This article provides an analysis of the potential economic effects of the China-Australia free trade agreement, and provides a set of policy recommendations regarding such an agreement. The article begins with a review of China-Australia trade relations, showing the widening gap in the importance of one country relative to the other. Next, the article examines the competitive advantages of China and Australia in trade by way of local revealed comparative advantage (RCA) and finds that trade between China and Australia is predicated on differences in their factor endowments. The study then investigates the main problems in the negotiations for the China-Australia Free Trade Agreement and concludes with a set of policy suggestions
Key words: China-Australia FTA
JEL Codes: F13, F53, F59
1 Introduction
Since the 1990s, regional trade agreements have gradually taken the place of multilateral trade negotiations as a major means for promoting free trade. With free trade agreements spreading across Europe, the Americas and East Asia, China is also stepping up its negotiations on bilateral and regional free trade agreements. In addition to the China-ASEAN Free Trade Agreement, China has also concluded free trade agreements with Chile and Pakistan, among others. Speeding up negotiations on free trade zones is, on the one hand, a passive strategic choice for China in response to the upsurge in regional free trade agreements, and, on the other, part of a proactive strategy of China as a major economic and trade power to create a myriad of multi-tiered external markets, i.e. a diversified external market. It is against such a background that the negotiations between China and Australia for a free trade agreement were initiated. So far, nine rounds of talks have been held, but differences still remain. This article provides an analysis of the potential economic effects of a China-Australia free trade agreement, and provides a set of policy recommendations regarding such an agreement. Section 2 contains a discussion of the status quo with respect to trade between the two countries and the differences in the relative importance of the two countries to each other. Section 3 studies the characteristics of trade between the two countries and examines the competitiveness of the industries of the two nations by way of local revealed comparative advantage (RCA) indices. Section 4 investigates the main problems impeding negotiations over the China-Australia free trade agreement and offers a set of policy suggestions.
2 Trade between China and Australia: Status Quo and Comparative Importance
Bilateral trade between China and Australia has been growing continuously since the establishment of diplomatic relations between the two countries in 1972, and has basically undergone three stages. The first was the 1970s and 1980s, which saw a steady increase in bilateral trade. During that period, trade volume increased from US$1.14 billion in 1979 to US$1.55 billion in 1989. The second stage, one of accelerated growth, traversed the 1990s when the volume of bilateral trade rose from US$1.61 billion in 1990 to US$6.31 billion in 1999, an increase of approximately 300%. The third stage has been one of all-round expansion, which started after the turn of the century when China's accession to the WTO provided a more stable institutional framework for the growth of bilateral trade between the two countries. By 2006, the trade volume reached US$34.65 billion, of which US$15.41 billion came from Australian exports to China, making China the second largest market for Australia's exports, following Japan. In the same year, Australia recorded US$19.24 billion worth of imports from China, making China Australia's largest source of imports.
Despite the continued growth in bilateral trade between the two countries, Tables 1 and 2 show that the importance of Australia and China to each other as trading partners has become increasingly divergent. In the late 1990s, China was merely one of the five major trading partners of Australia, yet by 2006, China was the second largest export market for Australia. In contrast, Australia was still just one of several important trading partners for China. For example, Australia was only the twelfth largest trading partner of China in 2002 and the ninth largest trading partner in 2005. Furthermore, Australian exports to China typically constitute more than 10% of its total exports, while China's exports to Australia account for a much smaller share in her total exports, generally less than 2%. Similarly, Australia's imports from China exceed 13% of Australia's total imports whereas China's imports from Australia are valued at around 2% of China's total imports.
TABLE 1 SHARES OF AUSTRALIA'S TRADE WITH CHINA IN AUSTRALIA'S
TOTAL TRADE VOLUME ($100 million)
Year Exports to Share of Imports Share of
China Australia's From Australia's
Total Exports (%) China Total Imports (%)
2005 12,196 11.6 16,242 13.7
2006 15,413 12.5 19,237 14.5
2007 1-6 94,050 14.1 10,407 14.3
Source: http://www. mofcom.gov.cn.
