On 13 March 2012, the US, the EU and Japan filed separate but coordinated complaints against China to the World Trade Organization.

China’s export controls on rare earth metals and non-rare earth metals such as tungsten and molybdenum, which have many industrial uses, are at the heart of the complaint.

China is the world’s largest exporter of rare earths, and has been regulating its supply since 2008. Since then it has introduced measures including high export taxes and, in the case of some products, has prohibited trade altogether. Earlier, in 2007, China withdrew the 16 per cent refund of value-added tax on exports of unimproved rare earths. The effect of this decision, combined with the export-tax regime, is that non-Chinese rare earth processors, such as producers of cerium polishing powder and rare earth magnets, pay 31 per cent more for rare earth raw materials than their Chinese counterparts.

A request for consultations with the Chinese government is the first step in the WTO dispute settlement process. If, as is likely, the parties to the dispute are unable to reach a resolution after 60 days of talks, the US, the EU and Japan will have the right to request that a WTO panel be established to hear the complaint. As it is very likely that the parties will not reach an agreement the process could lead to sanctions against China.

The complaints follow the WTO Appellate Body’s January ruling that by restricting the exports of nine other raw materials including zinc, coke and magnesium, Beijing was in violation of both WTO law and the country’s obligations under the Protocol on the Accession of the People’s Republic of China. The Appellate Body concluded that there was no basis for general exceptions to apply to Paragraph 11.3 of the Accession Protocol, which requires China to eliminate all  taxes and charges applied to exports. Since the ruling, China has reportedly been increasing the supply of zinc, coke and magnesium, but not of rare earths.

In the present case, the complainants claim China is placing a range of export restraints on various rare earths and non-rare earths including export duties, export quotas, export licensing, and minimum export-price requirements. The US, the EU and Japan are also challenging aspects of the allocation and administration of export quotas, export licences and minimum export prices, and the alleged non-publication of certain measures. They further contend that the Chinese measures aim to satisfy domestic demand first, and control the international price of minerals, in violation of WTO law.

The measures appear to be inconsistent with various provisions of the GATT and the Accession Protocol, among other obligations. The most important provision on export restrictions is Article XI of the GATT, which prohibits quantitative restrictions. But export duties are not, in principle, prohibited under this article. Regarding quantitative restrictions, which are generally prohibited, the issue is whether China’s measures fit into a relevant GATT exception.

In both cases, China insists that its export restrictions fit within a legal exception to WTO rules, because its measures aim to protect the environment. In the January ruling, the WTO decided that price and quantity controls primarily targeting foreign entities were not a reasonable implementation of a conservation policy. China’s argument is unlikely to be more successful this time around. Article XX of the GATT, which lays out general exceptions to WTO law, allows trade restricting measures for the purpose of environmental conservation, but only if such measures apply in conjunction with restraints on domestic production or consumption. China has not placed restrictions on these activities domestically, and its argument is further weakened by the fact that regulating production — not trade — is the best option for the purposes of conservation and environmental protection.

China has already started negotiating with its counterparts. In particular, it has been advocating that more US, European and Japanese companies team up with local firms on rare-earth technology ventures. Environmentally friendly projects in areas like environmental management, recycling, and research and development of high-end applications have received considerable attention in recent times, but these proposals are unlikely to resolve the problems at the core of the dispute.

Despite the significance of China’s actions, most analysts argue that the shortage of rare earths will be a temporary phenomenon, because the rising prices for rare earth elements will encourage others to enter the market, leading to increased supply. The US, for example, has 13 per cent of the world’s known rare-earth reserves, and could re-enter the production and refining business. China’s efforts to exert price leverage are unintentionally driving a revival of global rare earths production and, over time, China will likely be just one of many global suppliers. China’s efforts to monopolise the sector are bound to backfire because such high-handed measures have prompted the rest of the world to formulate alternate strategies.

At the same time, businesses and policy makers around the world alike are concerned about the increasingly restrictive and unpredictable environment of international trade in industrial raw materials. Multilateral disciplines governing export restrictions are ambiguous, which creates uncertainty for industries that require these materials and raises the risk for investment in both mining and processing facilities worldwide.

Nabeel A. Mancheri is a Postdoctoral Associate at the National Institute of Advanced Studies, Bangalore.

1. Rare earth metals export ban, a Chinese own goal
2. China’s export restrictions on rare earths
3. China and the supply chain of rare metals: Table of [dis]contents

A reform-minded status-quo power sits somewhere between rigid and anti-status quo powers.

A status-quo state accepts the existing rules of the game and does not seek to change them because it is generally satisfied with the current situation. China has benefited from the existing international system, and has risen to become the world’s second-largest economy. Logically, it would not aspire to overthrow this system within which it is rising to new heights. In this sense, China is a status-quo power. Nevertheless, China is not simply looking to rigidly adhere to this existing system.

Rather, China has been arguing that the current international order is flawed, that there are numerous unjust and unreasonable components, and that changes to the international order are long overdue. In this sense, China is a reform-minded status-quo power.

China has actively participated in the G20’s deliberations and actions, put forward its suggestions, sought to expand its share and voting power in international financial institutions — in accordance with its rising status — and promoted the internationalisation of the renminbi. So, while having accepted and observed the current rules of the game, China is seeking changes that will lead to greater institutional power and better global governance. This aspiration became stronger when it appeared that China had fallen into the ‘dollar pitfall’, where it had been ‘abducted’ by its large reservoir of US treasury bonds. The value of these bonds is determined by US domestic policy decisions, and when the dollar devalues, China’s dollar assets shrink. This risk may have prompted Beijing’s desire for a new international reserve currency that is independent of a particular nation’s policies.

