COVID-19 and the Australia-China relationship’s zombie economic idea

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James Laurenceson, Director, Australia-China Relations Institute, University of Technology Sydney

Michael Zhou, Project and Research Officer, Australia-China Relations Institute, University of Technology Sydney

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Executive Summary

• Zombie economic ideas are those that should have been slain by an accumulation of facts and evidence but continue to walk the land, stalking public policy. The Australia-China relationship has its own zombie economic idea: that Australian entities engaging heavily with the Chinese market are irresponsible in their risk management, and that, at a national level, Australia is ‘too dependent’ on China. The COVID-19 pandemic has seen this zombie economic idea injected with a fresh dose of un-life. News stories of Australian companies in distress as Chinese demand fell in January and February 2020, as well as disrupted supply chains, have been presented by some commentators as evidence that it is now a ‘necessity’ for government to force greater diversification in trade ties away from China. That is, to force a decoupling of the Australian and Chinese economies.
• The latest data confirm Australia’s significant trade exposure to China. In 2018-19, this reached $235.0 billion, compared with just $88.5 billion with Japan in second place. A comparative analysis shows that by share of total goods exports going to China, Australia is now ranked 16th globally (and 1st amongst the OECD). In terms of exposure to a single export market, whether China or otherwise, Australia ranks a more modest 46th globally. Canada’s reliance on the United States (US) market, for example, is double Australia’s reliance on China. In terms of the share of goods imports from a single market, Australia ranks more modestly still at 70th globally, with Canada’s reliance on the US again double Australia’s reliance on China.
• A significant trade exposure to China is not, in itself, compelling evidence that Australian businesses have been irresponsible in their risk management, nor that the country as a whole is ‘too dependent’. In terms of exports, Australian businesses selling heavily into the Chinese market stand to lose the most if that market is disrupted. This provides a strong incentive to be well-informed about both opportunities and risks, and take steps to mitigate the latter. This is not to say that business risk management is failsafe. Rather, simply that the basic incentives businesses have to get the risk/return equation right are, for the most part, not there to the same extent for the Australian government.
• There are important qualifications, however. Australian businesses with business models geared towards China need to understand that it is not the government’s responsibility to bail them out in the event of a downturn in the Chinese market. Further, the government’s considerations extend beyond the benefits of trade to encompass national security and the strategic outlook. Sometimes the government will take decisions it judges to be in the national interest, including steps to preserve Australia’s sovereignty and freedom of action. These decisions may run counter to what China regards as being in its interests. Australian businesses need to recognise and factor into their risk management the possibility that their business model could suffer if China applied coercive economic pressure in retaliation.
• But these qualifications do not imply that it serves the national interest for the Australian government to force a decoupling of the two economies. First, for most Australian businesses with significant international exposures, monitoring and responding to developments in a diverse set of risks, including political risk, is already standard practice. Second, the government can use its convening power, and draw on knowledge garnered from its international diplomatic network and trade and investment promotion agencies such as Austrade, to make sure business are aware of the risks and opportunities that exist, in China and elsewhere. Third, to the extent that the Australian government has access to information sources that businesses do not, a business accounting of the risks they face can be enhanced through regular and frank dialogues with, amongst other arms of government, national security agencies. There are successful sector-level precedents such as the collaboration last year between government and universities resulting in the formulation of best practice guidelines to guard against foreign interference.
• That some Australian entities like universities have attracted particular criticism owing to a significant exposure to the Chinese market misses the national interest benefit they have delivered, as well as the broader context. Despite being located in a small domestic market, seizing export and internationalisation opportunities, particularly those with China, has allowed seven Australian universities to earn a place in the worldwide top 100, placing Australia at the global forefront of knowledge creation, and supporting 259,100 full-time local jobs in 2018. And examples of businesses with an even higher exposure to China can be found right across the Australian economy. The Australian wool industry, for example, for example, sells 80 percent of their output value to China.
• At a national level, claims of being ‘too dependent’ on China for exports assume that an alternative country stands ready to buy Australian goods and services. That is, Australia can be ‘less dependent’ on China by being ‘more dependent’ on, for example, India or Indonesia. But the fact is that of the net $180 billion increase in Australia’s annual export value over the past decade, just one country has been responsible for delivering 60 percent of the jump: China. In comparison, other major Indo-Pacific countries like the US, Japan, India and Indonesia have hardly registered. In other words, the only trade diversification strategy that potentially makes sense for Australia is a ‘China-and-’ one. Forcing trade ties away from China – a ‘China-or-’ strategy – guarantees less Australian income and jobs.
