Australia’s China dependence: do we need a Plan B?

Australia is now the most China-dependent economy in the world – does this pose a problem for our future? AAP/Alan Porritt

If something can’t go on for ever, it won’t. – Herb Stein, chief economic adviser to former US president Richard Nixon.

China’s economic rise has been a good news story for Australia. According to most economic policymakers and commentators, the growing middle classes of China and the rest of Asia will ensure Australia continues to flourish over coming decades.

Treasurer Joe Hockey, for example, recently argued:

China’s middle class of around 150 million people is expected to reach one billion in just 16 years … This rising middle class of Asia wants what comes from Australia’s farms and our gas fields. They want to come here as tourists, attend our universities and they need our financial sector to manage their wealth and plan their retirement.

Reserve Bank economist Alexandra Heath also contends:

Even if the sustainable growth trajectory for the Chinese economy gradually declines over the medium term, the economy is much larger than it was and is still growing. This implies there will continue to be a huge appetite for commodities of many kinds.

They could be right, and if you judged future opportunities based on past performance you’d be reasonably confident. But what if they’re wrong? Is Australia prepared if the optimistic scenario doesn’t eventuate? Do we need a plan B?

Australia is now the most China-dependent economy in the world. Australian exports to China have grown from 8.5% of the total in 2003-04 to 32.5% in 2013-14 – and they continue to grow.

Australia’s dependence on its top three export destinations has also increased over the past ten years. The top three accounted for 33.7% (Japan 15.7%, US 9.5% and China 8.5%) in 2003-04, rising to 55.1% (China 32.5%, Japan 15.8% and South Korea 6.8%) by 2013-14. The top five now account for 63.7%, up from 47.7%.

More worryingly, not only is Australia more China-dependent, but so is most of the rest of Asia. This means that a China slowdown (or worse) will also hit Australia’s exports to Japan and South Korea – our second and third-largest export destinations.

Let us hope that the dreamers are right about China’s long-term progress and that the doomsayers are wrong. But remember also that all of this export growth to China occurred without the free trade agreement that Australia and China have concluded negotiating. It’s possible that the agreement will help to diversify Australia’s export mix to China – more agriculture, more services – but it might also just make us more vulnerable down the track as Australia becomes even more dependent on China for earning foreign exchange.

Current policy settings aim to reinforce Australia’s strengths. While this has worked well for us over recent years, Australia’s long-standing economic vulnerabilities remain. These include our vulnerability to falls in the demand for – and prices of – resources, and high levels of foreign and household debt.

This leads us to the big question: does Australia need a Plan B? And what would that be? A Plan B would involve a realisation that while resources have helped to make Australia rich, they’re not enough to sustain our prosperity over time. Australia needs active policy efforts to diversify the economy away from a reliance on resources and on buying and selling houses.

Efforts to extract greater rents from Australia’s mining sector are necessary. AAP/Alan Porritt

Policymakers need to reconsider industry policies and think of ways to develop new industries rather than just support old ones in ad hoc ways. Efforts to extract greater rents from Australia’s 80% foreign-owned mining sector are also necessary – that is, through mining taxes. Encouraging the development of renewable technologies through a carbon price should also be a no-brainer for Australia.

In other words, the two policies that the Abbott government trumpets as successes are anything but.

The continuing transformation of the Australian political economy is likely to cause ongoing political volatility as Australian governments deal with the electoral consequences of structural changes and economic vulnerabilities.

The best way to ease the pain and avoid resistance to necessary structural reforms is to ensure a fairer distribution of Australian prosperity and a fairer distribution of the pain when the current period of economic growth ends. There are no guarantees of political success, but a fairer political economy is likely to underpin support for economic openness and flexibility. Both are vital preconditions for a more productive economy.

Improvements in productivity – the efficiency of labour and capital – and an egalitarian distribution of the fruits of that productivity are what matters for long-term prosperity. Getting Australia’s policymakers and the wider population to realise that the two are not contradictory is the short-term challenge.

Both good and bad things can come from political processes but we cannot remove politics from the equation. It is worth remembering that Australia is a wealthy and relatively equal country because of political interventions, not despite them. Australia needs to utilise its luck to lessen its vulnerabilities.

If policymakers simply believe that China will sustain Australia’s prosperity over the next 20 years, then many Australians will think there’s no reason to change tack – until it’s too late.