ will be challenged in the name of pursuing more-achievable — or less-ambitious — goals. Australian Minister for Trade Craig Emerson said the situation ‘argues for breaking the round into its component parts … instead of waiting for some grand bargain, magically, like a bolt from the blue, to strike us from the sky’.

Tension will be regarded as a plus, and created by excluding trading partners from special deals. Plurilaterals will proliferate, both within and without the WTO. We will move to a world in which there are clubs within clubs, and in which they all overlap. There is also the possibility of great tension in the Asia Pacific as ‘a line is drawn down the middle of the Pacific’.

It is not clear what the circuit breakers will be in this situation. Whatever happens, small group negotiations within the WTO could be okay if guided by the right principles. Some will call for new leadership at the top, in order to consolidate and multilateralise small groups outside the WTO. Others hope that the situation will be resolved from below, via competition; some clubs will exit (in effect, if not in name) or amalgamate, and what remains will be (hopefully) efficient. 

Our best chance is to build confidence in reform led from within economies. This requires transparency and benchmarking (via strong trade-policy reviews in the WTO, good peer reviews in APEC and clones of Australia’s Productivity Commission). It will also require us to demonstrate the real linkages between policy and performance, and the ability to translate that work into compelling public commentary. We then have to think through where world trade policy is at now, and develop a new, more coherent global strategy.

Christopher Findlay is Executive Dean at the Faculty of the Professions, University of Adelaide.

1. Implementing the G20 commitment to World Trade Reform
2. World trade policy in crisis
3. Trade policy needs to go global

Australia benefits substantially from the growth of the Chinese economy at this stage of China’s development.

China is now Australia’s most important trading partner and is an important driver of the growth of Australian resources exports. In 2009, China’s share of Australian exports was more than three times its world import share China’s competitiveness in manufacturing provides low-cost imported goods for Australia and contributes further to the improvement in Australia’s terms of trade.

While market forces have driven this deepening relationship, the policy framework in which that has occurred has also been evolving but with less coherence and greater variability. There is insufficient attention to the long run structural change of the Chinese economy. This is evident in a number of recent policy challenges — in foreign investment, visas for students, air transport policy, minerals taxation, domestic reform and structural adjustment in Australia and in the approach to the FTA. These are directly related to key areas of interest in the relationship with China, and the manner in which Australia is responding will affect the evolution of this relationship.

Alongside the growth in trade, Chinese FDI projects surged to more than A$7 billion in 2005–06 and then quadrupled in 2008–09. This occurred in the face of the global financial crisis. Australian policy, however, remains unnecessarily discriminatory approach to approvals of Chinese projects, with concerns about their size and the distribution of benefits of projects. More important to deal with those issues is in Australia a better understanding of and support for the progress of corporate reform in China. But meanwhile, since these capital flows are complementary to trade flows in food and in resources, a restrictive Australian policy also creates opportunities for competitors and risks in the trade growth.

An important feature of the bilateral relationship is the movement of people. In 2006, the Chinese became the largest Asia-born group in Australia, accounting for one per cent of the population. Migrants from China are found in the top-three occupational categories in terms of skills (managers and professionals), underlining the extent to which students from China in Australia transfer to permanent residence. A critical policy response in Australia, that had become an impediment, was the treatment of international student visas. Migration risk — the risk that people arriving in Australia will not abide by the conditions of their visa — has been driving policy on visas. The concern was that people apparently arriving for one purpose, such as study, might actually have in mind another goal, such as work or settlement. Following the Knight Review of these policies a number of changes have been made to speed up processing times, reduce the financial requirements and make it easier to work. Research by Philippa Dee shows student flows are highly sensitive to these regulatory matters and it will be important to monitor future students in response to these changes.

Tourism is also growing in both directions. China is likely to become number one in terms of the number of arrivals and their expenditure within a few years. Chinese ‘visitors’ now spend more nights in Australia than arrivals from any other country. A critical policy issue for Australia in this sector is the treatment of air transport services between Australia and China. Australia has committed itself to the ‘ultimate objective’ of an open-capacity arrangement with China but currently capacity levels are capped. These have increased from 14,500 seats a week in 2010 to 18,500 in March 2011, and 22,500 in February 2012. A more liberal approach to aviation will be important, also because of the scope to offer services beyond China to Europe.

A more commonly discussed challenge for Australia is to manage the minerals and energy boom. The prospect is after a period of high prices, supply will increase and prices will fall again, though not necessarily to the pre-boom levels. These price swings create opportunities for Australia in the short term but also significant structural change, especially in the rest of the economy which is exposed to international competition. Important in this situation are further reforms to add flexibility in the economy and to contribute to productivity growth in the sectors being squeezed. The more immediate policy response was not focused on these questions but on taxation of mineral rents. This led to a series of policy changes and a new system, in which it is still not clear whether the fundamental problems of the preceding royalty arrangements have been resolved.

