Why an Australian FTA with China has never stacked up

The economic argument for an FTA with China isn’t as strong as some may assume. derekGavey/Flickr

Despite trade in goods and services between Australia and China exceeding A$125 billion in 2012, negotiations between the two countries for an FTA that began in 2005 have been so unproductive that both sides appeared to have largely lost interest.

However, a couple of factors have combined recently to see the FTA re-enter the policy debate.

Firstly, Australia’s new Prime Minister, Tony Abbott, voiced his desire for an FTA with China to be finalised within one year.

On the Chinese side, in the middle of this year President Xi Jinping expressed similar hopes for an “early conclusion”.

Secondly, New Zealand successfully concluded an FTA with China in 2008 and several of the provisions of this FTA kicked in during 2012 and 2013. This has meant that an increasing number of Australian companies now feel that they are at a distinct disadvantage relative to their Kiwi counterparts when seeking to sell into the Chinese market

Before speculating on whether an FTA will be completed sooner rather than later, and what form it will take, it’s worth reflecting on why progress to date has been so limited.

The three factors standing in the way

Firstly, the lack of an FTA has clearly not prevented a burgeoning trade relationship. Over the period 2006-2012, the value of Australia’s merchandise exports to China grew at an average annual rate of 25%. True, this may have been even higher with an FTA, and the lack of diversity in Australia’s exports to China is worrying, but it is hard to be disappointed by these headline numbers and easy to become complacent.

Secondly, some readers may be surprised to learn that economic modelling of an FTA shows the benefits to be gained are actually quite limited.

A recent op-ed piece in the Australian Financial Review referred to modelling performed by the Centre for International Economics and commissioned by the Australia-China Business Council, which “…suggested that Australia’s GDP stood to gain an annual boost of 0.7% over two decades with an FTA in the bag”.

My reading of this modelling output is very different - namely, 20 years after the conclusion of an FTA, Australia’s GDP will be just 0.7% higher than otherwise (a business as usual, no FTA baseline).

Moreover, this 0.7% increase occurred in a best-case scenario that involved not only full trade liberalisation, but full investment liberalisation as well.

The estimated increase in China’s GDP over the same time horizon was just 0.1%.

To state the obvious, an FTA with China will do nothing to liberalise trade with the other countries that currently account for two-thirds of Australia’s merchandise exports. This is the inherent limitation of a bilateral trade deal as opposed to a multilateral one.

Further, as fellow economist Leith van Onselen observes, a bilateral deal with China could even lead to welfare losses for Australia to the extent that it results in lower cost production from other countries being displaced by higher cost production from China.

It is also the case that many of the big ticket export and import items between Australia and China are not subject to trade barriers anyway. For example, iron ore, which accounts for more than half of Australia’s merchandise exports to China, is not subject to any tariff.

According to WTO data, the trade-weighted average duty Australia’s non-agricultural exports to China face is just 0.2%. The equivalent figure for agricultural exports is much higher, 21.3%, but these only account for 6.4% of total exports.

The third reason that an FTA with China has stalled is because any comprehensive deal would almost certainly involve significant political costs.

For an FTA to be economically meaningful for Australia, it would need to include Chinese concessions in the areas of agriculture and/or services.

Yet since joining the WTO in 2001, China has been reluctant to make any further concessions in these areas. In the case of agriculture this reflects, amongst other factors, fears surrounding food security, and the plight of Chinese farmers who are disproportionally represented in the lower end of the income distribution.

The implication is that for a deal to be struck, Chinese concessions with respect to agriculture and services would need to be balanced by some fairly hefty concessions on the Australian side.

The experience of New Zealand may provide some indications here. In successfully completing an FTA with China, New Zealand was able to extract significant concessions in the area of agriculture. However, in order to realise such outcomes, it agreed to the phased elimination of tariffs on all products of Chinese origin, including textiles, clothing and footwear. The FTA also made it easier for businesses to import Chinese labour.

Inward investment

In FTA negotiations to date, China has reportedly been pushing for Australian concessions with respect to inward investment, in particular, an increase in the threshold that sends Chinese investment proposals to the Foreign Investment Review Board.

In practical terms, the threshold for most Chinese investment proposals currently stands at A$0. This is in contrast to the A$1 billion threshold for most investment proposals from the US and New Zealand.

While I have argued in favour of the liberalisation of inward Chinese investment irrespective of an FTA, polls by the Lowy Institute show that my enthusiasm is not widely shared amongst members of the Australian public. The preference of minor Coalition partners, the National Party, for more restrictions on inward investment, not less, is also well known.

As long as inward investment liberalisation is kept off the table by the Australian side, it would be difficult to imagine the Chinese side coming to the party with the liberalisation of agriculture and services.

Let’s also not forget that China’s inward investment regime is even more restrictive than Australia’s. For example, Australian investors are barred from buying shares in companies listed on the Shanghai Stock Exchange, except via schemes that are subject to rigid and meagre quotas. Yet I doubt that the liberalisation of such restrictions will be even broached in FTA negotiations.

So where does this all leave us?

My best guess is that an FTA will be signed within the next 12 months, but that it will be far from comprehensive. It will be sold on the basis that something is better than the nothing that negotiations over the past 8 years have delivered. Perhaps, but at least in economic terms the improvement over the status quo will be marginal at best.