China - Minerals Council of Australia

JUNE 2015

A policy paper commissioned by the Minerals Council of Australia

China, minerals and energy and the China-Australia Free Trade Agreement (ChAFTA)

POLICY PAPER

Trading Nation Consulting

China, minerals and energy and the China-Australia Free Trade Agreement (ChAFTA) This paper was prepared by Trading Nation Consulting, whose partners are Mike Adams, Nic Brown and Ron Wickes, former senior trade officials and co-authors of Trading Nation: Advancing Australia’s interests in world markets, UNSW Press, Sydney 2013. Cover photograph courtesy of Rio Tinto. Minerals Council of Australia Level 3, 44 Sydney Ave, Forrest ACT 2603 (PO Box 4497, Kingston ACT Australia 2604) P. + 61 2 6233 0600 | F. + 61 2 6233 0699 www.minerals.org.au | [email protected]

Contents 1

Introduction

2 China’s strategic importance to Australia and the world 2.1 2.2 2.3

China’s ‘new normal’ China’s importance for trade and investment China’s significance for minerals and energy

3 ChAFTA and the bilateral economic relationship 3.1 3.2

Strengthening commercial and broader economic relations Creating a ‘living agreement’

5 7 7 10 13 21 25 27

4 Conclusion

29

Endnotes

31

References

33

Charts and tables Chart 1 Chart 2 Chart 3 Chart 4 Chart 5 Chart 6 Chart 7 Chart 8 Chart 9 Chart 10 Chart 11 Chart 12 Chart 13

China’s per capita GDP at purchasing power parity (percentage of the OECD average) China’s share of world trade China’s share of global FDI levels Chinese imports from selected regions as percentage of their GDP China’s share of world imports of selected commodities Consumption of energy per capita, selected economies (1990-2012) Crude steel consumption and GDP (PPP) per capita (1968-2012) Aluminium and copper consumption and GDP (PPP) per capita (1963-2010) Shares of China’s import markets for coal and iron ore (2000-2013) China’s share of Australia’s trade in goods and services China’s share of Australia’s minerals and fuels exports China’s share of selected metals exports China’s share of Australia’s foreign direct investment levels

8 11 11 12 13 14 15 15 18 22 23 23 24

Table 1

ChAFTA – Australia’s exports of resources with tariffs to be eliminated

25

Box 1

Australia’s trade and investment relationship with China

22

4

Minerals Council of Australia

1 Introduction Shortly after Australia’s recognition of China at the tail end of the Cultural Revolution, just about all Australians living in Beijing could have sat around a modest sized dining room table. Now a few thousand live there and many thousands more visit the city on business or as tourists or students. In little more than a generation, Beijing has changed from a city where most residents lived in crowded and insanitary court-yard homes to a bustling city of high rise towers and considerable affluence. There have been comparable changes in many other parts of China and its economy has grown massively. Reticence in dealing with foreigners has given way to much more openness as China has re-emerged as a great trading nation. Consumer priorities and middle class aspirations are now not unlike those in western countries. And China’s approach to economic reform, centring increasingly “on the decisive role of the market in allocating resources” (CPC 2013), represents an almost unimaginable leap from the autarchy of the not-too-distant past. The China-Australia Free Trade Agreement (ChAFTA) is a product of the new possibilities for partnership and cooperation created by China’s unimaginable leap. From the outset Australia saw the possibility of expanding trade with a significant economy that, at the time, ranked just below New Zealand among Australia’s principal trading partners. Few, if anyone at the time, saw the possibility of China displacing Japan as Australia’s principal trading partner within little more than half a decade. And China took a cautious view about what was to be gained from an agreement. Australia’s

recognition of its market economy status had been secured earlier as part of agreeing to a joint Australia-China FTA feasibility study.1 It took a combination of China’s ongoing economic reforms and the acceleration of its heavy industries with their insatiable demand for resources for Chinese trade officials to develop a clear rationale for engaging in serious negotiations. This report examines China’s economic development and prospects, particularly in terms of trade and investment in resources. The frenetic phase of China’s development is over. The slowing economy is very gradually becoming less resource intensive and investment-led and more consumptionled. And flattening demand for some key commodities is generating lively debate on the implications for world trade and for Australia as a major supplier of energy and minerals. We suggest here that the implications of China’s ‘new normal’ cannot be assessed accurately through the lens of Japan’s post-war experience or that of the Asian Tigers, though they provide useful context. China is different because of the sheer scale of its economic development with different regions in different phases of development. If China is approaching peak consumption of some commodities – which appears to be the case for steel and some other base metals – they are likely to be protracted peaks that extend over a considerable time.