Meanwhile, the structure of the Chinese economy is shifting and offers the scope for a series of new business opportunities for Australia. The extent to which they can be captured, in services, for example, depends in part on the features of the trading system that links the two economies. Negotiations on an FTA are attempting to shift that system but so far with little progress. A new focus — on structural changes in China and the prospects they offer, and on current issues in regulatory systems in Australia — might provide more productive avenues of discussion.

Professor Christopher Findlay is Executive Dean of the Faculty of the Professions at the University of Adelaide. Professor Findlay’s research was presented at China Update 2011. The annual China Update conference is hosted by the China Economy Program, in collaboration with the East Asia Forum, at the ANU in July.

This article is a digest of Professor Findlay’s chapter, ‘Australia–China Economic Relations’, in Jane Golley and Ligang Song (eds), Rising China: Global Challenges and Opportunities (ANU E Press, 2011), available in pdf here. This book is the latest publication in the China Update Book Series, launched at the China Update conference every year.

1. Looking back on China’s relations with Australia
2. Australia-Japan economic partnership – Weekly editorial
3. China’s rise and the importance of Australia-China youth dialogue

Qantas, the Australian national flag carrier, has faced some major challenges over recent years.

Like many Australia-based services firms which sell into global markets, Qantas has had to deal with significantly rising costs, due to its base in an economy with a booming minerals and energy sector. It is also confronting new competition in its global markets, particularly with the emergence of low-cost carriers and the Middle Eastern airlines.

In response, Qantas announced in August a new strategy with an even more explicitly Asian focus.

Qantas has for some time been using Asian cities as hubs, where it can consolidate traffic subsequently to be flown to Europe. The airline will continue to do this out of Singapore (using its new aircraft), but the company’s new strategy will see it using its partner British Airways flights from Hong Kong and Bangkok.

This strategy looks like a further retreat to Qantas’ home base, which would lead to a steadily shrinking business and fewer Australian jobs. But it also has a complementary strategy to deal with the challenges; Qantas has simultaneously decided to establish more operations in Asia.

Qantas already has Jetstar Asia, a low-cost profitable carrier operating inside and outside Australia, but it is now planning to set up Jetstar Japan in partnership with Japan Airlines and Mitsubishi, and Jetstar Japan will also fly to China and East Asia. Additionally Qantas proposes to create a new premium-quality — but also joint-venture — carrier somewhere in Asia to serve this region’s ‘emerging middle class’. Singapore is the most likely base, though Kuala Lumpur has also been mooted.

Interestingly, the new service will not carry the Qantas brand. This appears to be reserved for premium services in Australian markets or those connected to Australia, such as routes from Europe to Australian cities. Instead, the Jetstar brand seems to have a much wider application in the low cost market.

The partnership approach may not be Qantas’ first preference. Instead, the decision to go with this strategy reflects in part how trade regulation systems in international aviation impose constraints on operators, functioning as they do like single-item free trade agreements. Ownership is used to identify the carriers with market-access rights in those arrangements, and Qantas will have to work around this constraint when applying its new strategy.

Still, Qantas now looks set to export its organisational and managerial capabilities through these new ventures — not by extending its traditional operations from an Australian base. At the same time, the strategy will bring in other inputs — including staff — from cheaper offshore locations. Manufacturers have been doing this for years, and it is now common strategy for services firms to plan in supply-chain terms.

Some argue that without the relocation of activity offshore, there would be even fewer Australian Qantas jobs in the future. Despite the power of this argument, recent experience shows how hard it is to manage the adjustment. It also shows how change has very different effects on different types of staff.

The announcement of these new strategies for going into Asia has brought a powerful backlash from Qantas unions, and the outbreak of an increasingly labour dispute. The current dispute began with Qantas employees pushing for the company to pay colleagues in overseas Qantas-owned operations Australian wages. Qantas’ proposal to create new businesses offshore added to employee concerns about incomes and jobs. The labour union campaign  included rolling strikes, which Qantas management argued were creating uncertainty and leading to a significant drop in forward reservations. Services firms, which cannot store their output, are highly exposed to staff threats about the withdrawal of services. Manufacturers, on the other hand, might be able to ‘stock up’ for a more drawn-out conflict. This dispute between the unions and Qantas culminated in the lockout of workers which grounded the airline until national legislation was brought to bear to end it and to force an arbitrated settlement on the grounds of the damage it was causing to the economy. According to Australian industrial relations arrangements, the parties have three weeks from 31 October to reach an agreement — the regulator having agreed with Qantas and the government that the industrial action should be terminated. If Qantas and the unions fail to agree, there will be compulsory arbitration.

