2 December 2008
There has been a significant proliferation of bilateral free trade agreements (FTAs) in recent history, particularly FTAs struck between governments in the same region, notably in the Asia-Pacific region.
At the time of the Asian financial crisis in 1997/98 there were only six FTAs in the Asia-Pacific region. At the end of 2006, there were more than 60 FTA projects in various stages of development or negotiation. Some governments, including Australia, believe that FTAs are a significant first step towards regional-level and multilateral agreements, and other forms of regional cooperation.
Since 2003, Australia has concluded FTAs with Thailand, Singapore, the US and Chile. Australia is also negotiating FTAs with ASEAN (jointly with New Zealand), the Gulf Cooperation Council, China, Japan and Malaysia, and has begun feasibility studies on possible FTAs with Indonesia, India and Korea.
This Background Note examines the impact of the FTAs thus far concluded and their trade impact on Australia.
Bilateral trade agreements or FTAs
Bilateral FTAs are distinct from multilateral agreements in that non-trade considerations often predominate in FTAs.
FTAs are negotiated between two governments (more if it is a regional agreement, as with Australia’s proposed FTA with ASEAN and New Zealand) and additional, non-trade terms can be negotiated, such as a services agreement and improved customs protocol.
Typically, there is a phase-in period for free trade between the two countries (over a five, ten, or fifteen-year period) to take account of politically sensitive areas of trade which have high levels of protection, so that not all trade is free.
Generally, the WTO is not supportive of FTAs because the trade benefits and welfare gains are limited to the parties. The Most Favoured Nation clause of the WTO Agreement requires any member benefit that is applied to one member state be applied to all member countries (thus maintaining liberalisation processes and the benefits).
FTAs are excepted from the WTO via Article XXIV of the WTO Agreement, but only one FTA has been approved out of more than 300 submitted.
In economic theory, trade diversion resulting from FTAs runs contrary to the general idea of comparative advantage by favouring those countries that have negotiated an FTA.
Trade diversion occurs when a country chooses to trade with a partner country because of its preferential or zero-tariff status under the FTA, rather than because of their efficient production or price of inputs.
Research suggests that FTAs offer little in the way of trade liberalisation and a shift to more liberal trade policies, particularly in agricultural trade. Rather, FTAs are used more often to promote other non-economic, diplomatic and regional interests.
The Thailand-Australia Free Trade Agreement (TAFTA) came into effect on 1 January 2005.
Thailand is South-East Asia’s second largest economy and is also one of the fastest growing economies in the region.
After Vietnam, Thailand is the most protectionist member of ASEAN. Before the FTA, most of Australia’s exports to Thailand (close to 80 per cent) were affected by high tariffs. In some cases, the tariffs were up to 200 per cent. An official 2004 study and modelling of the TAFTA described it as a winner.
The study, commissioned by DFAT, estimated Australia’s GDP would increase by 0.01 per cent (or $3 billion) peaking at 0.03 per cent (or $9 billion) in 2010 as a result of the TAFTA. Also, the welfare gains (or real GDP increase) over 20 years were estimated at US$2.4 billion to Australia and US$6.8 billion to Thailand.
The introduction of the TAFTA eliminated more than half of Thailand’s 5000 tariffs. Remaining tariffs will be reduced or eliminated over the next five to 15 years and will result in free trade for close to 95 per cent of all trade between Australia and Thailand.
In 2007, trade between Australia and Thailand totalled $12.3 billion compared with $6.8 billion in 2004. Since the TAFTA came into effect, bilateral trade has nearly doubled and Australia’s trade deficit has risen from $711 million to $3.5 billion.
As a result of the TAFTA, Thailand has established itself as an alternative source for electronics (mainly computers, electrical machinery and appliances), motor vehicles and household goods. Imports of these goods have risen sharply by 105 per cent, 317 per cent and 93 per cent respectively since 2004.
Australian imports of motor vehicles from Thailand have tripled from $1 billion in 2004 to $3.2 billion since tariffs were removed. A factor contributing to the increase in motor vehicle imports has been the decision of Japanese car makers to relocate manufacturing plants to Thailand.
By comparison, Australia’s exports to Thailand have risen by 44 per cent. In 2007, Australia’s main exports to Thailand were crude oil ($861 million), aluminium ($762 million), gold ($551 million) and copper ($332 million).
Tariffs for some Australian agriculture and food products are 60 per cent less than those for competitors from other countries. This has created opportunities for agricultural exports, particularly dairy products which have increased by 50 per cent.
The Singapore-Australia Free Trade Agreement (SAFTA) came into effect on 28 July 2003.