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We also suggest that Australia’s effectiveness in preparing for the opportunities and challenges of China’s ‘new normal’ will be critical for our long-term prosperity. ChAFTA is the best available option for advancing Australia’s broader commercial interests with our largest trading partner, including by advancing our interests in minerals and energy and related services and investment. The Agreement provides for substantial liberalisation of trade and investment that will deepen bilateral economic integration. It eliminates all tariffs on minerals and energy exports to China within four years of entry-into-force, reducing transaction costs by up to around $600 million per year. It sets up a review process that should, over time, extend, deepen and refresh the agreement as the commercial relationship evolves. It completes the latest phase of Australia’s integration with North East Asia. And, less tangibly, it provides a platform for numerous ChAFTA-related interactions with numerous Chinese agencies at many different levels, and for strengthening government and business links. Interaction of this kind usually strengthens bilateral relations, particularly if it feeds in to regular high-level meetings at the level of the Prime Minister, Treasurer, Foreign Minister, and Trade Minister, and if it fits into an evolving overarching view or approach that both countries seek to develop in advancing bilateral and wider interests. The report is organised as follows. China’s strategic importance to Australia and the world is discussed in the next section. It examines the implications of the ‘new normal’ and ‘rebalancing’ for trade and investment, particularly commodities trade over the near term (to 2020) and the medium-to-long term (to the 2030s). Section 3 considers ChAFTA and the bilateral relationship. It suggests why, in general terms, it is a big deal, particularly for Australia, to take the economic relationship to a new level. And how the liberalisation already announced as part of the ChAFTA deal, and future liberalisation that should follow as part of the Agreement’s built-in reform agenda, should benefit Australia’s minerals and energy sector and strengthen China’s resources security. There also is a brief discussion on how the dialogue, high-level contact and cooperation that is central to ChAFTA might be leveraged to foster collective thinking about, and approaches to, regional and global issues. Finally, Section 4 sets out a few conclusions.

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ChAFTA is the best available option for advancing Australia’s broader commercial interests with our largest trading partner, including by advancing our interests in minerals and energy and related services and investment.

2 China’s strategic importance to Australia and the world Negotiating an FTA with China has been an ambition of Australia’s since at least 2002 when the Australian Government first formally proposed the concept of negotiating an FTA as a superior option for upgrading the economic and trade relationship than the trade and investment framework arrangement being discussed at the time. The following decade or so has only strengthened the case for an ambitious FTA that can be revised and improved over time. There are three major reasons for the Australian mining sector (and the business and broader community) to welcome the FTA with China: • China’s economy is more than double the size it was in 2005. Its massive economy is slowing but the ‘new normal’ of 7 per cent economic growth still adds to the world economy the equivalent of the Australian economy every two years. Solid sustained growth should generate substantial opportunities for Australia if we can combine the improved access ChAFTA offers with maintaining and improving our international competitiveness. • China’s growing economic weight means that it is both a major market for Australia and others, and has systemic significance regionally and globally through the magnitude of its imports of intermediate goods and services, imports of commodities, imports and exports of finished goods, and inward and outward flows of foreign direct investment (FDI).2 Australia has a big stake in building trade and investment links with China and in working with China to expand opportunity across the region and beyond. • China’s dominance of world trade in minerals and energy has arisen over little more than a decade. The phase of frenetic import growth is over as China reduces excess capacity in heavy industry, grapples with the property

bubble and gradually engineers a more sustainable growth path over the medium-to-long term. After a potentially bumpy transition, the next phase out to the 2030s should be marked by continuing massive import volumes of commodities, including of iron ore and coal, but also by increasing competition from resources producers who have lifted their production capacities. Australia is a key supplier of commodities to China and a major enabling force behind China’s industrialisation. ChAFTA is needed to maintain access and strengthen the Australia-China trade and investment relationship in minerals and energy.