TABLE 2 SHARES OF CHINA'S TRADE WITH AUSTRALIA IN CHINA'S TOTAL TRADE
VOLUME ($100 million)
Year Exports to Share of China's Imports From Share of China's
Australia total exports (%) Australia Total Imports (%)
2005 16,242 2.1 12,196 1.8
2006 19,237 2.0 15,413 1.9
2007 1-6 10,407 1.9 94,050 2.2
Source: http://www. mofcom.gov.cn
In China's implementation of its strategy for market diversification through regional free trade agreements, Australia has no obvious advantages. Table 3 groups countries into three categories according to China's exports to each individual country as a percentage of China's total exports, in order to analyse the current status of diversification of China's export market. The first category consists of countries
that each account for more than 10% of China's total exports; the second is countries that account for between 5% and 10% of China's exports and the third, countries that account for a mere 1-5% of total Chinese exports. The first two categories together constitute the important trading partners of China. Australia falls in the third category. While trade between the two countries has grown rapidly, China has not been forceful enough in its effort to implement its market diversification strategy as far as Australia is concerned.
TABLE 3 CHINA'S DIVERSIFICATION OF ITS EXPORT MARKET
DEVELOPMENT (1985-2005)
Year First Category Second Third Total
Category Category
1985 Hong Kong (22.17%) EU (8.69%) Jordan First
(4.09%) Category 2
Japan (21.64) Singapore (8.08%) Soviet Union Second
(3.74%) Category 2
United States Brazil Third
(10.23%) (1.63%) Category 6
Switzerland
(1.36%)
Romania
(1.03%)
Poland (1%)
1990 Hong Kong (35.7%) United States Soviet Union First
(9.25%) (4.1%) Category 2
Japan (17.04%) EU (7.05%) Singapore Second
(3.58%) Category 2
Thailand Third
(1.77%) Category 4
Pakistan
(1.09%)
1995 Hong Kong (24.19%) South Korea First
(4.5%) Category 4
Japan (19.13%) Singapore Second
(2.35%) Category 0
United States Taiwan Third
(18.43%) (2.08%) Category 7
EU (12.83%) Thailand
(1.18%)
Russia
(1.12%)
Australia
(1.09%)
Canada
(1.03%)
2000 United States South Korea First
(20.91%) (4.53%) Category 4
Hong Kong (17.8%) Singapore Second
(2.31%) Category 0
Japan (16.71%) Taiwan Third
(2.02%) Category 8
EU (15.33%) Australia
(1.38%)
Canada
(1.27%)
Indonesia
(1.23%)
Malaysia
(1.03%)
Russia
(1.12%)
2005 United States ASEAN (7.3%) South Korea First
(21.4%) (4.6%) Category 4
Taiwan, Second
China Category 1
(2.2%)
EU (18.9%) Russia Third
(1.7%) Category 6
Hong Kong Canada
(16.3%) (1.5%)
Australia
Japan (11%) (1.5%)
UAE (1.1%)
Source: China Commercial Year Book (1985-2005), at:
http://www.mofcom.gov.cn.
The widening gap in the importance of one country to the other in the trade arena comes as a result of the rapid increase in China's total trade volume, as well as the implementation of its market diversification strategy. By 2005, China was the fourth largest economy of the world, while Australia was the fifteenth. Figures 1 and 2 compare the rates of growth in trade by China and by Australia since 2000. When it comes to diversification of markets, there is a lack of diversification in the case of Australia, which relies heavily on Japan, China, and South Korea as export markets, whereas for China, as shown in Table 3, a diversified export market has already taken shape.