As yet the, details of the final outcome of this particular dispute are not yet clear. What is clear is that Qantas is moving toward a change in its structure, aimed at garnering a return on its core capabilities — and with a focus on the growth markets in Asia.

Professor Christopher Findlay is Executive Dean of the Faculty of the Professions at the University of Adelaide

1. The dance between BA and Qantas is over
2. The flying kangaroo – An endangered species?
3. Structural reform takes off (a bit) in Japan

The way ahead in the European debt crisis appears to lie in refinancing the debt held by those countries whose sovereign bond spreads are widening and who are at risk of default: but who will pay?

There is some move to have the private sector contribute — with a new financial transactions tax being debated and writing down the value of government debt  — and while the Germans are resisting, they will more than likely pay most of the cost. Germany, in particular, gained a great deal from the current euro zone arrangement, as its exports benefitted from a lower currency than might otherwise be expected. Now, if they want to sustain the structure as it is, it will cost them.

Refinancing comes with the expectation that recipient economies will also cut spending, which will subsequently build confidence about their ability to repay these debts in the longer term, and potentially reduce the moral hazard problem. But some have argued that this could well be a ‘death trap’. Spending cuts across Europe mean no strong external demand to help countries adjust while US growth also falters.

Another response would be to introduce reforms aimed at raising productivity and evening out competitiveness, as there are surprisingly high divergences among European economies in the quality of economic regulation. Labour market regulation in Portugal, for example, lowers productivity growth. Certain rules, such as those on layoffs and the provision of other services to workers, kick in at specific firm sizes, leading to a larger number of smaller and less productive firms, something which is also highly topical in Australia. Others have talked about how Italy needs a ‘change of regime’.

Though not much discussed by those focusing on the way ahead, micro reform would be a real way out of the crisis: a credible set of commitments might be valued by lenders. But in the current context, this may not work fast enough either. There are other suggestions for a response. The EU President, for example, is now calling for ‘economic union’, or an institutional set-up which would support tighter coordination of fiscal policy and presumably regulatory reform.

Greater fiscal discipline and micro reform measures should already be in play, and the financial market constraints associated with the adoption of the euro were supposed to be their key driver. That was a grand expectation. In fact, the availability of finance from the rest of the world (including East Asia), and the expectation of financiers that lending to EU governments was a good bet, actually reduced the pressure to implement any of this. In any case, the large-scale political reform that would be required to put such a package together is not likely to happen quickly enough either — or if they want to wait until it does, the Germans will be refinancing other people for a long time to come!

The crisis is therefore more likely to drive fragmentation than consolidation, given the timelines and the current situation. The question then arises of who could eventually leave the euro zone. It might seem obvious that the high debtor nations would pull out and go their own way. But Michael Pettis recently pointed out that this would risk a ‘downward currency spiral’ and that Europe might well learn from the Asian financial crisis, and the Korean experience in particular. He also refers to another discussion underway, which speculates that it could be the Germans and other northern European countries who pull out to create a new currency (mark II?) and leave the devalued euro to the southerners.

But whichever outcome eventuates, it will be an interesting scenario from the Asia Pacific’s viewpoint: the potential effects of Europe turning into a constellation of clubs, even overlapping for different purposes, would not be limited to those European countries alone — though France would have an interesting choice to make in such a scenario, and this is perhaps what the English always thought should and would happen.

It is clear now that the EU should have worked harder and sooner on real reform. Europe’s leaders should not have done this in a ‘one-size-fits-all’ manner, as it has not been effective. The current crisis is an important lesson for promoters of sophisticated Asian integration and also for those worried about two-speed structures in existing federations. And the lesson is: do not lose sight of the never-ending task of structural reform, expect diversity in responses across economies and keep productivity growth going.

Professor Christopher Findlay is Executive Dean of the Faculty of the Professions at the University of Adelaide.

1. The European crisis and the G20 Summit
2. The Greek tragedy: Global debt crisis and balance sheets
3. China into the European breach, but not just yet

Commentators on these pages have been pondering the implications of the Fukushima explosion on Japan’s energy policy and its strategy for international purchases.

Samuels suggests an extensive re-examination of energy policy in Japan and a possible shift toward renewable energy. Vivoda pointed to a scenario in which the share of nuclear power in Japan’s total electricity consumption could fall. This share previously accounted for 30 per cent of consumption, and even as little as 12 months ago the plan was to raise this to 50 per cent.

