Australia’s economic relationships with China

Dr Anne Holmes, Economics

Key issue
As the Chinese economy moves from a focus on investment in physical infrastructure to developing social infrastructure, and as it moves from export driven growth to consumption driven growth, there will be changes in what it imports from other countries. Australia will look to maintain and build upon the trading partnership it has had with China in recent years.

Background

China's growth since the 1970s has entailed urbanisation, growth in manufacturing, and investment in infrastructure. This created demand for building materials, energy for electricity and transport, and raw materials for manufacturing. Australia was well placed to meet a lot of this demand, and it was a ready market for Chinese manufactured goods.

Today, China is Australia's largest trading partner in terms of both imports and exports. Australia is China's sixth largest trading partner; it is China's fifth biggest supplier of imports and its tenth biggest customer for exports. Twenty-five per cent of Australia's manufactured imports come from China; 13% of its exports are thermal coal to China.

A two-way investment relationship is also developing.

As China moves into its next phase of development, its demand will shift from raw materials to elaborately transformed manufactures, services, and expertise. Australia has some potential advantages in the supply of these, but they are not the clear advantages possessed by the resources sector. Few other countries had Australia’s huge supplies of iron ore, which were close to the sea and easily developed, and proximity to China for shipping minerals (of which transport costs are up to 10% of the value). But many developed countries have the education and technical expertise to meet China’s new demands.

China as a market for our commodities

As the drivers of China's growth change from urbanisation and basic manufactured goods to domestic consumption and more complex goods and services, the growth in demand for Australia's resources will moderate. Australia's resource exports to China are likely to continue to grow, but at a slower rate, with natural gas to some extent supplanting coal. Other commodities, such as wool and wheat, and other minerals will probably also do well as incomes in China rise.

Australia’s terms of trade are likely to fall as new coal, iron ore and gas capacity in both Australia and the rest of the world comes on stream. A probable result is that the Australian dollar will fall. This will mean a partial reversal of the huge rise in living standards which (contrary to popular perception) Australia has experienced in the last ten years. At the same time, it will improve the competitiveness of other traded goods and services industries which have suffered from the strength of the currency. China may be a market for some of them.

China as a market for more complex goods and services

The Chinese market for more complex goods and services will expand in two ways. First, rising wages and consumer demand will increase demand for more sophisticated manufactured goods (where Australia has some niches of excellence, for example, in medical devices) and for services such as tourism (where China is already an important market).

Second, as China moves production to more sophisticated goods and services, it will require high quality human resources, well-developed infrastructure, a well-developed financial sector and a good regulatory system. Australia has the expertise to help to develop these. Australia’s public sector works very efficiently; in a number of areas such as budgeting, health administration and social security, it is a world leader. Already, China is the biggest market for Australian education services. Australia's financial sector is well regarded internationally for its efficiency and effectiveness, and its banks are among the most sound and stable in the world. This expertise in government and services can be exported. Indeed, Australian banks are already operating in China and Australian experts have advised in a range of areas, for example, in urban development and health financing.

China as a competitor

The development of manufacturing in Asia has been a major reason for Australia's failure to compete in many areas of manufacturing. As China moves up the value chain, more industries will be subjected to this competition. This may be ameliorated by a shift in the focus of the Chinese economy away from exporting to domestic consumption.

Ninety per cent of Australia's merchandise imports are from China and, of those, 90% are elaborately-transformed manufactures. The initial imports of textiles, clothing and footwear were replaced by household appliances in the 1990s; today 50% per cent of Australian merchandise imports from China are engineering products, including office and telecommunications equipment.

Australia has niches where it can compete with the best in the world. It will be important to retain what lead it has in education and in the sophistication of the workforce.

China as an investor

Australia relies heavily on foreign investment. China ranks only ninth as an investor in Australia, with a 3% share of total foreign direct investment. That investment has grown rapidly in the past few years, but China’s foreign investment is likely to fall as its savings rate falls. On the other hand, there is evidence that Chinese businesses are keen to invest in Australia, particularly in infrastructure projects.

Australian businesses have benefited from low interest rates worldwide which have been driven by the large amount of Chinese savings available for lending, both directly to Australia, but also internationally. As these are reduced, interest rates will rise, putting downward pressure on the profits of Australian businesses, revenue and growth.

China as a destination for investment

While Chinese savings will probably remain high enough to fund domestic expansion, there will be room for Australian companies to invest in China. This would be a useful way for business to learn about Chinese tastes and preferences, as well as business culture.

One great advantage Australia has in industries providing sophisticated goods and services is the large number of Australian speakers of Mandarin. Another is the base of knowledge and contacts built up through the trade in resources.

Conclusion

The adjustment from the resources boom may be, as economist Ross Garnaut predicts, ‘costly and difficult’, but there are opportunities for Australia in the growing Chinese market.

In April 2013, the Australian and Chinese Governments agreed to establish a new diplomatic architecture for the relationship which would consist of an annual leaders’ meeting and ministerial-level economic and foreign and strategic dialogues. This new architecture will provide an important platform for the government to progress negotiations surrounding the Free Trade Agreement, to build other trade and investment links and to resolve disputes.