[FIGURE 1 OMITTED]
[FIGURE 2 OMITTED]
3 An Analysis of Australia and China's Competitive Advantages in Trade and the Economic Effect of the Free Trade Agreement
Trade between China and Australia covers industrial products, mineral resources, and agricultural goods and services. The products exported by China to Australia are mainly industrial goods while the commodities exported by Australia to China are mainly agricultural products and mineral resources. This demonstrates a strong complementarity in imports and exports between the two countries. In this section I examine the competitive advantages of China and Australia in industrial products and mineral resources respectively by way of local revealed comparative advantage (RCA). (1) The local RCA shows the comparative advantage of each country's exported products in the other country's market.
From Tables 4 and 5 one may conclude that the trade relationship between China and Australia is a true reflection of their comparative advantage in factor endowments. Chinese exports to Australia mainly consist of industrial manufactured goods. Products in which it has enjoyed a traditional advantage, for instance textiles and garments, machinery & equipment, and tools, take up a large portion, while export of products with high value added, for instance, computers and telecommunications equipment, is also growing quickly. China's exports to Australia have reflected its traditional advantage in low-wage manufacturing. Similarly, Australian exports to China of such resource-based products as metal ores, copper, iron, timber and hides, as well as certain high-value-added manufactured goods and services, is indicative of its advantages in resources and capital. Noteworthy is the fact that in the comparison of local RCAs, Australia's advantage in resources endowment, as shown in resource-based products, particularly metal ores, outweighs China's advantage in labour endowment. For instance, the local RCA index of metal ores is rated as high as 105.
TABLE 4 THE LOCAL RCA OF CHINA'S EXPORTS TO AUSTRALIA
HS Product 2004 2005 2006 Average
Code
84 Nuclear Reactor; Boiler; 10.72 11.92 12.01 11.55
Machinery and Accessories
85 Electric Machinery; Electric 15.19 15.55 17.44 16.06
Equipment; Acoustic Equipment and
Accessories
62 Garments, not Knitted or 55.76 53.00 17.44 42.06
Crocheted
61 Knitted or Crocheted Garments and 64.46 60.67 58.25 61.13
Clothing Accessories
94 Furniture and Bedclothes 31.89 33.69 34.65 33.41
95 Toys; Game and Sports Products 47.80 44.72 45.12 45.88
and Related Parts and
Accessories
73 Iron and Steel Products 17.71 16.44 17.50 17.22
64 Parts of Footwear; Gaiters and 50.30 47.76 46.95 48.34
Similar Products and Accessories
39 Plastics and Related Products 10.74 11.44 11.75 11.31
63 Other Textile Products; 43.64 42.13 40.91 42.23
Second-hand Garments
87 Vehicles and Related Parts and 1.23 1.19 1.46 1.29
Accessories
90 Optical; Photographic and Medical 5.22 5.20 4.53 4.98
Instruments Related Parts and
Accessories
76 Aluminium and Related Products 23.80 21.42 24.05 23.09
40 Rubber and Related Products 5.64 7.01 8.05 6.90
27 Mineral Fuels; Lubricants; 1.64 1.07 0.75 1.16
Asphalt
72 Iron and Steel 5.98 10.53 6.18 7.56
82 Base Metals; Edge Tool; Dishware 16.24 14.74 16.34 15.77
and Accessories
28 Inorganic Chemicals; Precious 11.82 9.37 9.53 10.24
Metal Compound
44 Wood and Wooden Products; 7.92 7.35 8.73 8.00
Charcoal
71 Jewellery; Precious Metal and 1.76 1.91 1.18 1.62
Related Products; Artificial
Jewellery; Coins
49 Presswork; Manuscript; Typescript 6.64 7.81 8.17 7.54
and Design Drawing
Source: http://www.stats.gov.cn.