An increase in the share of gas and coal in the short to medium term and a switch to renewable energy sources in the longer term is now expected: Peter Drysdale referred to the growth of LNG imports this year and its likely further growth in 2012. That nuclear power is not so cheap when the costs of meeting safety or dealing with incidents are taken into account is the key driver behind these developments, as Len explains. Still, expectations about a switch to gas, at least in the short term, are a source of anxiety in Japan. The main gas suppliers to Northeast Asia are Southeast Asia, the Middle East and Russia — nothing comes from the Pacific. There are also expectations that two major suppliers — Malaysia and Indonesia — will switch to net imports. Consequently, obtaining more gas without paying a higher price is not going to be so straightforward. And there is also the possibility of having to deal with a smaller number of suppliers.

The scope for growth in trans-Pacific gas trade was addressed in a report for the Pacific Economic Cooperation Council (PECC). The scope to shift toward gas is driven firstly by the reassessment of natural gas reserves in North America. If shale gas deposits are included, the North American share of world reserves could rise from 5 per cent to around 36 per cent. Further, there is a big price gap between the East Asian and North American markets, which have been segmented. Before Fukushima, this gap — based on indicators in both markets — was around US$6.40/MMBtu, but it is now about US$12.50/MMBtu. These margins are attractive to both US and Canadian producers, although Canada has a considerable location advantage. But the US could then focus its resources on replacing the need for such imports, including those from Canada.

There are stumbling blocks to this scenario, and the PECC report points to these. One is the capacity of gas terminals in North America, particularly those in Canada. There may also be local community resistance on the grounds of environmental impact, although Canada has an advantage in that its terminals will be in relatively isolated areas. Another issue is the use of the fracking process in the gas’ recovery and the subsequent reaction of communities in North America. Resistance to investment in export-related projects by the present buyers of natural gas in North America, who fear the impact on domestic prices, is a third issue.

Another implication is the growth in investment by Asian economies in North American gas projects. The PECC report provides some examples, referring to China, South Korea and India partaking in gas projects, which add up to nearly US$14 billion. Investors in other current export countries like Indonesia and Australia might think about how to get a return on their expertise in exporting LNG, one way or another. And finally, a thicker market in gas might lead to a change in the pricing mechanisms for natural gas, which is now mainly traded under long-term contracts. An alternative could be the greater use of spot markets that complement structures for managing risk.

The reassessment of global gas supplies creates new opportunities for trade, but does not diminish the role of regional cooperation. The trade, infrastructure, finance and investment components of the response are all talking points in the short term, and even if the US picks this up in its role as APEC chair, the incoming Chair (Russia) will most likely give the topic even further attention. There is one more thing to consider: relative prices will move against Australia — despite the regional growth in energy demand — because of the long-term supply response. This said, Australia could ultimately maintain its volumes, but at lower prices — even in the face of North American competition.

Professor Christopher Findlay is Executive Dean of the Faculty of the Professions at the University of Adelaide.

1. Fukushima’s implications for Korea’s nuclear dilemmas
2. Happy days ahead? Policy implications of the global recovery for India
3. The new DPJ government in Japan: Implications for law reform

Authors: Jane Drake-Brockman, Trade and Environment Solutions, Hong Kong and Christopher Findlay, University of Adelaide

The GATS’ contribution to services reform is ‘negligible.’ This is the assessment by Joe Francois and Bernard Hoekman in a recent paper (‘Services Trade and Policy’, Journal of Economic Literature, September 2010, XLVIII (3)) where they argue most services reform has been unilateral.

Regional agreements appear to have wider coverage than the GATS but their contribution with respect to actual policy change and implementation is difficult to assess. Other research stresses the importance of studying not only sectoral commitments in regional agreements but also the offsetting ‘horizontal’ restrictions.

The lack of progress on making international commitments is a problem for policy makers who want that process to offer support for their domestic programs. It looks like they’ll be waiting ‘till the cows come home’. But it’s also a problem for the WTO because services are not offering much grunt there either.

How to get out of this vicious circle? The answer is to think in different ways about what services offers the WTO and vice-versa. It’s not about disassociating services from the WTO, but it is about cutting the link with the single undertaking in the WTO.

But first, what is the problem? Why are there so few commitments?

The politics of services reform differs from that of goods. Additional foreign market access is not required as part of a big political bargain to offset the local resistance to reform in services. Services are largely about FDI. When barriers are removed, local activity (when that mode does matter) can actually increase, not decrease as in tariff reform.

Furthermore, the demand for services reform is in many cases led by service sector businesses themselves, who have identified unnecessary regulation or rules that are high-cost relative to their benefits. These businesses are seeking better policy to remove impediments to their competitiveness.