Singapore has a tradition as a duty-free port and a major trans-shipment hub. It has a highly developed free market economy. Exports of consumer electronics and appliances, and IT equipment are particularly important to Singapore. Other significant industries include ship repair, petroleum refining and offshore platform construction.
With no domestic agricultural production, Singapore relies on food imports. Australian food exports (meat, dairy products, fresh fruit and vegetables) account for 15 per cent of total exports to Singapore and are the largest export item after crude oil.
A 2001 study of the net benefits of an FTA with Singapore commissioned by DFAT found no quantifiable net gain to Australia.
In 2007, bilateral trade between Australian and Singapore was worth $14.5 billion compared to $9.4 billion in 2004. However, Australia’s trade deficit has more than doubled in the same period, rising from $3 billion in 2004 to $6.4 billion in 2007. The higher trade deficit is due mainly to the increase in refined petroleum imports which account for 55 per cent of total imports from Singapore.
In February 2004, the government secured an historic FTA with the US. After several rounds of negotiations and the personal intervention of the Australian Prime Minister and US President, an FTA was concluded in the latter half of 2004.
The Australia-US Free Trade Agreement (AUSFTA) came into effect on 1 January 2005. As a result of the agreement, 97 per cent of Australian manufacturing exports to the US are duty free, while 99 per cent of US manufacturing exports to Australia are duty free. All Australian and US tariffs on manufactured goods will be zero by 2015.
Australia’s manufacturing sector was the biggest winner, particularly motor vehicle producers and component manufacturers. Large export gains were forecast with the removal of the 25 per cent tariff on commercial vehicles. Other manufacturers that were expected to gain from the AUSFTA were metal, seafood and chemical producers. Manufactures represent almost half of all exports to the US.
In the year following the AUSFTA and in 2007, exports to the US fell while US imports increased. Manufactured exports fell across most categories in line with the decline in exports. Australian exports of motor vehicles fell by more than 200 per cent from their peak in 2004. Exports of vehicle parts also fell sharply from their peak of $286 million in 2003 to $131 million in 2007. 
The prospect of increased manufactured exports remains doubtful given the current US recession and much higher manufacturing productivity levels in the US.
Australia’s $13.6 billion trade deficit with the US in 2007 is the highest trade deficit Australia has recorded with any trading partner. Along with the widening trade deficit, two-way trade with the US has fallen to a record low, now accounting for only 9.5 per cent of total trade. Just five years ago the US share of Australia’s trade was 14 per cent.
In the first three quarters of 2008, two-way trade with the US continued the declining trend, accounting for 9.1 per cent of total trade.
During 2003 and 2004, five different assessments were made on the impact of the AUSFTA on the Australian economy. Of the five studies, four – by the International Monetary Fund (IMF), ACIL Tasman, the National Institute of Economic and Industry Research (NIEIR) and Dr Philippa Dee of the ANU – found that the AUSFTA would have little or no impact, or would be bad for the Australian economy.
At worst, NIEIR found that the AUSFTA could cost the Australian economy up to $50 billion and 200 000 jobs.
The IMF study found that a free trade agreement with the US would shrink the Australian economy by 0.03 per cent per year with US$5.26 billion of extra US imports. At the same time, additional Australian exports of manufactured goods were estimated at only US$980 million per year. The bulk of extra imports (US$5 billion or 95 per cent of extra US imports) would be US manufactured goods, of which US$2.7 billion would replace imports mainly from Asia, the EU and Japan.
The report by ACIL Tasman, commissioned by the Rural Industries Research and Development Corporation, found that the AUSFTA would damage Australia’s economy and it was questionable whether there would be any net benefit from a bilateral deal with the US.
In terms of current trade flows, the assessment by the IMF has proved the more reliable although US imports have not risen by the amount forecast and Australian manufactured exports have declined.
It remains unclear whether the widening trade deficit with the US and the decline in manufactured exports to the US can be attributed to the AUSFTA or to the lagged effect of the strong Australian dollar beginning in early 2004, or to a combination of both of these factors.
The Australian and Chilean governments are aiming for the recently concluded FTA to come into force on 1 January 2009. Most tariffs will be eliminated except for those relating to the textile and clothing industry, and all trade will be tariff free by 2015.
Bilateral trade between Australia and Chile is very small, involving $540 million in 2007. Chile ranks as Australia’s 41st trading partner. In 2007, Australia’s main exports to Chile were coal ($94 million) and civil engineering equipment ($21 million). Main imports from Chile comprised copper ($96 million), and pulp and waste paper ($57 million).
The conclusion of the FTA was at a time when Australia’s trade deficit with Chile was $141 million in 2007. Since the beginning of 2008, the trade deficit has risen to $239 million.