• The overall pattern of Australia’s exports can mostly be explained by basic economic drivers like complementarities in production across countries and purchasing power that is growing faster abroad than at home, particularly in China. In terms of the purchasing power outlook, under the weight of COVID-19 the International Monetary Fund (IMF) expects China’s growth to fall to just 1.2 percent in 2020. This is sobering given that one-third of Australia’s total exports now go to China. But Australia’s exposure to China remains preferable to that of many of its peers. Canada, for example, has a much larger single-country exposure to a US market that is forecast to shrink by 5.9 percent. And the United Kingdom (UK) will struggle to sell to its more dominant European Union (EU) market, which is expected to contract by 7.5 percent. In the decade to 2030, the Australian government’s 2017 Foreign Policy White Paper sees China’s economy adding more new purchasing power than the US, Japan, India and Indonesia combined.
• The single-country concentration of Australia’s exports is also not the only factor affecting the risk profile. Another is an increasing concentration of Australian exports in a narrow range of products. However, analysis shows that Chinese demand has alleviated rather than exacerbated this trend. Australia’s exports to China are now more diversified by product than to Japan and vastly more than to India.
• The notion of trying to engineer more diverse export markets is not new. Consistent with its foreign policy strategy, which has focused particularly on the Indo-Pacific region since at least 2012, the Australian government draws on a variety of tools to promote economic links with a diverse mix of partners. These include Free Trade Agreements (FTAs), sponsoring business roadshows and the placement abroad of specialist staff from trade and investment promotion agencies like Austrade. There is limited evidence, however, that using them to actively develop other markets would significantly shift the dial on the pattern of Australia’s exports.
• In the case of imports, Australian businesses have strong incentives to take supply chain risks seriously for the straightforward reason that if these are disrupted they will not have a product to sell. This is not to say that the profit maximisation objective of businesses is consistent with ensuring supply chain stability at all costs. But, as with exports, the basic incentives businesses have to get the risk/return equation right do not, for the most part, exist to the same extent for the Australian government. Businesses need to be aware, however, that particular risks, such as those around economic coercion, apply as much to imports as they do exports.
• Importing a lower proportion of final goods from China is a wholly inadequate approach for managing risk when Australia’s supply chains are fed by global value chains (GVCs) which see inputs and stages of production spread across multiple countries, and with key locational decisions made by multinational companies beyond the direct reach of Australian policy-makers. There are other approaches that the Australian government might utilise to potentially influence supply chain risk more effectively. For example, the government might incentivise businesses importing goods it regards as critical to hold additional inventories. Or it might elect to directly maintain strategic stockpiles for a broader basket of critical goods. Or industrial policy could be used to increase Australia’s production self-reliance for critical goods. But the benefits and costs of such actions need to be clearly accounted for, and compared with the status quo, to determine if they serve the national interest.
• Some of the claims made about China’s role in Australia’s supply chains appear to be built on misinformation. For example, contrary to some commentary, Australia does not have a food security problem. Rather, it is one of the most food secure countries in the world with imports only accounting for 11 percent of food consumed, while 70 percent of Australia’s agricultural production is surplus to domestic needs and sold overseas. Another example is medicines. In 2019 only two percent of imported medicines and pharmaceutical products came from China. The European Union (47 percent) and the US (21 percent) were far larger suppliers. Of course, China might be involved in the GVCs for some of the medicines that Australia imports from other countries. But to the extent this is true, these GVCS are mostly managed by giant European and American pharmaceutical companies, and pretending that simply switching to importing a medicine from India or Vietnam will address the issue, or that the Departments of Defence or Health in Australia have the antidote, is disingenuous. Rather than supply chain disruptions, panic buying can be the culprit behind empty shelves, with US President Donald Trump’s touting of hydroxychloroquine to treat COVID-19 an illustration.
• There are important discussions to be had around managing the risks associated with Australia’s international economic exposure, particularly when confronted by a challenge like COVID-19. Some of these relate to national security and strategic developments and apply more acutely to trade ties with China than other countries. But the argument that Australia’s national interest is best served by forcing a decoupling of the Australian and Chinese economies mostly reflects a zombie economic idea, an economic idea that deserves to be laid to rest once and for all.

Authors

Professor James Laurenceson is Director of the Australia-China Relations Institute at the University of Technology Sydney.

Michael Zhou is a Project and Research Officer at the Australia-China Relations Institute, University of Technology Sydney.