Other reasons for the lack of commitments apply to FTAs. It’s hard to define origin in a way that supports discrimination. Market failures are not linked to the origins of services. Regulatory practice, if there is a problem of information for example, should apply uniformly to domestic and foreign providers. Offering special conditions for particular foreign suppliers could risk being stuck with a high cost provider.

Barriers to services transactions can be ‘at the border,’ such as whether offshore providers can enter and the terms on which they can set up. But often more important are regulations that affect operations, and these apply equally to domestic firms; that is, they restrict the entry of all firms into a market and raise the costs of their operation.

Reform means identifying the problem that a regulation is supposed to solve and replacing that regulation with a more efficient measure. Well­-designed domestic institutions can lead this process.

In that case, let them do so and remove services from the single undertaking in the WTO. This would shift the focus of international cooperation to transparency and to capacity building to support that institutional reform.

Can the WTO still help services reform? It can agree on and promote the key principles for services reform, document current and actual policy and bind it, accept reports and schedules of reform in services in the WTO process and submit to the trade policy review mechanisms (or even the dispute settlement process) members’ concerns about the manner of implementation of reforms in a particular country. The WTO can also promote international disciplines in yet unchartered services waters — eg. subsidies and domestic regulation — in ways that go beyond transparency to include discussion of what is ‘necessary’ and ‘least trade restrictive.’

Can services reform help the WTO? Critics of breaking the link are concerned that there is less ‘on the table,’ which complicates bargaining for agriculture and manufacturing. But services negotiations are not ‘calling the cows’ as it is. Better to encourage economies to get on with their own reforms, make policy transparent and cut costs of services inputs for other traded sectors where the adjustments are going to be significant following the conclusion of the Round. Use services reform, in other words, to cut the political cost of goods reform.

Jane Drake-Brockman is Principal Consultant, JDB Solutions, Hong Kong and a Director of the Australian Services Roundtable

Christopher Findlay is Professor of Economics and Head of School at the University of Adelaide and a member of Australia’s Pacific Economic Cooperation Committee.

1. Services negotiations in the WTO are stuck: What is the circuit breaker?
2. Trade policy needs to go global
3. APEC and structural reform

Japanese politicians are still debating whether Japan should join the Trans-Pacific Partnership (TPP). TPP members are not allowed exclusions. Agriculture is the issue, specifically the domestic political constraints imposed by protection of that sector in Japan. At the same time, the business sector is pushing hard to join.

The TPP builds on the Trans-Pacific Strategic Economic Partnership Agreement which Brunei Darussalam, Chile, New Zealand and Singapore set up in 2006. The TPP negotiating group now includes those four plus Australia, the US, Peru, Vietnam and Malaysia. The Japanese debate brought the TPP back to the headlines and highlighted the questions about the value of the preferential route to trade and domestic reform.

A number of factors have contributed to Japan’s interest in the TPP. A tactical interest in the short term is to respond to political issues in its various bilateral relationships. A commitment to a structure which includes the US might act to offset the consequences of other developments in the bilateral relationships with both China and the US. Joining the TPP may also give Japan more economic leverage in its dealing with the EU, and protect it from discrimination if a US deal eventually comes off with Korea.

But with Japan in the chair, there were also questions about APEC’s relationship to this very different binding and formal structure, and about the ability of TPP to deliver genuine integration across the region.

What does the TPP offer? Generally the average tariffs are low among the founders. They have, in some cases, made big changes over the years, in line with APEC’s path to the Bogor goals. Vietnam is still working to get its tariffs down (they averaged 16.8 per cent in 2007), but it is in the process of implementing WTO accession commitments. There are relatively high tariffs in Peru (6.1 per cent) and Malaysia (8.8 per cent) in 2008, according to StatsAPEC.

The challenge for the TPP is that the process of most-favoured-nation (MFN) tariff cuts has reduced the interest of business in participating, at least in the tariff aspect of preferential agreements if, on average at least, the margin of preference is not big. So the TPP may not offer so much on tariffs, especially when a number of members already have their own bilaterals.

Apart from the strategic questions noted above, there are two other issues.

One is that, as the agriculture debate in Japan indicates, there are still some sectors where in a preferential agreement such as TPP, the margins of preference can be big enough to create an expectation of some gain to exporters in trading partners. But then the question is whether the dynamics of negotiating the TPP would contribute to wider integration or rather drive the region apart with systematic exclusion of non-members, including potentially China.

A small new group in an arrangement like this has the incentive to join up new members, especially in the early stages where the market expansion exceeds the effect on competition from those new members. But over time, the competition effect becomes more important. The group may not be resilient enough to take on new members. Its constitution at foundation and the rules on access then become critical. The earlier P4 agreement does refer to the interest in taking in new members but allows for the differential treatment of new members.