China’s approach is reformist rather than revolutionary. In this regard, there are two main features of China’s reformist stance. One is incrementalism, where China is patient and attempts to bring about changes gradually over a fairly long period. The other is consensus-based reform. China is prepared to seek consensus in multilateral settings, working with other actors and partaking in global economic governance. After all, governance is a collective endeavour.

Crisis usually drives change, as seen with the G20’s transformation following the 2008 global financial crisis. The G20 is now being elevated to the summit level, and its rise to prominence is a product of its role during the global financial crisis, when the G8 was unable to fight the crisis alone. Against this backdrop, countries had to collectively combat the crisis. And with the rise of the developing powers, countries must also collectively tackle the challenges of reform.

On the issue of UN Security Council reform, China can largely be seen as a rigid ‘status-quo seeker’. As one of the permanent five members — which possess veto power and thus have a vested interest in maintaining the current order — China is more rigid and reluctant to expand veto power to other nations. This is similar to other permanent members, especially the US and Russia. China’s rigid position is also reinforced by Japan’s ambition for a permanent seat and Sino–Japanese rivalry.

We should not lose sight of the fact that China has espoused the necessary changes for a ‘new international political and economic order’. When that sounded too revisionist — and being aware that China is a benefactor of the existing order — Beijing opted for a more moderate rhetoric: pushing the international order to become more just and reasonable. China wants to avoid being seen as an anti-status quo power and wants to demonstrate a realistic attitude. In the meantime, China has its own ideals and desires for a better world. For example, it would like to see a more even distribution of power between established and emerging powers, better treatment of the less developed countries and fairer representation of countries with various levels of development. China generally supports constructive reforms while accepting the existing rules, and wants to further integrate itself with the world. China’s role and participation within the G20 demonstrates this well.

Ren Xiao is Professor at the Institute of International Studies and Director at the Centre for Chinese Foreign Policy Studies, Fudan University.

This article is based on the author’s working paper titled, ‘A Reform-Minded Status Quo Power? China, the G20, and Changes in the International Monetary System’, available here.

1. Reform in China: Experience with economic system reform
2. China takes on the mantle of a great power
3. China: little to no political reform

With Aung San Suu Kyi now in parliament and Myanmar’s ongoing reform, it is time for Australia to increase the pace and level of engagement with this long-isolated state.

Numerous institutions within Myanmar require assistance to build capacity and implement reform (education is one key shortfall), but the military in particular must become the subject of increased and well-considered engagement. It is in Australia’s interest to see Myanmar continue to undertake economic and political reforms, and engaging the military is crucial in this process. The challenge is to engage in such a way as to avoid frightening the authorities into rejecting such overtures — and there are three underlying concerns that Australia must keep in mind when considering how to approach Myanmar.

First, the authorities’ deep-set concerns about foreign intervention have historical roots in the British, Chinese and Japanese invasions of the 19th and 20th centuries. As these invasions are still relatively fresh in the minds of the ruling elites, any planned engagement must be geared toward disarming this fear.

Second, the authorities have a gnawing fear about the potential balkanisation of the country — and there is a plethora of insurgent groups that would happily exploit any apparent fragmentation of the state. Engagement needs to be approached in such a way as to minimise concerns that reform initiatives may weaken the state and lead to greater levels of armed conflict.

Third, the country has a track record of fierce xenophobia. Nearly two million Indians were forcibly expelled in the 1950s as Myanmar retreated into its isolationist shell, despite the fact that the Indian population made a huge and largely positive contribution to the local economy. The state has also long shown a disregard for the many other ethnic groups including the Karen, Kachin, the Wa, the Shan, the Mon and Rohingya.

In light of these three concerns, any engagement has to be modest and discrete, rather than overbearing. Engagement requires cultural sensitivity, and Australian efforts need to be respectful of Myanmar’s history, culture and religious heritage. Having weighed up the issues at stake and the urgency of the tasks at hand, Australia should seize the moment. Competing vested interests within the country’s military (the Tatmadaw) and the government may yet unravel many of the reforms currently being implemented. Australia should declare its hand in support of reform, and offer its moral and practical support accordingly.

It is important to keep in mind that the Tatmadaw remains the most powerful and significant institution in the country; understanding its world view is important if engagement and reform are to gain any traction and longevity. The Tatmadaw-controlled constitutional process has ensured that no matter how much democracy is introduced, the military still remains the country’s back-stop.

The military will continue to play a pivotal role in determining Myanmar’s fate and remains central to any plan that aims to resolve ongoing conflicts with various separatist groups. The Tatmadaw is considered opaque, but little has been done to try and understand what they are thinking or why, as virtually no one seeks to engage them directly.

Arguably, then, the central institution requiring reform is the Tatmadaw. But to encourage reform requires deft handling and innovative thinking about how to proceed. Part of the issue is that many in the Tatmadaw simply do not know what the modern norms of acceptable military behaviour are. And Australia can only fully appreciate what the issues are by taking the risk of engaging with the military directly.

Herein lies the problem: while the Australian embassy in Yangon is staffed by excellent and dedicated people, none of them has military experience and they have few meaningful connections with the Tatmadaw. This is in part because the latter has a preference for speaking with those it sees as more like-minded — that is, others in uniform. Australia does have a part-time defence attaché assigned to the country, but the representative resides in Bangkok and must deal with competing priorities.

If Australia is to focus its efforts on Myanmar accurately and efficiently, then permanent military representation is needed in the country. Beyond that, Australia could offer the ‘law and leadership’ training program offered to (and warmly received by) other ASEAN armed forces. Short reciprocal information-exchange visits between defence academies could also be a first step toward deeper engagement. Australia should also start exploring — perhaps in conjunction with other ASEAN states — how it could offer a ‘good offices’ arrangement to help find a peace settlement between the state and warring ethnic groups such as the Kachin.