2.1 China’s ‘new normal’ The magnitude of China’s economic transformation in little more than a generation is unmatched in the economic history of any other country at any time. Emerging from the chaos of the Cultural Revolution as poverty stricken, economically dysfunctional and marginalised from regional and global policy making, China became the world’s largest exporter around 2007 displacing the United States; the world’s largest manufacturer in 2008, again displacing the United States; the world’s second largest economy measured by purchasing power parity (PPP) in 2009, this time displacing Japan (World Bank/ Development Research Center of the State Council PRC 2013 p.5); and the world’s largest economy in PPP terms in 2014, displacing the United States.3


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Chart 1

China’s per capita GDP at purchasing power parity (percentage of the OECD average) % 50

40

30

20

10

0

1995 2000 2005 2010 2015 2020 Source: OECD 2015, p. 9

The speed of China’s resurgence is illustrated in Chart 1, which compares China’s per capita GDP in PPP terms as a percentage of the OECD average: it shows that in the space of generation China has significantly narrowed the income gap with advanced countries and seems set to continue to narrow it.

reward the quality of growth – improvements in productivity and in metrics like health and education outcomes. It would defy common sense to expect that these sorts of transformations will occur without a hitch and without much testing and periodic backsliding.

Just like over the last 20-30 years, China faces serious challenges that, if poorly handled, would severely limit its growth prospects and opportunities to create jobs and improve living standards. For example:

• Investment-led growth, particularly in the wake of massive fiscal injections in response to the Global Financial Crisis, created demand but beyond a certain point produced the excess capacity that now affects industries like steel, aluminium and residential property. Export growth cannot be the long-term answer to excess capacity. It may help, but given the size of China’s economy and the scale of the excess, it would be difficult for the global market to absorb and a sustained attempt by China to force the issue would invite a predictable backlash from its trading partners. China’s only sustainable alternative is to build a modern, consumption-based economy.4

• China is in the midst of a series of large and complex transformations that are occurring at different speeds and with different intensities in different regions across the country. Society is becoming increasingly urbanised, though it has a long way to go even by the standards of other emerging countries. Private ownership is now a dominant force in much of the economy, though again it has a long way to go particularly in heavy industry and many services. There is a gradual shift from investment-led to consumption-led growth and from manufacturing-based growth to services-led growth. A youthful population with high workforce participation that lifts output is giving way to an aging population that lifts social costs. And governance systems that reward the quantum of growth are yielding (in some cases very reluctantly) to more flexible systems that

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• Debt levels are high, particularly among provincial and lower levels of governments. Some of that borrowing is risky and involves the shadow banking system. Slowing growth must, to some extent, reduce debt servicing capacity and increase the prospect of a spike in bad debts with flow-on effects for jobs and potentially for social stability (Wolf 2015).

But just like over the last 20-30 years, there is a good basis for being positive about China’s economic prospects and even for expecting that it could overtake the United States as the world’s largest economy measured at market exchange rates within a decade or two. If history is a guide, China can handle multiple complex problems using its time honoured approach of gingerly crossing the river by touching the stones. It has huge strengths: a hard-working and entrepreneurial people, an improving education system, extensive investments overseas, and opportunities for catch-up growth. It also has leaders with a good sense of what supply and demand side reforms are needed and how to implement them. Rebalancing the economy is not a new policy objective and will extend over many decades. The objective of ‘harmonious, balanced and sustained development’ was enshrined in the 11th and 12th Five Year Plans (covering the period from the mid-2000s), while the idea of narrowing inequality between China’s central and western provinces and the more developed coastal provinces dates back to the late 1990s. The keys to rebalancing and sustained growth also have not changed over these years: they remain greater penetration of the market, which means reforming stateowned enterprises (SOEs); more urbanisation, which means reforming the household registration system and extending education and social benefits to tens of millions of rural migrants; more education and upskilling; and more agricultural reform, which means making progress on the vexed issue of land rights and the portability of those rights. And the cautious, step-by-step approach to rebalancing and to reform in general has not changed. Re-balancing is hard: sub-national levels of government often choose to interpret central government directives in ways that are most relevant to provincial interests, and building a consumption-based model of development requires first overhauling urban welfare, health and education systems.5 What has changed is “the willingness of Chinese officials to tolerate lower rates of economic growth in order to rebalance the economy” (Tobin 2014).

There is a good basis for being positive about China’s economic prospects ... It has huge strengths: a hard-working and entrepreneurial people, an improving education system, extensive investments overseas, and opportunities for catch-up growth. It also has leaders with a good sense of what supply and demand side reforms are needed and how to implement them.