TABLE 5 THE LOCAL RCA OF AUSTRALIA'S EXPORTS TO CHINA
HS Produce 2005 2006 Average
Code
26 Ore; Slag; Mortar 113.58 96.63 105.11
27 Mineral Fuels; Lubricants; Asphalt; 5.80 3.42 4.61
74 Copper and Related Products 7.85 7.63 7.74
41 Raw Hides and Leather 16.65 22.46 19.56
75 Nickel and Related Products 27.40 32.86 30.13
52 Cotton 21.72 12.88 17.30
84 Nuclear Reactor parts; Boilers; 1.54 1.07 1.31
Machinery and Accessories
32 Tanning; Dyeing Materials; Painting 19.46 14.31 16.88
Materials; Putty; Ink
85 Electrical Machinery; Electric 0.27 0.22 0.25
Equipment; Acoustic Equipment and
Accessories
44 Wood and Wooden Products; Charcoal 8.28 6.47 7.38
15 Animal and Vegetable Oils; Fats and 13.34 9.02 11.18
wax; Refined Edible Oils and Fats;
Fish; Shellfish; Molluscs and other
Aquatic Invertebrates
47 Paper Pulp and Cellulose Pulp; Paper 3.69 3.44 3.56
and Paper Board Waste
3 Fish 17.08 7.31 12.19
72 Iron and Steel 1.66 1.08 1.37
71 Jewelry; Precious Metal and Related 12.29 2.19 7.24
Products; Artificial Jewelry; Coins
28 Inorganic Chemicals; Precious Metal 2.28 1.45 1.87
Compound
48 Paper and Paperboard; Articles of Paper 4.63 3.29 3.96
Pulp or
Source: http://www.stats.gov.cn.
In terms of the composition of the imports and exports of agricultural products, wool, cotton, and livestock products are the main items that Australia exports to China, while crustaceans, cereal preparations and fruit juices are the products that it imports from China. Chinese exports to Australia are mainly labour-intensive agricultural products while Australian exports to China are mainly resource-based agricultural products, a fact that shows a high level of complementarity in the bilateral trade in agricultural products. As Australia has more advantages in terms of agricultural commodities, China has always had a trade deficit with Australia. While the deficit was only US$600 million in 1998, it reached US$2.3 billion in 2004, registering an increase of almost fourfold over those six years.
The trade creation effect that comes with the China-Australia free trade agreement might be expected to promote structural adjustment in the domestic industries of both countries, but such adjustment could have the following characteristics. First, both countries would adjust their industrial structure in a way that would enable them to better exploit their respective comparative advantages, given that their trade has been based entirely on their respective endowment advantages. Second, only a limited scope of industrial adjustment would be brought about by the free trade agreement; or in other words, the economic effect of the free trade agreement would not be so manifest. According to a study by Hu et al. (2006) based on the Global Trade Analysis Project (GTAP), (2) on the Chinese side, there will be a decrease of less than 1% in the output of certain sectors producing industrial raw materials, while other industrial sectors may see some increase in output, albeit small, at no more than 1%. For the agricultural sector, a slight downward trend can be expected after the creation of the free trade agreement, with output dropping by no more than 1%. In contrast, however, the free trade agreement is likely to bring about a large increase in the output of Australian resource-intensive agricultural and livestock products, but for the industrial sector, and especially the textile industry, output would decrease. A similar conclusion has been drawn by Yang et al. (2005) in their GTAP simulations, i.e. that the creation of the free trade area in 2010 would benefit China's textile and garment sectors most, by generating an increase of 0.52%, and this would exert a negative impact on the Australian textile and garment sectors, leading to a drop in production by 5.98%. The simulations by Yang et al. (2005) also recorded negative values for the impact of the free trade agreement on China's heavy and light industries. Third, the China-Australia free trade agreement would benefit Australia more than its does China. The free trade agreement would strengthen Australia's advantages in exports. As for the overall effect on both countries' GDPs, Hu et al. (2006) indicate with their GTAP simulations that the creation of the free trade area will lead to an increase of 0.08% in China's GDP and 0.6% in Australia's GDP.