New members, if the TPP is to be a building block for regional integration and not another noodle in a crowded bowl of other agreements, must be able to join on the same terms as the foundation members. It would be even better if all potential members could review the rules even if they do not plan to join right away.

The incentives will be strong for the foundation group to, first, close off accession until they get an agreement then, second, negotiate with new members one by one rather than have open entry on the basis of accession on the same rules. They may also differentiate among each other and new members, by making exceptions in respect of the way they are treated, for example.

This outcome is most likely because of the constraint on US negotiators to have approval by Congress in order to deal with new members. This approval rests on arguments for the negotiation, such as the creation of ‘high quality jobs’. This is clear in the letter from USTR Ron Kirk to the Speaker of the House of Representatives advising of his intention to include Malaysia in the negotiations.

So while margins of preference in some sectors might be a driver of interest for a small group of first movers, it is a dangerous dead-end in terms of wider regional integration.

A second issue is that the TPP agenda is meant to include items behind the border as well as those at the border. Regulatory coherence and connectivity for example are talking points. These are important and offer significant welfare gains across the region. They offer to cut costs in supply chains which have become relatively more important as tariffs have fallen.

It might make sense to get going on work on with these issues in a smaller group setting but generally their implementation is not sensibly done in a discriminatory manner. It will be costly to distinguish between trading partners in their application. At the same time, when implementation is not discriminatory, both members and non-members will get benefits in the markets of trading partners. This also means these commitments on domestic reforms won’t provide a driver for widening membership and therefore won’t help resolve the problem of the dynamics of membership just described, because others can free ride on the implementation.

Why then is progress with regulatory and other domestic reform bundled up in the preferential agreement?

More important than reforms behind the border in trading partners are the domestic gains from national reform, and the adjustment of domestic regulatory processes and benchmarking them against the practice in other economies. These domestic reforms create not only gainers and but also losers who might resist change. International commitments might help, in that context, to sustain the domestic reform program. The question is whether a preferential agreement is the best way to deliver those commitments. While the strategy is understandable in terms of negotiating traditions, particularly in the United States, it’s messy and it carries significant ‘baggage’. As illustrated by reference to the US negotiating authority, market access is seen to matter in this negotiating environment. Nor is it clear that support for its own domestic reform is a major US motivation, though it welcomes that progress in other members.

For these reasons, the TPP is not by itself and in the end likely to contribute to wider regional integration. If it is to make any contribution there has to be some ‘higher power’ which maintains the momentum and widens the participation.

There are a couple of ways of finding that momentum. The WTO offers a venue in which the issues related to border barriers might be resolved, since multilateralising the small group commitments is the best way forward. But potential TPP members still have to get to the table in the WTO with offers in their hands. Even more important then is to keep focusing on the end goal and the purpose of reform.

This is where APEC continues to make its great contribution. The Bogor vision remains relevant — and how it is set forth including a statement of the value of the reform agenda behind the border plus a clear set of expectations of how the members’ preferential agreements could and should evolve.

Japan, the chair of APEC Summit completed this weekend, was in a position to provide leadership on this question. Its efforts in APEC could still well be vital to whether or not its own TPP strategy simply further muddies the water on regional integration.

Christopher Findlay is Professor of Economics and Head of School at the University of Adelaide and a member of Australia’s Pacific Economic Cooperation Committee.

1. Three reasons why Japan should join the TPP
2. Are there real dangers in the Trans Pacific Partnership idea?
3. Deflated hopes for Japan joining the TPP negotiations

The big news in Japan this week has been the opening of another runway at Haneda, and the use of that downtown airport for international flights, and a brand new international terminal.

The estimate is that there will be an extra 110,000 landing slots a year from the new runway and 60,000 will be used for international flights. This is planned to increase at a later date to 90,000.

This is a big change in the structure of the delivery of air transport services in Japan, not only adding capacity but also connectivity to other cities in Japan.

At the same time, Narita is adding extra flights from 220,000 a year to 300,000 (through new options made possible by lengthening a runway) and also eventually including more domestic connections in those extra flights.

The hope is that this will contribute to tourism growth in Japan and cut transport costs (including time costs) for people and freight. Both changes are contributors to growth.

The advocates of structural reform might be much heartened by these developments, but these events also raise more questions and they highlight some of the challenges of reform.

One of the drivers has been to compete with Korea, which had been channeling travelers to regional cities in Japan. This was facilitated by a more open arrangement to regional centres between Korea and Japan.  So better connectivity between international and domestic flights (and avoiding the bus trip from Narita to Haneda) is part of the response.

A second driver is to make more space for the low cost carriers. Japan has so far missed out on the low cost carrier boom. Its air transport traffic has stagnated.