Some may say this is too hard or too risky. But with risk comes opportunity. Something needs to happen to halt the strife between Myanmar’s ethnic groups and the central government. Democratic reform will remain constrained until this vexed issue is addressed holistically. Now is the time for Australia to think outside the box and offer to engage with an open hand and a genuine desire to help find a way out of an otherwise apparently intractable situation.

John Blaxland is Senior Fellow at the Strategic and Defence Studies Centre, College of Asia and the Pacific, the Australian National University.

1. Détente and the Myanmar spring?
2. Why democracy will foster ethnic reconciliation in Myanmar
3. Toward real national reconciliation in Myanmar?

The Chiang Mai Initiative (CMI) is a regional foreign exchange liquidity support mechanism that developed as a result of the 1997–98 Asian financial crisis.

The CMI was designed to be closely linked to the IMF, and later evolved into a multilateralised mechanism, the Chiang Mai Initiative Multilateralisation (CMIM). A regional surveillance unit, the ASEAN+3 Macroeconomic Research Office (AMRO), supports the CMIM. But AMRO is still in its infancy, and will need time to increase its effectiveness and gain market confidence.

The CMIM is a self-managed reserve pooling mechanism of the ASEAN+3 economies, with a total size of US$120 billion. It provides a short-term (90 days) swap facility to economies in need, which may be rolled over a maximum of seven times (as of April 2012). Each economy’s swap quota depends on its contribution to the CMIM pool and its level of development and size. As with the CMI, using more than 20 per cent of a country’s swap quota requires a link to an IMF program. Voting weights for various countries have also been specified. A consensus is required for fundamental issues like membership, contributions and voting weights. And for a swap to be implemeted, a two-thirds weighted majority vote is required.

The CMIM still has many shortcomings and needs to be further developed to improve its effectiveness. First, the IMF link needs to be modified. The traumatic experience of IMF conditionality during the 1997–98 Asian financial crisis left a stigma on the IMF for most countries in East Asia. Because of this, when countries ran into foreign exchange liquidity shortages during the global financial crisis, they preferred to use bilateral swap agreements that had no IMF links rather than go through the CMI or the IMF. It is possible to develop the CMIM as a crisis prevention facility to deal with temporary liquidity shortages without linking to the IMF. When a country faces large temporary capital outflows, it does not make sense to impose IMF-like conditionality on the country; the CMIM’s 90-day swap should be available for the full quota without any links to the IMF. But if the country continues to need to roll over the swap, then the problem is more likely a medium-term macroeconomic structural problem rather than a temporary one. In such cases, it makes sense to link future rollovers to an IMF program. This arrangement would make countries more willing to access the CMIM swap and would also make the CMIM complementary to the IMF.

Second, the size of a country’s swap quota may not be adequate. One way to improve this is to double or triple the size of the CMIM. As the CMIM is a self-managed reserve pooling mechanism, economies do not place their contributions into a common pool. Rather, the reserves remain with the various economies, and a country’s contribution is only used if there is a swap drawing. So the actual cost of increasing the size of the CMIM’s reserve pool would not be that great. Another way to increase potential quotas available to countries would be to allow the addition of bilateral swaps from member countries linked to a CMIM swap. This would be similar to countries contributing to an IMF package.

Allowing the addition of bilateral swaps could also be used as a way to expand the number of countries involved in the CMIM process. Expanding the number of countries contributing to the CMIM pool would not be easy, as it would involve changes in voting weights and require a consensus among the current members. But countries such as Australia, New Zealand and India could be made ‘contributing partners’, where they can contribute their bilateral swaps to CMIM swaps. As contributing partners, they would also be allowed to participate in various financial cooperation activities under the CMIM umbrella, such as surveillance and initiatives to support deeper financial cooperation in the East Asian region.

Finally, for the CMIM to be effective, it is essential that AMRO becomes stronger and more capable. Building up AMRO’s capability and credibility is now the biggest challenge for increasing the CMIM’s effectiveness. AMRO needs to develop close links with other regional organisations, such as the Asian Development Bank and the ASEAN Secretariat. It should also have close links with international financial institutions, such as the IMF, the World Bank, the Bank for International Settlements and other monetary organisations around the world. In the longer term, AMRO should not simply act as a research office; it should evolve into a regional monetary organisation for East Asia, supporting the CMIM as well as carrying out technical activities to support financial cooperation in the region. This may include macroeconomic policy cooperation and coordination, a focus on regional financial regulatory frameworks and capital market development, as well as working to support the region’s longer-term financial and monetary integration.

Chalongphob Sussangkarn is a distinguished fellow at the Thailand Development Research Institute.

1. Affordable delays for the Chiang Mai Initiative?
2. The Chiang Mai Initiative: China, Japan and financial regionalism
3. Are the Philippines equal before the Chiang Mai Initiative?

South Korean voters find themselves in the midst of a busy political year.

The parliamentary election, which took place on 11 April, saw the governing Saenuri Party retain power. But attention is now turning toward the upcoming presidential election in December.

The Saenuri Party, which controlled 60 per cent of seats before the election, managed just to keep its majority in the national assembly by winning 152 of the parliament’s 300 seats. The party had feared a crushing defeat because President Lee Myung-bak’s approval rating remains low at around 20 per cent and successive bribery scandals have also damaged the party’s reputation.