China faces a delicate balancing act, particularly in the near term, juggling structural reform and reducing sub-national debt while preventing a sharp slowing of the economy. A sharp slowing, however, seems


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unlikely6 and GDP growth of up to around 7 per cent per year over the next few years and a doubling of per capita GDP between 2010 and 2020 remains feasible, notwithstanding its declining trend rate of growth (OECD 2015, p.8). Over the medium-to-long term, China’s growth rate is likely to continue to slow as a normal – and well recognised – part of the development process. Growth averaged around 8 per cent per year over the last few years and could reasonably be expected to slow to an average of around 4-5 per cent per year in the 2020s (World Bank/Development Research Center of the State Council PRC 2013, p.8) and to perhaps half of that in the 2030s (Treasury 2014, p.15). • Factors slowing growth rates include the slowing shift of resources from agriculture to manufacturing (the bulk of transfers have already occurred), the aging population, environmental constraints (particularly of water), excess capacity and debt, and an uncertain and potentially volatile international economic environment. • Positive factors include China’s growing middle class with its strong links to services and urbanisation: China’s urban population is expected to increase from around half of the total currently to upwards of two-thirds by 2030. Gradual rebalancing of the economy should bolster domestic sources of growth from consumption to services to improvements in energy and resources efficiency. Rising education standards should deliver a major growth dividend: the number of university graduates could rise to around 200 million by 2030 or more than the entire US workforce (World Bank/Development Research Center of the State Council PRC 2013, p. 9). There also are substantial opportunities for technological catch-up and for spreading opportunity via more open markets for goods, services and investment and (hopefully) through the strengthening of globalisation and regional economic integration. China has come to the threshold of middleincome status. Many countries have reached this point over the past 50 years but only a handful have made the leap to high income status. In our view China is the most likely emerging country to make that leap and therefore to create abundant opportunities, not only for its own people, but for the region and the world. Because its growth is now from a much higher base, the absolute growth of the Chinese economy in the decade ahead could plausibly be twice as great (or more)

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than when its economy was surging through the first decade of this century. That absolute growth will be sustained by food and fibre, resources and energy, manufacturing inputs, services, investment, and skills. China’s slowing growth is compatible with increasing Australian exports to China over the next 10-15 years providing we have the supply capacity (which we do), are cost competitive and have access to the market. This is explored further in Section 3.

2.2 China’s importance for trade and investment China’s growing economic significance, increasing openness to trade and investment and active participation in global and regional economic institutions underpin its systemic importance to the global economic and trading system. China accounted for approximately one-third of the increase in global economic activity in the aftermath of the Global Financial Crisis. Notwithstanding its slowing growth, it remains the principal driver of global economic expansion, accounting for a larger share of world economic growth than the rest of Asia combined (IMF 2015). It is the world’s largest trader (excluding European Union intra-trade): its increasing share of world manufacturing exports has been nothing less than spectacular over the past two decades (Chart 2). It is the second largest destination for foreign direct investment flows after the United States7, and third largest source of FDI after the United States and Japan: its shares of global FDI outward and inward stocks (levels) have risen strongly, particularly since the Global Financial Crisis (Chart 3). And its demand for commodities and manufactures influences economic conditions from Africa to Asia to the Americas. Chinese imports from the rest of Asia and Australia now account for over 5 per cent of Asia and Australia’s GDPs, while corresponding imports from North America and Europe account for over one per cent of these regions’ GDPs (Chart 4). Over the next 20 years, the global economy should grow substantially, driven by new waves of innovation, catch-up productivity gains, urbanisation, an expanding global middle class, and potentially increasing global trade integration in response to further reductions in transport costs and continuing liberalisation of trade and investment. China could generate perhaps one-quarter of global growth (World Bank/Development Research Centre 2013, p.369) depending on the pace and effectiveness of its economic restructuring.

China’s share of world trade

Chart 2

Agricultural products

Fuels & mining products

Manufactures

Commercial services

%

%

18 Exports

Imports

18

16

16

14

14

12

12

10

10

8

8

6

6

4

4

2

2

0 1990 1995 2000 2005 2010

0 1990 1995 2000 2005 2010

Source: WTO statistics database

China’s share of global FDI levels

Chart 3

Inward FDI (US$957 billion in 2013)

Outward FDI (US$614 billion in 2013)

% 4

3

2

1

0 2000

2002 2004

2006

2008

2010

2012

Source: UNCTAD Statistics


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Chart 4

Chinese imports from selected regions as percentage of their GDP 2013

%

2000

7 6 5 4 3 2 1 0 Africa Australia OECD Other Other OECD OECD Asia Asia America Europe America Sources: OECD 2015, p.15, UN Comtrade database