A third is to help Japanese carriers design better networks and become more efficient and therefore more competitive. They compete with US and EU carriers who have much more flexibility in their homes (and across the Atlantic as well). And Japan has just finished a negotiation on a new open skies agreement with the US, which will signed on 25/10.

But questions remain.

First, there is a problem that regulatory process is being used to limit access to the new capacity. Flights to the US and Europe are currently constrained to take off between 10 p.m. and 7 a.m. Officials in Japan say this is because of the lack of capacity. This leads to arrivals in the middle of the night, which airlines describe as ‘not ideal’.

Second, structural reform is sometimes assumed to mean privatisation or a degree of privatisations, and that has happened in airports.

But more important is competition, which has not happened. In fact, landing fee revenue is pooled and then distribution across regional airports to cover their costs, and their scale and number has increased in response to domestic political pressure.

IATA estimates landing fees in Japan are 2-3 times higher than say Singapore or Incheon. And the Wall Street Journal reports that it costs about 770,000 yen, or about $9,400, to land a Boeing 747-400 at Narita, compared with 70,000 yen at Heathrow.

This is the next frontier for reform in this activity. Having built the capacity, there is certainly scope for a competitive market in airport services, and a boom in international LCC travel (supported by the train network). Of course, that can run in both directions, so outbound travel might also rise.

So forces from the international markets can trigger reform, but domestic political interest can still constrain its outcome or slow down its progress.

Proponents of structural reform are often brilliant at coming up with the list of things that should be done.  Implementation is another question. Those who argue for structural reform are naïve if they don’t provide along with their action lists some sense of strategy, of what will drive reform and how to deal with private interests who oppose it. 

Vital is to have a clear understanding of the endpoint of the reform process and the gains it offers. This means provide a clear view of the benchmark and therefore of the costs of the halfway house and the likely benefits of hitting the target. These data can be used to mobilise the countervailing interest groups at home. There also has to an institutional set-up in which the debate can be managed and then resolved.

Sharing experience on these matters is also useful and that is exactly where APEC can be a great help. 

Bring on the meetings in Yokohama, but the suggestion here is to include a field trip to Haneda.

Christopher Findlay is Professor of Economics and Head of School at the University of Adelaide.

1. APEC and structural reform
2. Indonesia’s structural reform: Putting words into action
3. The Japanese economy: Tackling structural problems

Managing the global recovery and the transmission of shocks that might accompany economic integration continues to be a talking point around the region. An example is the recent conference in Korea organised by the IMF.

These meetings generally conclude with statements that everything matters and statements such as ‘actions in multi-country frameworks can be used to complement strengthening measures adopted at the individual economy level’.

But what are the priorities? The best way to answer this question is to look at the data. In work for a recent ERIA project, research was conducted to check where shocks come from. Are financial markets the villains? Does financial integration promote the synchronicity of business cycles in economies in the region?

This relationship could actually work in either direction. Standard international business cycle models predict that greater financial integration should lead to lower synchronicity because of the opportunities to diversify risk, while models of contagion suggest a positive relationship.

Research in the ERIA project finds that a higher level of financial integration is not associated with an increase in business cycle synchronicity. This suggests that the business risk smoothing opportunities created by integrated financial markets dominate the contagion effects. Deeper financial integration, in other words, provides a buffer between economies that are integrated in other ways.

This result is important in the current debate, where it is often feared that the downside of greater financial integration is that it can pose risks to stability. It is also consistent with new research that argues that greater integration is not the problem on its own, but when a too-rapid liberalisation of financial markets interacts, for instance, with certain distortions in the economy such as weak and lax supervisory regulations as well as problems of credibility and enforcements of contracts, these distortions are magnified and financial instability problems arise.

Shocks to economies remain, of course, and the next question is how have they been absorbed? Research in the ERIA project was undertaken to measure how much of the change in a country’s domestic income (an income ‘shock’) is absorbed by offsetting movements in income from abroad (income risk sharing) and how much is offset by a change in national saving. Both of these changes can protect consumption from having to adjust to short-term changes in income. For countries in the region it was found that the current level of consumption smoothing is rather low. Most of the reduction in variation in consumption compared to income (23 per cent) comes via the use of credit markets (i.e. from changes in national savings) while capital markets (i.e. access to the international financial system) account for very little (2 per cent). These results mean that a very large part of changes in GDP (75 per cent) that lead to changes in consumption is not smoothed.

Our interpretation of this research is that the benefits of financial integration are not being fully utilised. There is room for welfare gain from greater financial openness in the region. On the other hand, this research suggests that constructing new ‘top-down’ institutions, such as systems for monetary integration, are not a priority. Those institutions are very difficult to establish efficiently in the presence of the range of country differences that are also identified in this research. Instead, of more value in the immediate term is to identify the impediments to the consumption-smoothing role that integrated capital markets might play. In other words, there is greater value in further work on a ‘bottom-up’ approach to integration, including action at the national economy level but supported by regional cooperation.