But after leading the Saenuri Party to a surprising victory in the parliamentary elections, the party’s leader, Geun-hye Park, now stands a good chance of becoming South Korea’s next president. It would make her the first democratically elected female president in South Korea, an economically vibrant but largely male-dominated society. Park’s new platform of robust welfare-oriented policies helped to move the traditionally conservative party slightly to the left. This new focus was an appeal to voters otherwise fed up with the nation’s jobless recovery following the global financial crisis.

The presence of a clear presidential front runner and a centre-right vision for the country’s future seems to have helped the Saenuri Party win more seats than the opposition in South Chungcheong and Gangwon provinces, where the opposition had been successful in the last parliamentary and local elections.

Following the 2008 national assembly elections, a new version of regionalism seemed to have emerged throughout the country. The new regionalism contrasts voter behaviour between Seoul and other metropolitan areas with the less-urbanised areas. On the other hand, the old regionalism highlighted the parties’ regional strongholds. The result of the April 2012 election surprised many because it seems to suggest that the old version of regionalism has reappeared, with both the Saenuri Party and the Democratic United Party taking almost all the seats in their respective strongholds.

The degree of influence that social media exerted on voting behaviour also seems to be divided between cities and non-cities. Statistics show that around 60 per cent of people who use these services live in Seoul and other metropolitan areas and they are predominantly younger voters, often with liberal leanings. This indicates that South Korea’s metropolitan areas should have been ripe for the opposition parties to take advantage of strong anti-government sentiment. While the opposition parties did gain 62 per cent of seats allocated to these regions, it was not enough for them to take full control of the national assembly. Seoul and other metropolitan areas hold 46 per cent of the 246 seats allocated to local districts across the country, but the opposition parties won only 4 seats of the 67 allocated to the southeastern Youngnam regions. The Saenuri Party, on the other hand, swept up the other 63 seats in this area, which represents 50 per cent of the seats the party acquired in the local districts.

The liberal opposition Democratic United Party secured 127 seats; its coalition partner, the left-leaning United Progressive Party, won 13 seats. The election results were particularly disappointing for the opposition coalition, which sought to win a comfortable majority in the national assembly. The governing party already suffered a setback in local elections two years ago, and again in the 2011 by-election for Seoul’s mayor. Furthermore, the April election was largely regarded as a referendum on President Lee Myung-bak and the governing party. The opposition parties expected to ride a liberal, anti-government wave to victory in the parliamentary elections, yet their failure to do so turned the result into an unwelcome surprise. One of the main explanations for the defeat is the opposition’s perceived lack of vision for the future. Many South Koreans believe the opposition relied on the president’s low approval rating to win them votes, without developing their own policy alternatives.

Voter turnout for the parliamentary election was 54.3 per cent — an 8.2 percentage point increase on the 2008 election, which had the lowest turnout for national assembly elections since democratisation in 1988. Many academics are paying special attention to South Korea’s voting patterns this year to determine how the traditional cleavage structures of regionalism change across generational, class and ideology lines. Looking forward to the presidential election in December, we may get some further clues about the possible realignment of the relationship between parties and their traditional regional support base.

Myoung-ho Park is Associate Professor at the Department of Political Science, Dongguk University, Seoul.

1. South Korea’s 2012 national assembly elections
2. Korea inter pares? – South Korea on the global stage
3. Singapore facing a watershed election

Indonesia’s new mining regulation requiring divestment of majority foreign investments is unlikely to generate many formal investor-state arbitration (ISA) claims against Indonesia, based on existing bilateral or regional FTAs, or investment treaties.

Avoidance of arbitration is primarily motivated by immediate pragmatic considerations. But considerable scope remains to use the international investment law framework further down the track and this may lead to complex adverse effects on cross-border investment, particularly in the rapidly evolving Asia Pacific region.

A conciliatory attitude toward the new regulation is still likely where the investor’s home state desperately lacks natural resources, such as Japan. This is one explanation for the lack of (direct) ISA claims by Japanese investors, despite Japan’s growing number of investment treaties around the world. These include the investment chapter contained within the 2006 Japan–Indonesia Economic Partnership Agreement, with its heavy focus on enhancing Japan’s energy security.

But Indonesia’s new regulation could still lead to formal ISA claims, or — more likely — it could frame renegotiations with foreign investors and possibly their home states, which may well be covered by investment treaty protections. Indonesia has reportedly only been subject to three ISA proceedings under the 1965 International Centre for Settlement of Investment Disputes (ICSID) Convention, to which Australia, Japan and the UK are also party. But a British mining company (Churchill) has recently announced it intends to bring ICSID proceedings against Indonesia for an earlier incident involving one of the world’s largest potential coal coking reserves.

Indonesia is also taking very seriously a highly politicised claim filed last year by a large UK-based investor in the financially troubled Bank Century. Rafat Ali Rizvi is alleging unfair treatment by the Indonesia authorities, including the judicial system, and expropriation after the Deposit Insurance Agency forced the bank into administration in 2008. On 4 April 2012 the tribunal (chaired by a former Solicitor-General of Australia) reportedly rejected Indonesia’s application, under ICSID Rule 41(5), for the claim to be dismissed on an expedited basis as manifestly without legal merit. A key issue — whether the claimant’s investment was properly ‘granted admission’ under the Indonesia–UK bilateral investment agreement — was found to be too complex to resolve under this preliminary procedure. Nonetheless, the arbitrators are likely to re-examine this jurisdictional objection at a later stage of proceedings.