The faltering of Doha negotiations since the Seattle meeting in 1999, and more recently in Geneva, has led trade policymakers to develop bilateral strategies and FTAs as ‘a second best’ policy against the collapse of the WTO trade order.
Of the four FTAs currently in force, a common feature has been their impact on trade flows. The FTAs were followed by higher Australian trade deficits and a much slower rate of reciprocal export growth, as well as trade diversion as products were sourced from countries with which Australia has zero tariffs.
The potential risks of the current FTA model adopted by Australia are clear: structural trade imbalances leading to higher trade deficits favouring the FTA partner country, long phase-in periods for free trade (in particular agricultural trade), and negative impacts on the Australian economy which are related to trade diversion.
The anticipated gains for Australian exporters have fallen well short of estimates. Given the growing importance of FTAs in the Asia-Pacific economy, policymakers need to evaluate FTA models and their importance relative to the region’s most significant multilateral project, APEC.
In light of the current experience it is questionable whether Australia’s FTAs, on a country by country basis, can speed up trade liberalisation by delivering benefits to Australian producers faster than through the multilateral processes.
. All references to trade are to merchandise trade.
. See J. Audley, Bad Bilateral Trade Deals Are No Better Than Bad Multilateral Deals, Issue Brief, Carnegie Endowment for International Peace, October 2003,
http://www.carnegieendowment.org/pdf/files/issuebriefoct2003.pdf, accessed on 26 November 2008; C.M. Dent, ‘Lattice Regionalism: Asia-Pacific Bilateral Free Trade Agreements’, European Journal of East Asian Studies, 2005, vol. 4 (2), pp. 287–314.
. Department of Foreign Affairs & Trade, Composition of Trade 2007, Market Information and Analysis Section, DFAT, May 2008, pp. 280–281, http://www.dfat.gov.au/publications/stats-pubs/cot_cy2007.pdf, accessed on 26 November 2008.
. See DFAT, Submission to the Review of Australia’s Automotive Industry 2008, May 2008, p. 20, http://www.innovation.gov.au/automotivereview/Documents/113%20DFAT%20220508.pdf, accessed on 26 November 2008.
. DFAT, Composition of Trade 2007, op. cit., pp. 280–281.
. Access Economics Pty Ltd, The Costs and Benefits of a Free Trade Agreement with Singapore, September 2001.
. DFAT, Composition of Trade 2007, op. cit., pp. 258–259.
. Australia is a net importer of refined petroleum.
. See Centre for International Economics, Economic Analysis of the AUSFTA – Impact of the bilateral free trade agreement with the United States, prepared for DFAT, April 2004, p.75,
http://www.thecie.com.au/content/publications/CIE-economic_analysis_ausfta.pdf, accessed 26 November 2008. Estimated an increase in exports of 0.9 per cent rising to 1.3 per cent above the base line in 2025.
. DFAT, Composition of Trade 2007, op. cit., p. 290.
. A. Young, J. Wilkie, R. Ewing, & J. Rahman, ‘International comparison of industry productivity’, Economic Roundup, Issue 3, 2008, pp. 45–61. The Treasury paper found that Australian manufacturing industries had much lower relative productivity levels.
. ABS, International Trade in Goods and Services, ABS, Cat No 5368.0, September 2008, http://www.abs.gov.au/AUSSTATS/abs@.nsf/allprimarymainfeatures/
A5FB33BD2E3CC68FCA257496001547A1?opendocument, accessed on 26 November 2008.
. NIEIR, An Assessment of the direct impact of the Australian-United States Free Trade Agreement on Australian trade, economic activity and the costs of the loss of national sovereignty, prepared for the Australian Manufacturing Workers Union, May 2004, http://www.aph.gov.au/Senate/committee/freetrade_ctte/submissions/sub463att2.pdf, accessed 26 November 2008.
. A. Hilaire & Y. Yang, The United States and the New Regionalism/Bilateralism, International Monetary Fund, Working Paper, WP/03/206, October 2003, http://www.imf.org/external/pubs/ft/wp/2003/wp03206.pdf, accessed on 26 November 2008.
. See ACIL Consulting, A Bridge Too far?: An Australian Agricultural Perspective on the Australian/United States Free Trade Area Idea, report for the Rural Industries Research and Development Corporation, February 2003, http://www.rirdc.gov.au/reports/GLC/ACIL-ABridgeTooFar.pdf, accessed 26 November 2008.
. The equilibrium model used by the IMF assumed free trade between Australia and the US.
. DFAT, Composition of Trade 2007, op. cit., pp. 155–156.
. ABS, op. cit., Table 14a & Table 14b.
For copyright reasons some linked items are only available to members of Parliament.