Despite this skeptical finding about large-scale institution building related to financial markets at this stage of the region’s development, there remains a rich agenda for regional cooperation. Within the region, there are not only significant country differences in experiences, but also a wide range of experiences of various sorts of institutional structures in financial markets and their links with local corporate structures. There is a lot of experience to share in well-designed capacity building programs backed up by good research.

Jenny Corbett is a professor of economics at The Australian National University and executive director of the Australia-Japan Research Centre (AJRC). Christopher Findlay is head of the School of Economics at The University of Adelaide.

1. Tables turned in Japanese and US financial markets
2. Emerging markets, globalisation and social protection
3. Asian Regional Financial Arrangements and the IMF

The new Gillard government has responded to a vigorous industry campaign to revise Australia’s proposed taxation arrangements for minerals and energy projects. This followed the earlier plan under Prime Minister Rudd to introduce a tax (called the Resource Super Profits Tax) on resource rents in addition to the company income tax. In the revised plan (called the Minerals Resource Rent Tax) only coal and iron ore will be covered along with gas and oil.

In these new arrangements:

• - The headline tax rate is reduced from 40 per cent to 30 per cent and there is a 25 per cent ‘extraction allowance’ so the effective tax rate is 75 per cent of 30 per cent which is 22.5 per cent.
• - Taxes losses generated in the early years of a project can be carried forward at the government bond rate plus 7 per cent (called the uplift rate) and they can be transferred to other projects but there is no guarantee that these losses will be refunded if a project fails

The guarantee of the refund had been offered in RSPT with a lower uplift rate but that is now withdrawn – the industry, at least the big miners who led the negotiations, said they did not value this.

A criticism of the RSPT was that it would also tax the return to the assets which were specific to mining companies, for example, their skills, and drive investors offshore, and that any tax like this would reduce the incentives to work for higher productivity growth. The response had been that the tax rate had been limited to 40 per cent so that while firm-specific assets were being taxed the resource rents were also being shared. Now the tax rate has been reduced.

There has been some debate about the implications of tax changes for the assessment of Australia’s sovereign risk, especially the retrospective application of the tax to existing projects.  However the previous situation was not one of ‘no other tax’. There was already a tax regime in place for capturing resource rents and the question is whether the new arrangements are more efficient.

The existing arrangement was the royalty systems (based on volume charges) imposed by the state governments. These arrangements are less efficient than a profits-based tax because they distort decision making. But they also add to project risks.  As commodity prices rose, the royalties would be increased. Maybe this would happen with a lag but they would be expected to rise. In other words, this regime was not stable either – it involved its own sovereign risks! As commodity prices fell at some future point, it was less likely the royalties would fall. The shift to a tax based on profits would help solve this problem. The minerals sector, it is reported, saw benefit in that respect. The issue they had was the rate of tax in and other conditions of the new profit based system.

While the shift is to a profit-based system, state governments can still impose their royalties. These are credited against the MRRT. This reinforces the incentives to the states to raise royalties to the MRRT rate. Companies can also carry forward unutilised royalty credits.

How does the revenue compare? The Australian Minerals Council reports that in 2008-09 $7b was paid in royalty (about twice that of the year before). The new MRRT system is expected to raise $10b although critics doubt that amount, since the RSPT was expected to raise $12.5b and with a much lower tax rate, yet the new MRRT raises only slight less.  It will be interesting to see if the result is actually closer to neutral in terms of revenue, in which case the Federal government will be left with little once the states take out their royalties.

Small companies may have some problems with the MRRT compared to the RSPT. For example, they might face higher borrowing costs than the larger companies, higher than the ‘uplift’ rate.  They may not have so many projects on which to offset the tax losses. This diminishes the efficiency advantages of the new tax, since it then may like a royalty hold back some projects. However, there are now even stronger incentives for consolidation in the minerals sector, or for that to happen earlier than it might otherwise have done, and foreign buyers of minerals are expected to be among the investors exploring for options to do that.

This is tax policy by negotiation. There were complaints about sovereign risk associated with these changes but the real risk is not the introduction of this particular tax but the way the original proposal was redesigned in the political market place.  The political capital of Australia, that is the ability to manage efficient reform, is further eroded. The MRRT might actually be better than the royalty system, despite the issues it pose for the smaller companies, but the way it was arrived at leaves a bad legacy for future reform.

1. Taxing Australian mining: A new way of doing business
2. North Korea’s minerals sector: China’s gain, South Korea’s loss
3. India: Taxes and the social contract