Many investment treaties concluded by Indonesia, as well as several other ASEAN states, contain provisions requiring investments to have been ‘admitted’ in specified ways. For Australian investors potentially affected by mining investment divestment regulations and considering investment treaties with Indonesia, for example, the 1993 treaty between the two countries defines an ‘investment’ to be one ‘admitted by [Indonesia] in its territory in conformity with the laws, regulations and investment policies of [Indonesia] applicable from time to time’. It applies to investments ‘granted admission in accordance with the Law No. 1 of 1967 concerning Foreign Investment or with any law amending or replacing it’. (Indonesia’s current Foreign Investment Law is Law 25 of 2007.) The 2010 ASEAN–Australia–New Zealand Free Trade Area agreement (AANZFTA) defines a ‘covered investment’ somewhat differently: one ‘admitted by the host party, subject to its relevant laws, regulations and policies’.

Such provisions may create difficulties for foreign investors considering treaty claims against Indonesia. Post-Soeharto democratisation and decentralisation have generated an extraordinarily complex set of laws and policies affecting the admission and operation of foreign investments. But if such preliminary hurdles can be overcome, Australian investors seeking compensation or a better negotiating position might argue that the new Indonesian regulations breach the following substantive protections under international treaty law.

First, one avenue may be through AANZFTA, which, for covered investments, provides ‘national treatment’, namely ‘treatment no less favourable than that [which the host state] accords, in like circumstances, to its own investors and their investments’. But footnote 33 makes this commitment subject to a Work Program, with national treatment obligations only coming into effect along with schedules of reservations permitted under Article 12 of the agreement. Australia’s 1993 investment treaty with Indonesia does not provide for national treatment, but it does include ‘most favoured nation’ provisions, allowing Australian investors to claim the benefit of protections extended by Indonesia to third countries.

Second, foreign investors might claim compensation for ‘expropriation’ or its equivalent arising from the host state’s measures. This option is provided in both the 1993 investment treaty and AANZFTA.

Third, the host state commits to extending ‘fair and equitable treatment’ to Australian investors under both the 1993 treaty and AANZFTA. Both treaties also extend other protections, which Indonesia’s new regulations may well violate, such as a requirement for the ‘transparency of laws’. Some provisions may impact on future measures as well, such as proposed restrictions on foreigners holding key management positions in human resources departments.

Lastly, while the 1993 treaty only allows Australian investors to commence ICSID arbitration, AANZFTA adds several options designed for ad hoc proceedings. The former usually provides for greater transparency in proceedings, but AANZFTA allows the host state, for example, to make public all awards and decisions rendered by a tribunal. This is important for host states, given the greater public interests involved in ISA compared to inter-firm commercial arbitration.

The international law regime does not and cannot solve all disputes, even with the increasingly sophisticated drafting of investment treaties. Widely accepted legal interpretations are still evolving and ISA disputes tend to become quite fact-intensive, generating costs and delays. But international law provides additional mutually agreed understandings aimed at balancing a host state’s interest in maintaining appropriate regulatory discretion while attracting foreign investment, with the reasonable predictability foreign investors expect — particularly in the resources sector. The ISA mechanism is important in giving traction to substantive rights. Recent developments in Indonesia therefore provide another reason to reconsider the eschewal of ISA in all of Australia’s future treaties, a change in direction announced by the Gillard Government’s Trade Policy Statement in April 2011.

Simon Butt is Senior Lecturer at the Sydney Law School and acting Director of the Centre for Asian and Pacific Law at the University of Sydney (CAPLUS).

Luke Nottage is a Professor and Associate Dean at the Sydney Law School, University of Sydney, and founding co-director of the Australian Network for Japanese Law (ANJeL).

Brett Williams is Senior Lecturer at the Sydney Law School, and Public International Economic Law Program coordinator at the Sydney Centre for International Law.

A longer version of this article, including hyperlinks to further sources, is available here on the Japanese Law and the Asia-Pacific blog. The article draws on research for Luke Nottage’s project with Micah Burch and Brett Williams, ‘Fostering a Common Culture in Cross-Border Dispute Resolution: Australia, Japan and the Asia-Pacific’, supported by the Commonwealth through the Australia-Japan Foundation, which is part of the Department of Foreign Affairs and Trade.

1. Implications of tax treaty arbitration for an Asia Pacific community
2. What future for investor-state arbitration provisions in Asia Pacific treaties?
3. Time for a US-India investment treaty

Indonesia will be the tenth-largest economy in the world by the end of the decade, Nouriel Roubini reckons, and could be the sixth-largest economy by 2030.

Citi’s Research and Analysis group suggests that it will be the fourth-largest economy in the world by 2040, accounting for 4.8 per cent of global output. But these goals are unlikely to be realised unless there is an enabling environment for the necessary investment and employment opportunities in the country and the economic policy settings remain open to trade, investment and international competition.

On that, there have been mixed signals in recent months.

Indonesia’s economic fundamentals remain strong. Investment realised from abroad climbed by more than 50 per cent in 2010, with another big increase in 2011. This reflects Indonesia’s attractiveness as an investment destination, given its large market of 240 million people, rapidly expanding middle class, wealth of natural resources, and strategic location. The Fitch Ratings Agency has recently upgraded Indonesia’s long-term and local currency ratings to ‘investment grade’, a move that further boosts Indonesia’s standing among global investors. The Indonesian government has worked hard to ensure macro-economic stability. It is crucial that the government continues its reform program and strengthens its macroeconomic fundamentals. Indonesia is now building the financial and physical capital to complement its young and dynamic workforce as well. It is working to develop stronger capital markets to intermediate domestic saving and to ensure capital inflows are well used, while the government is also providing incentives to promote investment in priority sectors. To facilitate investment, Indonesia has passed a law to provide greater certainty around land access, addressed the political risks in public–private partnership infrastructure projects and enhanced the availability of long-term funding to finance long-term infrastructure projects.