But whether it is less or more, China should continue to grow considerably faster than advanced countries and continue to increase its share of world trade, perhaps even doubling it in the period to 2030 (OECD 2014, p. 28). Three outcomes seem likely: • China will become a key partner in more bilateral trade relationships regionally and around the world. Barring major political or economic shocks, much of this increase will continue to revolve around the United States, the European Union and Japan, but a significant part also should involve substantially larger bilateral trade flows between China and other countries in our region as well as between China and countries in South America and Africa. • China will strengthen its role in manufacturing trade, specialising increasingly in higher value added areas in response to rising incomes and skill levels. It will continue to import massive volumes of energy and minerals as part of modernising its infrastructure and creating an urban society. And it will play an increasingly important role in regional and global services trade both as an importer and exporter as its industrial mix moves more towards services as a normal part of development. • And China will continue to strengthen its

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value chains through policies that translate current account surpluses into assets other than US Treasuries. This should include increasing outbound FDI, investing in strategic resources, engaging in mergers and acquisitions and portfolio investment abroad, lending to international organizations, and providing more economically tied aid to developing countries. A key insight from these observations is that the Australia-China economic relationship – already very substantial – is set to become larger still. Over the next decade or two, more Australian companies across the industrial spectrum will trade with China and many will locate there for production, trade or research. At the same time more Chinese companies will locate here, producing for domestic and international markets, providing employment and contributing to national growth and wellbeing. Part of this increased engagement will no doubt continue to reflect the strong complementarities between the two economies and factors like geographical proximity and good relations. Part will reflect the effects of reasonably strong continuing growth and structural change in China’s economy and adjustments by Australia to a more competitive international environment. And part should reflect initiatives like ChAFTA that provide a firm institutional basis for Australia-China trade and investment. This is discussed in Section 3.

2.3 China’s significance for minerals and energy The commodities super cycle started in the early 2000s, driven by very high rates of Chinese investment in infrastructure and factories producing for export. China’s massive fiscal stimulus in response to the GFC – equivalent to about 17 per cent of GDP – prolonged the cycle. The two combined to underpin the biggest surge in industrial production and commodity trade in world history. In 2000, China consumed 12 per cent of the world’s metals. By 2014, it consumed nearly half. Its steel production was equivalent to the production of the next 31 largest steel producing economies. Its iron ore imports increased more than nine fold between 2000 and 2013, accounting for 90 per cent of the global increase in demand for iron ore (Szewczky 2015). And its demand for coalbased energy drove more than four-fifths of global growth in coal production in the period from 2000 (Cornot-Gandolphe 2014, p. 6). Over the past decade, China’s surging economy and investments in heavy industries and infrastructure have been by far the most important factor behind burgeoning world minerals and energy trade (Chart 5). China is now the world’s largest coal importer, taking around one-fifth of global imports: the transition from small net exporter to the world’s largest

Chart 5

importer was completed in three years (20082011). It is the largest importer of copper (taking around 35 per cent of the global imports), manganese (60 per cent), and aluminium and iron ore (65 per cent) (OECD 2015, p.15). It also is the world’s largest exporter of steel as well as being a substantial importer. That frenetic and unsustainable phase of surging production, consumption and trade is over and has been replaced by slowing economic growth, restructuring, flattening demand for energy and steel, and over-supply in key industries (including residential property, which is one of the largest users of steel). Unsurprisingly, there are high levels of unprofitability among Chinese steel producers, iron ore miners and coal companies: about 70 per cent of coal mine operations in China were loss making in the first half of 2014 (Cornot-Gandolphe 2014, p. 2). The speed of the turnaround has challenged comfortable assumptions about China’s medium-to-long term role in world trade in energy and resources, and has generated debate on prospects for international commodity trade (e.g. Garnaut 2015). Will China’s rebalancing and slower growth lead to drastic cuts in production of commodities like steel, reducing demand for inputs like coal and iron ore, including imported inputs from countries like Australia? Has Chinese production of steel and other metals reached