4 Strategic Choice for China in Negotiations over the Free Trade Agreement
Analysis of trade between China and Australia has shown that there does exist a high degree of complementarity between the two countries in some traded goods, thus providing the necessary precondition for the conduct of negotiations on a free trade agreement. However, Chinese scholars hold the widespread view that such negotiations may not result in substantial economic returns for their country and that the influence on the overall economy would be minimal. Therefore, they believe that Australia should be put into the third category of nations in the context of China's strategy for diversification of external markets (see Li, 2007; Yu, 2006).
Negotiations between the two countries have recently not fared well. Since the ninth round of talks ended in June 2007 in Beijing, no progress has been made on market access, especially for agricultural products, leaving the negotiation process deadlocked. Import tariffs in Australia are characterised by an obvious inverse relationship with the competitive edge of the products concerned. Since its agricultural products are highly competitive on the international market, Australia already sets import tariffs for many agricultural products at zero. Thus, there will be little change in the profitability of China's agricultural exports to Australia, even if Australia reduces import tariffs for all agricultural products to zero after the China-Australia free trade area is established. On the other hand, China is more concerned about the impact of Australian quarantine measures on the export of its agricultural products. China's position is that Australia's quarantine measures are both cumbersome and unnecessary, and are contrary to the requirements contained in the 'Agreement on the Application of Sanitary and Phytosanitary Measures' and the 'Agreement on Technical Barriers to Trade'. In terms of industrial products, the average tariff applied fell marginally from 4.8% in 2002 to 4.1% in 2006, while tariffs remain high on such industrial goods as textiles, garments and footwear. (3) High tariffs on these products have dampened China's advantages in the export of manufactured goods. How should China handle the stalemate in the negotiations on the China-Australia free trade agreement? From China's perspective, there are several issues that need to be resolved.
4.1 China's Strategy of Market Diversification and its Key Trading Partners
The prevalence of regional free trade agreements is increasing, showing that developed countries are seeking to build economic spheres of influence in which they can play a dominant role. This in practice has served to boost the diversification of markets. As a result, China must respond positively to the trend towards regionalisation by formulating a strategic framework for market diversification. While a recent study by Li (2007) has suggested that China's strategy for market diversification should be focused on Sino-American, Sino-European and Sino-Japanese-and-South Korean trade relations, due attention must also be given to the importance of Australia as the tenth largest trading partner of China. The economic uncertainties and ever-increasing trade barriers that have emerged in Europe and the United States have made Australia an attractive trading partner for China. The 2007 sub-prime mortgage crisis in the United States has spread to the European economy and the world economy beyond 2008 is fraught with uncertainties. Trade frictions between China and the United States and Europe have been escalating, causing serious damage to China's exports. All this has prompted China to seek new trading partners in order to diversify the external risks involved in the process of its domestic restructuring.
4.2 China's Overall Strategic Interests versus its Strategy to Acquire Raw Materials
Although the negotiations on the China-Australia free trade agreement may have little influence on the overall development of the Chinese economy, trade between China and Australia in raw materials has strategic significance to China. With such minerals as iron, manganese and copper expected to be in short supply for its continued economic growth by 2010, China is keen to make Australia--a major world exporter of mineral products--one of its key suppliers of raw materials. Minerals have long been the main commodity that Australia exports to China. In 2006, Australia exported US$8.25 billion of minerals to China, accounting for 53.6% of its total exports to China, representing an increase of 34.4% over the previous year. In the same year, Australian exports of nickel, lead, zinc and copper to China increased by 159.0%, 122.2%, 73.1% and 70.0% respectively on a year-on-year basis. Thus Australia is becoming increasingly prominent in China's strategy to acquire raw materials.
4.3 Ensuring that Both Parties Gain Something from the Free Trade Agreement
As China and Australia differ markedly in their factor endowments, the establishment of a free trade area will strongly affect China in those sectors in which Australia has held clear advantages. On that account, both sides need to pay particular attention to the balance of their interests during the negotiations, taking into account not only their own capacity, but also the legitimate requirements of the other party. On the one hand, sufficient allowance needs to be given in terms of the scope and timetable of tariff concessions for those sectors in which one party is lagging. On the other hand, both sides need guaranteed gains to make the process worthwhile.