Since the East Asian financial crisis in the late 1990s, FDI in the country has been on the rise. While inward investment in the period 1993–2003 was only US$1.8 billion a year, net inflows have been edging towards US$10 billion a year in recent years. The FDI Restrictiveness Index of the Organization for Economic Cooperation and Development (OECD), reveals that, among the 46 countries surveyed in 2010, Indonesia was placed in fifth position as the most restrictive country in terms of FDI behind China, Iceland, the Russian Federation and Saudi Arabia. The A.T. Kearney FDI confidence index, which involves a series of surveys of companies with annual global revenue of more than US$2 trillion and provides an assessment of the prospects of international investment flows, ranked Indonesia 21st in 2007 but the 19th-most-attractive investment destination in 2010. Although handicapped by its weak legal system and poor infrastructure, Indonesia remained a popular destination for investors in the manufacturing industry.

At the same time there are powerful forces in the Indonesian polity that push back on economic openness, atavisms from its constitutional origins and nationalist philosophical roots. These forces can be seen particularly in the resources and agricultural sectors. Indonesia, of course, is not the only country with a nativist approach to investment in these sectors — Australia has been confronting its own nativist instincts in face of the recent surge in Chinese investment — but they are institutionally and constitutionally deeply entrenched there.

In February this year, the Indonesian government issued regulations requiring majority or wholly foreign-owned companies holding mining licenses in Indonesia to divest a majority share of their assets — a minimum of 51 per cent — to an ‘Indonesian participant’ after 10 years of production. For many foreign investors, this means mandatory divestment of equity and represents a step backward in foreign-investment openness.

In this week’s lead essay Simon Butt and Luke Nottage discuss the implications of this move for Indonesia’s foreign investors in the mining sector. As Butt and Nottage point out, the divesting of foreign interests in Indonesian mining enterprises is not a new idea. The 2009 Mining Law required a divestment after five years of production, but did not specify the required amount of this divestment. A 2010 regulation required that Indonesian participants hold 20 per cent equity in foreign-owned mining operations after five years of production, but did not require further divestments. And mining companies operating in Indonesia have long had divestment obligations under ‘Contracts of Work’ with the Indonesian government. But the new regulation goes further, requiring divestment of a majority share.

There is no doubt that the new mining investment regulations significantly reduce the Indonesian mining sector’s attractiveness to foreign investors. Mining contributes 17 per cent to Indonesia’s GDP and constitutes a similar share of FDI (US$3.6 billion of US$20 billion in 2011). If Indonesia wants to increase its economic growth, then it will need to continue to attract more foreign investment, including in the mining sector. Protectionist moves are not isolated to mining — Indonesia’s central bank has recently mooted setting caps on single-shareholder stakes in the country’s commercial banks. This move could also force some foreign investors to reduce their holdings and could delay the biggest-ever acquisition in the country, by Singapore’s DBS Group Holdings Ltd to acquire PT Bank Danamon.

While the management of the macro economy has so far continued to produce relatively good outcomes, delay on the commitment to reduce fuel subsidies will have an adverse impact on the budget and send a bad signal to investor confidence on economic management.

On foreign investment, trade and the diminishing appetite for regulatory reform, the signs are that Indonesia is turning inward and backward. Roubini’s prediction is unlikely come true without invigoration of Indonesia’s reform agenda and re-commitment to open foreign economic policy strategies.

1. Divestment of foreign mining interests in Indonesia
2. New thinking about foreign policy strategy in Japan
3. Indonesia: Blessed by strong economic growth and the curse of resources

The Indonesian government issued a regulation in February 2012 requiring majority or wholly foreign-owned companies holding mining licenses in Indonesia to divest a majority share of the company — a minimum of 51 per cent — to an ‘Indonesian participant’ after 10 years of production.

For many foreign investors, this will mean a mandatory divestment of equity.

An offer to purchase the share must first be made to the central government. If the central government is not prepared to purchase the share, then it must be offered to the provincial government or city/county government. And if they also refuse, then the shares are to be offered by auction to (in order of priority) a state-owned enterprise, a regional state-owned enterprise or a national company. Failure to divest according to this schedule can lead to suspension of production and even a revocation of the mining license.

The concept of divesting foreign interests in Indonesian mining enterprises is not new. The 2009 Mining Law required a divestment after five years of production, but did not specify the required amount of this divestment. A 2010 regulation required that Indonesian participants hold 20 per cent equity in foreign-owned mining operations after five years of production, but did not require further divestments. And mining companies operating in Indonesia have long had divestment obligations under ‘Contracts of Work’ with the Indonesian government, as outlined under the 1967 Mining Law. But the new regulation goes much further by requiring divestment of a majority share.

Predictably, many mining companies argue that 10 years is insufficient for them to make an adequate return on their investment. They also complain about the uncertainty the new regulation brings. In particular, some companies operating under a Contract of Work with less onerous or no divestment provisions fear they will be required to renegotiate their contracts to comply with the regulation’s mandatory divestment provisions. But on this, the government appears to have given mixed signals. Some officials have said the regulation only applies once the Contract of Work has expired or when an extension to that contract is sought, while others say they can be renegotiated whenever the government deems necessary.

Mining companies have also faced difficulties with the divestment process. It is often hard to find a tier of government or Indonesian company with sufficient funds to purchase the stake. And if funds are available, national and regional governments sometimes bicker over which of them should have first priority.

The main problem with the divestment policy, miners and Indonesian economists point out, is that it significantly reduces the Indonesian mining sector’s desirability for investors. Mining contributes 17 per cent to Indonesia’s GDP and a significant proportion of Indonesia’s FDI (US$3.6 billion of US$20 billion in 2011). If Indonesia wants to increase its economic growth, then it simply must attract more foreign investment, including in the mining sector.