China’s share of world imports of selected commodities 2000

%

2005

2010

2013

70 60 50 40 30 20 10 0 Coal

Copper

Manganese

Aluminium

Iron ore

Sources: OECD 2015, p15, UN Comtrade database


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the point where the focus shifts slowly from increasing the volume of production to increasing the quality of output and the efficiency of production processes? And, if the latter, is it plausible that Chinese import demand for resources and energy could rise over the medium-to-long term after weathering testing conditions in the next few years?8 The starting point in attempting to answer these questions is to consider the relationship between changes in per capita consumption of commodities and per capita income. This is demonstrated for energy commodities in Chart 6. It shows that there is a strong and positive relationship between rising incomes and rising consumption of energy in China, reflecting China’s specialisation in heavy industry as a core part of the early stages of its industrialisation. It also shows that the relationship weakens as economies become wealthier and therefore (usually) less dependent on the expansion of heavy industry. China is well below the income threshold at which income growth and energy consumption are weakly correlated (Chart 6).9 The relationship between changes in per

capita consumption of commodities and per capita income is demonstrated for three metals in Charts 7 and 8. The data suggest that steel consumption reaches a plateau at around $US18,000 per capita10 and then tends to decline gradually, and that per capita consumption of high grade metals grows strongly to per capita income levels of around $US20,000 before again plateauing. If these relationships hold more generally – and recent work by the International Monetary Fund suggests they might11 – then this would suggest that China’s commodity consumption should continue to rise, but at a slower pace for commodities like iron ore and copper and an accelerating pace for commodities like aluminium. This would be consistent with slowing investment in infrastructure and accelerating consumption of consumer durables in the sub-set of Chinese provinces and metropolitan centres nearing the threshold of industrialisation. It also would be consistent with modest rises in some Chinese resources imports over the medium term. Just how then might markets react to China’s ‘new normal’ and its changing demand patterns for commodities with rising prosperity?

Consumption of energy per capita, selected economies (1990-2012)

Chart 6

China

Japan

Australia

Korea, Rep.

European Union

United States

Energy use (kg of oil equivalent per capita)

9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0

0

10,000 20,000 30,000 40,000 50,000 60,000 GDP per capita, PPP (constant 2011 international $)

Source: World Bank, World Development Indicators

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Crude steel consumption and GDP (PPP) per capita (1968-2012)

Chart 7

China

Korea, Rep.

Japan

European Union

United States

Taiwan

1,400

kg of crude steel per capita

1,200 1,000 800 600 400 200 0 0

10,000 20,000 30,000 40,000 50,000 60,000 GDP per capita, PPP (constant 2011 international $)

Sources: World Bank, World Development Indicators; US Bureau of Labor Statistics, Division of International Labor Comparisons; Heston A, Summers, R and Aten, B 2012; World Steel Association, Steel Statistics Yearbooks, various years.12

Chart 8

Aluminium and copper consumption and GDP (PPP) per capita (1963-2010) China

South Korea

Japan

Malaysia

United States

Taiwan

30 Aluminium

Thailand

40 Copper

kg per capita

kg per capita

30 20

10

20

10

0

0 10,000 20,000 30,000 40,000 50,000

10,000 20,000 30,000 40,000 50,000

GDP per capita (EKSS2011)

GDP per capita (EKSS2011)

Source: Coates, B and Nghi, L 2012. GDP per capita (EKS$2011) are Purchasing Power Parity measures of GDP used by the OECD and Eurostat.


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The near term outlook for commodities

China has massive economic and social ambitions: to be an increasingly prosperous and more urbanised society, to spread that prosperity more evenly across the country and to integrate more closely with the wider region through more effective multi-modal transport and communications systems. Each of these ambitions requires high continuing levels of resource-intensive investment far into the future.

The shift away from over capacity heavy industries towards new priority ones like higher level manufacturing and services will be very gradual. In part it will be slow and deliberate because it involves re-engineering the entire economy. But it also will be slow because all levels of government in China want to avoid spikes in unemployment and the risk of social instability – thousands of loss making enterprises across China are being propped up by local governments – and the Central Government in particular wants to avoid a spike in business failure followed by reduced bank lending and potentially a protracted period of little or no growth. Continuing to cut interest rates appears to be part of the government’s response to these risks (as previously noted), but alleviating deflationary pressures by pre-prioritising infrastructure projects and re-invigorating the property sector also now appears to be part of the response. Local government is the main agent for infrastructure investment in China, and China’s Finance Ministry has recently allowed them to refinance Rmb 1 trillion in off-balance sheet debt by selling bonds to state banks. The central government also has ordered the banks to keep lending to ongoing infrastructure projects (Financial Times, 22 May 2015). These sorts of measures have the overall aim of keeping the economy moving along relatively quickly, and alleviating some of the problems of over-capacity among heavy industries. China’s crude steel consumption declined slightly in 2014 for the first time since 2000 and demand for steel is expected to decline marginally in 2015 and 2016 and to be flat to 2020 (Szewczyk 2015; Powley 2015). Prospects are a little brighter for metals like copper. Demand should be steadier as China edges more towards consumption-led growth, but strong growth is not in prospect. In this environment, imports of commodities are likely to be volatile at least for the next three or four years as demand attempts to catch up with supply, and as the Chinese Government uses a combination of sticks and carrots to impose some budget restraints on sub-national governments, lessen excess capacity in heavy industry and housing, and attempt to shore up domestic producers:

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• Continued weakness in the housing sector in particular should weaken demand for steel and therefore for iron ore. Residential property construction accounts for approximately one-fifth of China’s demand for iron ore. • Chinese iron ore production remains stubbornly high. The 40 per cent reduction in the resources tax paid by Chinese iron ore miners appears to be an attempt to boost domestic production at the expense of imports. Assistance from local government also is widespread and easily disguised. • Key coal producing regions have been instructed to reduce production and leading power groups to reduce coal imports. These instructions have been reinforced by recent increases in applied coal tariffs within China’s WTO tariff bindings13, which appear to be aimed at making domestic coal cheaper than imports14. The ban on imports of high polluting/low calorific coal introduced in January 2015 may have a marginally depressing impact on coal imports (CornotGandolphe 2014, p.3). • According to the International Energy Agency (IEA), India could surpass China as the biggest market for seaborne thermal coal by the end of this decade as a result of constraints on Chinese production and strong demand in India (Hume 2014). • Reductions in electricity prices from coal fired power stations reflect falling coal prices but appear to be aimed at assisting highly energy-intensive domestic industries like aluminium. • China’s demand for gas has outpaced domestic production. It is importing gas by pipeline from central Asia and through LNG imports. A new pipeline development with Russia also has been agreed recently. There is some uncertainty about China’s future LNG requirements linked to uncertainty over future progress with its conventional and shale gas production, but on balance LNG imports should increase significantly (Sikorski 2014).

The medium term outlook for steel and iron ore There are claims and counter claims about whether China’s steel production has already peaked or whether it will continue to increase but at a slowing rate. China’s economy

will become less resources-intensive as it modernises and become more services oriented. But if China has entered some kind of peak zone for steel consumption, it is likely to be a long one and China will continue to need abundant supplies of iron ore. China has massive economic and social ambitions: to be an increasingly prosperous and more urbanised society, to spread that prosperity more evenly across the country and to integrate more closely with the wider region through more effective multi-modal transport and communications systems. Each of these ambitions requires high continuing levels of resource-intensive investment far into the future, even as the economy gradually becomes more reliant on the pull of domestic consumption. • China is under urbanised given its per capita GDP. The urbanised population is estimated currently at close to 55 per cent, which is below the average for countries with similar levels of per capita GDP. China will still be under urbanised relative to other countries at roughly similar levels of development even if it succeeds in adding another 100 million to its urban population by 2020, which is the current plan (OECD 2015, p. 32). Urbanisation will continue through the 2020s and 2030s, and will require huge investments in housing, public utilities and transport systems in third and fourth tier cities where most rural migrants are expected to settle. It will require huge investments in major cities as they improve residential standards, build new industries, and improve and add to essential transport, communications, education, and health infrastructure. And it will generate new streams of wealth that will be reflected in shining new automobiles and other consumer durables. Urbanisation will underpin continuing strong demand for steel and other versatile metals like copper and aluminium. • China is retaining labour-intensive industries while moving up the value chain in manufacturing and exports. Poorer provinces and smaller cities appear to be attracting and specialising in mature, labour-intensive industries that are no longer competitive in wealthier eastern provinces, while richer provinces and larger cities are specialising in services and skilled industries (World Bank 2015, pp.78-92). Poorer coalrich western provinces like Gansu, Ningxia, Qinghai and Xinjiang also are specialising in energy-intensive industries like aluminium


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smelting, allowing the central government to scale back smelters and steel mills in (or close to) major cities along the east coast. The combination of specialisation and industry concentration helps to spread prosperity more evenly through the country by binding disparate regional and provincial economies more closely together. To work effectively it requires building new industrial bases and investing in more (and better) hard infrastructure, particularly in disadvantaged areas. This comes back to high priorities for the central government like