4.4 Balancing External Impact and Internal Adjustment
The creation of the free trade area will impact heavily on the development of some sectors of the Chinese economy, and agriculture in particular. To address such impacts effectively, efforts made during the negotiations to gain more space to manoeuvre are themselves not enough. Internal adjustment must also be implemented. In its negotiations with Australia concerning the agricultural sector, China must insist on a gradual approach in opening up the market for the agricultural products that are most severely affected, and demand that Australia amend its current practice of imposing trade barriers via Sanitary and Phytosanitary Measures. At the same time, China needs to speed up its agricultural adjustment, for example by increasing financial and technological input in areas involving such labour-intensive agricultural products as vegetables and fruits, and enhancing the export advantages of these products.
5 Conclusions
On the basis of the above analyses of current trade between China and Australia, the competitive advantages of the two countries and the economic effects of the China-Australia free trade agreement, the following conclusions can be drawn. First, trade between China and Australia is predicated on differences in their factor endowments, and a successful conclusion to negotiations over a free trade agreement is in the interests of both sides. Second, the overall economic effects of a negotiated free trade agreement are not so obvious, with the positive effects more prominent for Australia and considerable negative effects on certain sectors in China, particularly agricultural products. Finally, a key factor in promoting negotiations on the free trade agreement is the recognition that at a strategic level Australia is an important partner to China in the latter's efforts to diversify its markets and a major source of supply for raw materials. Both sides must approach their negotiations with a view to achieving the ultimate win-win outcome by bridging their differences, while recognising that negotiations alone cannot solve all the problems. The fundamental way of avoiding the adverse side-effects of a free trade zone lies in the acceleration of domestic industrial adjustment.
(1) Local RCA is a modification of Balassa's 'Revealed Comparative Advantage'. RCA is defined as a country's share of world exports of a good divided by its share of total world exports. The RCA index is widely applied in comparing the comparative advantages of different economies with regard to different exported products. Local RCA analyses the comparative advantage of a country's exported products in the market of the importing country, and is defined as the share of a specified product from an exporting country in the total imports of that product by the importing country divided by the share of the exports of the exporting country in the total imports of the importing country.
(2) The GTAP model examines the influence of policy adjustment on production, imports and exports, commodities prices, gross domestic product and other economic indicators of various countries (or regions). It establishes sub-models that delineate the production, consumption and government expenditure of each country (or region), then based on trade patterns between countries, connects those sub-models into a general equilibrium model involving countries and sectors.
(3) On 1 January 2005, Australia unilaterally reduced its tariffs on textiles, clothing and footwear (TCF) products: the simple average applied MFN tariff declined from 12.0% in 2002 to 8.7% in 2005. No further reductions are planned until 2010 and 2015. Despite this reduction, the tariff is still much higher than the overall MFN average (4.1%).
REFERENCES
Hu. B, S. Zhou and Q. Cui (2006) "Analysis of the Economic Impact of Setting up a China-Australia Free Trade Area", The Journal of Agriculture Technology, 6, pp. 19-23.
Jun, Y., J. Huang and H. Chou. (2005) "Economic Impact of Setting up a China-Australia Free Trade Area and Policy Suggestions", Journal of International Trade, 11, pp. 65-69.
Li, Z. (2007) "Empirical Analysis of China's Regional TFA Strategy", Journal of World Economy, 7, pp. 46-51.
Yu, Y. (2006) "On Non-equilibrium and Trade Expansion between China and Australia", Journal of International Trade, 5, pp. 24-26.
by DAWEI CHENG.*
* School of Economics, Renmin University of China. Many thanks to Wu Yujia for helping with data collection and processing.