One explanation for the new regulation is ‘resource nationalism’ — a response to demands from Indonesians, particularly those who live near mining sites, for ‘a share of what the companies are earning’. The regulation’s preamble explicitly states that one of its rationales is to allow more Indonesians to participate in mining. This may be part of a broader wave of political nationalism, which many within government and various other political parties support. The exploitation of natural resources by foreigners is not publicly popular anywhere in the world, but in former colonial states such as Indonesia the sentiment has greater currency. Article 33 of the Indonesian constitution, requiring the state to control natural resources and important public utilities, reflects this sentiment.

It is also significant that under the 1967 Mining Law’s so-called ‘Contract of Work’ framework, the Indonesian government did not simply grant mining licenses to mining companies. Instead, the minister for energy and mineral resources appointed mining companies as contractors to carry out mining activities that the government or a national company did not or could not perform.

Compared to measures other resource-rich states have recently introduced or mooted, which are typically only prospective and do not discriminate against foreigners (such as a generic mining tax), the new Indonesian regulation seems more prone to violating substantive commitments made under various investment treaties or FTAs. This potentially opens the door for formal investor-state arbitration (ISA) claims against Indonesia. Although, for practical reasons, the international treaty law framework is much more likely to structure informal settlements than result in full-scale ISA proceedings.

The Australian government should reconsider its abrupt policy shift in the April 2011 Trade Policy Statement, which eschews ISA in future treaties, in light of recent developments in Indonesia as well as broader concerns about the shift and its underlying assumptions. Under two existing treaties between Australia and Indonesia, the ISA system provides important baselines agreed between states and jettisoning it risks undermining a system that has become widely known and accepted, even in Asia. It also risks destabilising sustainable cross-border investment flows in the region, particularly over the medium to long term.

Simon Butt is Senior Lecturer at the Sydney Law School and acting Director of the Centre for Asian and Pacific Law at the University of Sydney (CAPLUS).

Luke Nottage is a Professor and Associate Dean at the Sydney Law School, University of Sydney, and founding Co-Director of the Australian Network for Japanese Law (ANJeL).

1. Chinese interests in Pacific nations: mining ventures in PNG
2. Indonesia’s foreign economic policy strategy
3. New foreign investments in Indonesia’s resource sectors

ASEAN concluded its 20th Summit on 4 April 2012. The discussion shifted away from building an ASEAN Community, to debates over territorial disputes in the South China Sea between China, Taiwan and four ASEAN member states (the Philippines, Malaysia, Brunei and Vietnam).

There was significant debate on whether China should be invited to take part in the drafting of the code of conduct, envisioned as a legally binding document to prevent small incidents in the South China Sea from escalating into bigger conflicts.

In 1992, a year after China commenced consultation with ASEAN, the latter issued a declaration of principles on the South China Sea in which ‘all parties concerned’ were urged to exercise restraint in order to create ‘a positive climate for the eventual resolution of all disputes’. Ten years later, in 2002, China signed the Declaration on the Conduct of Parties in the South China Sea with ASEAN. Since then, ASEAN and China have been working on a ‘Regional Code of Conduct in the South China Sea’, but no agreement has been reached so far.

A number of factors informs how ASEAN, as a region, views the problem of the South China Sea.

First, since all ASEAN countries are not equally involved in the dispute, there is no single ASEAN-led approach to it. Because each ASEAN member state pursues its policy individually with China depending on its own economic interests, the ASEAN countries are arguably divided over their approach toward Chinese territorial claims in the South China Sea. As a result, ASEAN’s political and strategic position vis-à-vis China becomes relatively weak.

For some time now, China has been proposing to settle the dispute through bilateral consultation between the concerned countries. ASEAN is aware of its weaknesses and agrees that 10 countries together are a better strategic and political force against China. ASEAN member states must therefore stand united to convey a clear message to China.

Second, China understands that ASEAN countries have different approaches to China itself. After years of assurances that ASEAN countries have nothing to fear from a rising China, senior officials in Beijing have issued statements that suggest they treat countries that have territorial disputes with China, and those that do not, differently. Until now ASEAN’s policy of engaging China — and China’s accommodative approach to the South China Sea issue — has brought some temporary benefits. But it has not been very effective in managing the issue or restraining it from escalating.

During the 2010 ASEAN Regional Forum in Hanoi, the dispute between China and ASEAN came out into the open. US Secretary of State Hillary Clinton stated that the US is in favour of ‘a collaborative diplomatic process by all claimants for resolving the various territorial disputes without coercion’, which ASEAN welcomed. Other non-claimant countries, including Indonesia, Australia and Japan also got involved, weakening Beijing’s claim that the dispute is only between China and a few ASEAN members.

Realising this, ASEAN — under Indonesia’s chairmanship in 2011 — reached a consensus with China to discuss the joint development of undersea resources. ASEAN and China agreed to adopt a set of ‘guidelines’ to implement the declaration of conduct, and pledged to exercise restraint. Building on this progress, ASEAN senior officials have met several times since late 2011 to discuss ‘possible elements’ of a code of conduct.

In dealing with the South China Sea issue, one should keep in mind that over one-third of the world’s seaborne trade passes through this conduit, and half of this traffic is oil and gas. Solving the dispute has important implications for the free passage of shipping and the eventual development of oil and natural gas investments in the area.

