Free trade could be expensive for Australia

We should always pay considerable attention to the balance between government intervention and market forces on many issues, including our promotion of freer trade.  

Sure Australia’s recent greater adherence to freer trade has brought success with Australia recording an average 3.3 per cent GDP growth in the 17 years from 1992 (one of the highest levels amongst developed nations). In response to the changing demands of the international economy, Australia has benefited from policy reforms intended to make the Australian economy more competitive, including lower taxation and tariff rates along with labour market reform.

Yet, Australia’s economic response has hardly been in strict accordance to principles of free trade, despite the Industry Assistance Commission’s 1973-74 Annual Reportrightfully declaring that Australia’s industries needed to be made accountable for the assistance they received. 

First, it is a myth to suggest that Australia adhered to free trade just because the average effective rate of tariff assistance for manufacturing and agriculture was lowered from about 35 and 28 per cent in 1970 to around 5 per cent by 2005-6. While difficult to evaluate the true extent of non-tariff barriers (NTBs), a 2003 study of nine countries estimated NTB levels to be less than 10 per cent for Canada and the US across different industries; 12 to 18 per cent for Italy, Australia, and Germany; in the 30s for Belgium, the Netherlands, and the UK; and 58 per cent for Japan. In 2008-09, Australia’s motor vehicle and parts sector alone received an estimated $1.596 billion of net combined assistance of a total $8.295 billion provided to manufacturing, while agriculture received $1.755 billion and mining $420 million.

No wonder India during 2009 sought an integrated database through the WTO that will compile all non-tariff barriers existing worldwide.

Second, while WTO data indicates that manufactures still represented 66.5 per cent of world merchandise exports in 2008, compared to 8.5 per cent for agriculture and 22.5 for fuels and mining, Australia has benefited from the greater rise in the value of fuels and mining since 2000. Hence, during the period 2000-2008, the percentage of Australia’s merchandise exports from fuels alone increased from 20.9 to 31.8 per cent.

In other words, as indicated by Table 1, rising prices for coal alone since 2000 have helped offset a further decline in our proportion of global exports for agriculture and manufacturing.  

Table 1: World Merchandise exports: agriculture, fuels and manufacturing (billions of $US)

And despite the hopes for services (with that sector’s exports still about a quarter of merchandise exports in 2009-10), Australia’s future economic well-being increasingly relies on the economic fortunes of authoritarian China. A 2010 article indicates that 53 per cent of Australia’s 1.6 per cent GDP growth in 2009 came from exports to China. Further, data since 2005 indicates why the Australian sharemarket and Australian dollar are now heavily influenced by the prospects for China’s growth.

No wonder Prime Minister Gillard, when asking the US Congress to promote free trade further, suggested that the global economy “is not a zero-sum game”, and that “there is no reason for Chinese prosperity to detract from prosperity in Australia, the US or anywhere in the world”.

But Australian political leaders are dreaming if they think that industry protection will go away. While an Australian government site notes China’s efforts to comply with WTO trade commitments given that its average tariff rates on imports dropped to 9.8 per cent by 2007, with agricultural products at an average of 15.3 per cent and industrial products 8.95 per cent, it also noted that “a variety of non-tariff trade barriers still remain which impedes access to the China market”.

So what will Australia do? 

Sure we will take China’s money, although one doubts that authoritarian China will be allowed to take control of strategically important national companies. If public opinion allows it, Australian governments may even seek to boost GDP and help boost real estate values by allowing more rich Chinese to settle here. Already, some nations are easing citizenship requirements by offering enticements to attract foreign money to help restore their economies with more than 1000 people applying for EB-5 visa (US investment immigration) in 2009, double the 500 in 2008. With Europe less attractive for China’s rich immigrants because of strict policies and complicated procedures, the US, Canada and Australia are favoured more as ideal immigration destinations.

For now, Australia appears fortunate, but who knows what the future will bring given some concern about inflationary risks in China ultimately being exported to economies like Australia.

And there remains the prospect of greater economic tension between the US and China given that Americans cannot go on fuelling the world economy forever through higher and higher debt levels. Along with Table 2 indicating US decline in key industry sectors, US share of world merchandise exports fell from 12.6 to 8.2 per cent between 1993 and 2008 while China’s proportion increased from 2.5 to 9.1 per cent.

Table 2: Exports: Agriculture, fuels and manufacturing (billions of $US)

Although Americans are also concerned about manufacturing jobs being lost offshore everywhere, it remains to be seen how long the US (and other Western nations) are prepared to allow China to maintain an undervalued currency (and other protectionist measures) which has allowed it to sustain huge trade surpluses and accumulate more than $US2 trillion worth of foreign exchange reserves.

While the proportion of offshore employment for US manufacturing firms between 1957 and the late 1980s increased from 10 to 22 per cent, US multinational corporations in 2009 employed 21.1 million in the US and 10.3 million in other countries. GE now employs more people abroad than at home (54 to 46 per cent), and Oracle (maker of computer hardware and software) employed 63 per cent of its workers offshore by the end of 2010.

Sure Western societies must give developing nations their own trade opportunities, and there is a cost to the domestic economy from protection. After all, higher domestic prices benefit producers yet penalise consumers, and exporting such higher cost goods will deliver lower profits to domestic shareholders who own shares of companies making profits offshore.

But it is rather wishful to believe that Western governments should simply promote the greatest efficiency of the international economy forever in a belief that “manufacturing operations will continue to move to other countries until that point at which it is no longer efficient for them to do so”.

In reality, pure free trade will never exist as long as a hierarchy of wealth exists between competitive nations. Even the US continues to support anti-dumping and countervailing duties as part of the WTO process as a “safety valve” to help sustain a broad political consensus in favor of trade liberalisation by allowing WTO members to raise tariffs in specific cases where the pain of competition becomes too great.

No wonder the WTO Director General Pascal Lamy just days ago noted that differences between countries over how much to cut manufactured goods tariffs were “unbridgeable”, despite a hope that all parties would agree to further cuts via two formulas, one for developing countries and one for developed countries http://www.reuters.com/article/2011/04/21/us-trade-wto-doha-idUSTRE73K8I220110421

As for Australia, recent policy trends have merely entrenched our vulnerability in the international economy. I shudder to think what we will become of Australia if we eventually sell off our farms and land to foreigners when our manufacturing prowess rates so poorly when compared to many other developed nations.

While we hope for the best, our ties with the Chinese economy will mean that any future decline in the world economy will hit Australia hard. With the 25 per cent weighting of our local market to the materials, or resources sectors, this dual reliance saw the Australian sharemarket fall by 10 per cent in the first half of 2010 whereas the global sharemarket fell by only 4 per cent. One can also remember the Australian dollar dropping 33 per cent against the US dollar on a monthly average basis from its peak of 96c in June 2008, not long before the global financial crisis climaxed in September that year, to a trough value of 64c in January 2009.

What is now worrying for Australia is that only a major economic slowdown may reduce the value of the Australia dollar to help make its non-commodity goods and services exports and tourism more attractive for foreign buyers as high international commodity prices continue to shield many mining and rural industries from the worst effects of currency appreciation.

To conclude, yes Australia remains a lucky country when compared to other Western nations (largely because of its minerals and fuels in the ground), yet our growing trading reliance on China and our own housing bubble spells out that all is not well in this era of so-called freer trade.