SHIRO ARMSTRONG.- Is Australia trading too much with China (EAF 16.3.2020)

China accounts for close to a quarter of all of Australia’s international trade, and over a third of its exports, including both goods and services. Is Australia trading too much with China and too dependent on the Chinese economy, as a lot of the public commentary would have you believe?

This question has come into sharper focus with the Australian government’s travel ban on China due to the COVID-19 coronavirus outbreak. Australia’s tourism and higher education sectors suddenly lost their largest markets overnight.

A narrative is developing that universities were warned about their overdependence on one international market, and now deserve to pay the price for not diversifying. Two of Australia’s top economists, former Treasury Secretary Martin Parkinson and ANU’s Warwick McKibbin, have called on universities to become less reliant on Chinese students, going as far as describing the travel ban as a ‘net positive’ for universities in helping that along.

Hillary Clinton gave similar advice to Australia’s mining sector. Diversifying away from over-reliance on China would seem like the obvious strategy to pursue but if it makes sense, why haven’t Australia’s internationally competitive miners, education providers and the tourism sector not done it already? And is it a good idea to diversify no matter what?

Universities may wish to reduce the number of Chinese students they have, increase students from elsewhere, or both, but will do so only at significant cost. Chinese students are spending family savings and choosing Australian universities over American, British, Japanese and other universities to buy, for the most part, a quality international educational experience. The number of Indian and Southeast Asian students are growing but the biggest growth in the demand for international educational services, and most dynamic market globally is China. It’s the same in tourism and many other sectors of the Australian economy.

Australia policymakers can choose to reduce trade with China by impeding exports and imports, or it can reduce the share of trade with China by intervening in the market to expand trade with other countries, including by diverting trade away from China. President Trump has shown us exactly how that is done. These policy strategies necessarily incur costs. The question for those advocating such a strategy: if one-third of total exports to China is too much exposure, what’s the acceptable or the right share? And what’s the cost of attaining it?

It shouldn’t require too many sophisticated sums to show that de-concentration of Australia’s resource exports on markets in China, Japan and South Korea would come only at huge cost to the mining sector, Australian trade and the Federal coffers. The costs to China, Japan and South Korea on de-concentration in their imports of these materials would be similarly huge.

Australia’s ability to utilise its endowments and take advantage of opportunities internationally should be celebrated and protected. Australia is no stranger to having one country dominate its international trade shares. At its peak in the 1970s and 80s, Japan accounted for roughly the same share of Australia’s trade as China does today. Trade with the United States peaked during World War 2, accounting for 39 per cent of Australian imports and 40 per cent of its exports. The United Kingdom consistently accounted for over half of Australia’s trade, and up to 60 per cent, up until the end of Commonwealth preferences after World War 2.

Instead of intervening in the market to reduce trade shares with China, a far better strategy is to manage these highly interdependent economic relationships and manage the inevitable shocks in their fortunes, some self-inflicted, that occur from time to time.

Universities, farmers and other businesses make commercial decisions based on risk assessment that includes diversification. Diversification is a form of self-insurance and comes with a cost. One of the biggest risks for many businesses is to limit engagement in the huge Chinese economy with a rapidly growing middle class.

The first line of defence against economic shocks from abroad is a well-functioning and robust macroeconomic framework. A flexible exchange rate that acts as a shock absorber, a flexible economy and labour market that adjusts to the large prices changes, a robust social safety net and fiscal and monetary space to cushion and facilitate that adjustment. That’s what saved Australia from recession in the last 28 years despite the ups and downs of the Asian financial crisis, the boom and bust of the commodity super cycle and the global financial crisis.

The risk of shocks from natural disasters (earthquakes, floods and pandemics) can be dealt with in part in the same frame, with the addition of direct support to affected sectors and ramping up international cooperation to blunt their damage.

The management of the economic relationship with China needs to start with understanding the nature of that relationship and the framework within which it is nested.

Some worry that Australia might become the target of economic coercion by China taking advantage of that dependence to alter Australian policies. China is seen by the US government as a strategic rival, so allies of the United States like Australia, could be seen as a target of such coercion.

There are domestic and international constraints on Chinese political leaders, as there are everywhere. Much commentary assumes none exist.

The Australia–China economic relationship is an interdependent one that has been built and prospered under multilateral rules that both countries have signed up to and remain committed to, importantly for China through WTO accession in 2001. Those commitments have been entrenched through the bilateral ChAFTA free trade agreement. It is not a matter of trust but one of binding commitments willingly signed up to with a track record better than most.

The Australia–China relationship is not a one-sided or narrowly or purely bilateral relationship. Much of Australia’s merchandise imports from China are Japanese, American and European branded and will continue to be so even after supply chains adjust. Australian iron ore, coal and natural gas has fuelled China’s industrialisation and exports to the rest of the world. Australian education services are helping to increase the value-add of that production in China but also helping China avoid the middle-income trap. As China continues to transition from the factory of the world to one of its largest markets, it will become even more important.

In a world of increased uncertainty and risk, the instinctive response is to hunker down and avoid exposure to risk. Reducing exposure and reliance on the Chinese market as a form of risk mitigation is akin to asking for a pay-cut in the fear that a pay-rise might not be permanent. There are far better insurance policies.

As Australia and the world recover from the COVID-19 shock, the strategy going forward needs to be strengthening the macroeconomic framework and tools at home while engaging China and the global system in protecting openness, rules and engagement.

Shiro Armstrong is Director of the Australia-Japan Research Centre and Director of the Asian Bureau of Economic Research, The Australian National University.

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