But in recent months, Beijing has signalled its strong interest in joining the deliberation process that will issue the code of conduct. At the recent ASEAN summit in Phnom Penh, the Philippines and Vietnam strongly objected to China taking part in the discussion at this juncture. Some member-states argue that ASEAN must reach an internal consensus before involving China in the drafting process.

ASEAN’s main objective in developing a set of guidelines is to encourage China to agree to resolve the dispute peacefully and ease tensions in the South China Sea. ASEAN must manage its inherent differences quietly and develop the code of conduct to correspond with international legal norms, such as the 1982 UN Convention on the Law of the Sea. Though the dispute may not be resolved completely in the short term, such an approach will ease tensions with the international community, which relies on South China Sea trade routes. This way, ASEAN will not only play an important role in regional diplomacy — it will also help manage the economic interests of non-contending countries.

Sanchita Basu Das is Lead Researcher for Economic Affairs at the ASEAN Studies Centre, Institute of South East Asian Studies.

1. South China Sea developments at the ASEAN Regional Forum
2. Diplomatic currents running strong in the South China Sea
3. South China Sea dispute: Why China takes a pragmatic stance

The challenges wrought by burgeoning Asian demand for Australia’s natural resources have already begun to receive policy attention from the Australian federal government.

The Minerals Resource Rent Tax is just one example. But the challenges arising from trade flows are only part of the story that will confront Australian economic policy makers during the Asian Century. Countries are also linked by investment flows, and policy development in this respect is lagging badly.

The investment channel takes on added significance in the case of Australia because of the country’s long-standing reliance on foreign savings to fund domestic investment and consumption and to inject competition into domestic markets. Australian Bureau of Statistics data show that, bar a few quarters, Australia has not recorded a surplus on the current account in the past 50 years. By year end 2011, international investment liabilities exceeded international investment assets by AU$853 billion (US$892 billion). And data from the Reserve Bank of Australia show that 18.1 per cent of the liabilities of Australian banks are owed to non-residents.

What is striking about Australia’s international investment linkages is not their scale, but how dramatically their composition differs from trade linkages. In 2011, merchandise exports to Asia (ASEAN, China, Hong Kong, India, South Korea, Japan and Taiwan) accounted for 76.2 per cent of Australia’s total. Yet in 2010, the latest year for which data are available, these countries were only responsible for 21 per cent of total foreign investment flowing into Australia. If Japan is removed from the calculation, the share drops to a paltry 6.3 per cent.

The Asian share of the stock of foreign investment in Australia is no more impressive, standing at 12.87 per cent, or 6.87 per cent minus Japan. In contrast, the shares of the US and UK stood at 27.94 and 24.02 per cent, respectively. And for all the talk of behemoth Chinese state-owned entities buying up Australian mining and farming assets, the Chinese share of the stock was less than 1 per cent. In 2010, Chinese investment in Australia actually fell to AU$1.65 billion (US$1.72 billion), down from AU$7.82 billion (US$8.18 billion) the year before. The limited scale of Asian investment in Australia is particularly noteworthy given the region includes some of the world’s most prodigious net capital exporters, namely, China and Japan.

Aside from being limited in scale, Asian investment also appears narrowly concentrated in just one industry sector: mining. Comprehensive data showing foreign investment by country as well as industry sector are scarce. One source that provides some indication is the annual report of Australia’s Foreign Investment Review Board, which shows that for all countries between 2007 and 2010, the value of approved investment in the mineral exploration and development sector accounted for 47.34 per cent of the total. With the exception of Singapore, this share was considerably higher for Asian countries. For example, it reached 86.88 per cent in the case of China.

These numbers suggest that managing a two-speed economy is not the only challenge awaiting Australian policy makers: plotting a path to effectively tapping Asian capital markets in order to promote broader-based; higher value-added; and ultimately more sustainable, productive activities will be key.

This job will be facilitated to the extent that countries such as China continue to open up their economies and allow domestic capital to flow abroad more freely. But it would be naïve to assume that Asian interest in Australia’s natural resources will automatically translate into broader investment interests. To be sure, Australia already has a number of basic policy settings right, such as political stability and a strong system of intellectual property rights enforcement. Yet there is evidence that more can be done. According to UNCTAD’s latest World Investment Report, Australia ranked 15th out of nearly 200 countries for its FDI ‘potential’, but only 72nd for performance in attracting FDI. Understanding why there is such a gap, and seeking to bridge it, is vital.

Looking forward, China will undoubtedly become the big player in global investment flows. With a population of 1.4 billion people and an exceptionally high savings rate, China is expected to maintain its rapid income growth. Its capital account continues to open gradually and, as long as its own financial sector remains repressed (for example, real interest rates on savings deposits in China’s banks are currently negative), there will be additional incentives for domestic savers to seek out higher returns overseas.

And yet it is with respect to China that Australian investment policy performance has been most lacking. After the federal government recently banned Huawei Technologies from supplying equipment to the National Broadband Network, and with the near-hysteria surrounding Chinalco’s earlier proposed investment in Rio Tinto, it would be difficult for Chinese companies to view Australia’s attitude to foreign investment as anything other than arbitrary and opaque.

Until such basic policy positions can be clearly articulated and justified, it will be nearly impossible to pursue other worthy endeavours, such as positioning Australia to become an offshore trading centre for the renminbi. The recent Memorandum of Understanding between Australia and China relating to infrastructure projects is a welcome development in this respect, and one hopes that the working group charged with developing it meets with more success than stalled negotiations for an Australia–China FTA.

James Laurenceson is Senior Lecturer at the School of Economics, University of Queensland.

A version of this article was first published here on The Conversation.

1. Australia has a valuable role in the “great balancing act”
2. Traps for Chinese investment overseas
3. Is Chinese dominance distorting natural resource markets?