Chart 9

new railway construction, building ultra-high voltage power systems spanning the country and revamping core industries. Again this comes back to metals. • China is investing heavily in strengthening its trade, investment and people-to-people links within Asia and beyond through its New Silk Road and New Silk Maritime Road projects. Many tens of billions of dollars are being injected through its ‘policy’ banks – the China Development Bank, the ExportImport Bank of China and the Agricultural Development Bank of China – and aid

Shares of China’s import markets for coal and iron ore (2000-2013) 2000

% 70

2005

2010

2013

Black coal

60 50 40 30 20 10 0 Australia

Indonesia

Russia

Canada

Mongolia

% 70

Iron ore

60 50 40 30 20 10 0 Australia Source: UN Comtrade Database

18


Brazil

India

South Africa

program to build gas pipelines, multi-modal transport systems and other infrastructure (Wildau 2015). This has a foreign policy dimension – to strengthen China’s relationships with contiguous regions – but also economic dimensions ranging from facilitating trade to creating opportunities in some of its poorer Western provinces to building international demand (at least to a limited extent) for industrial products that are in excess supply in the home market.15 China’s initiative in promoting the Asian Infrastructure Investment Bank also can be seen as an element of a broad-based strategy to build regional infrastructure and trading links. Notions like ‘peak demand’ and ‘inflection points’ for steel (and other commodities) do not carry a precise meaning in the Chinese context because economic and social change is occurring in different ways and at different times in different regional and provincial economies. China’s development has a long way to go. Steel will continue to play an indispensable role in its development, and China will remain the global centre of steel supply and demand for a long time to come. This prolonged ‘peaking out’ should sustain international trade in iron ore far into the future, especially as Chinese production costs are increasing as mines become deeper. This obviously is to Australia’s advantage as the dominant overseas supplier (Chart 9), but the advantage could go further. Steel mills in China’s key steel making provinces (Jiangsu and Hebei) are under pressure to lower emissions and comply with new air pollution standards in major cities. As a result, steel mills are buying more high-grade ores that can be loaded directly into blast furnaces without sintering – a dirty process that contributes to air pollution and acid rain. In turn this is resulting in small adjustments to the quality of ore used in steel making, producing a bigger price premium for higher quality ores. Australia is a major supplier of these ores. Australia also is a major supplier of metallurgical coal used in the steel making process. Import demand is expected to remain robust over the medium term (BREE 2014a, 2014b), reflecting the underlying strength of China’s steel industry and current investment priorities for metallurgical coal. However, China is also a major producer of metallurgical coal and longer-term prospects for Australian exports will depend on the extent to which China raises its own production levels.

The medium term outlook for thermal coal China’s energy consumption will increase very substantially in the next 10-20 years. Under the IEA’s central scenario, additions to China’s electricity capacity between 2014 and 2035 are projected to be approximately double the capacity added in the United States, Europe and India, and to be nearly five times the capacity added in Southeast Asia (IEA 2014a, p. 100). Coal will continue to play a dominant role in China’s energy mix for many years to come, but “we have entered into a new time in which the outstanding growth from the past in all of the coal indicators, such as production, consumption and imports, will not be repeated” (IEA 2014b, p.13). A number of factors will support the continuing growth of China’s coal industry. The industrialisation of western and central China, increasing levels of urbanisation and rising per capita energy consumption as an essential part of development will continue to be the major factors on the demand side. Adoption of high efficiency coal-fired generating technology, carbon capture and storage (CCS)16 and new advanced coal gasification plants also should add significantly to demand and extend the longevity of the ‘coal age’. New large scale coal-power bases in western China and sizeable investment in overseas coal mines to meet domestic (and potentially regional) requirements will maintain supply. China is forecast to invest far more in coal and new technology High Efficiency Low Emissions (HELE) coal-based generation systems than any other country or region in the period to 2035, and coal-fired power generation is projected to continue growing through the 2020s and 2030 (IEA 2014a, pp. 29,192). Other factors will slow growth in demand for coal. China’s slowing growth and declining energy intensity will be important, as will its commitment to diversifying energy sources. Numerous Chinese municipalities, particularly in eastern China, are replacing inefficient coal fired heating systems with gas systems in response to strict air quality control measures. China is investing heavily in nuclear energy and may account for almost half of global growth in nuclear generation in the period to 2040. And it is currently investing more in renewables than the whole of Europe (OECD 2015, p.15) and seems set to continue doing so. These factors, along with others like China’s international pledge to begin to reduce its total greenhouse gas emissions by around 2030, underpin plans


19

to cap Chinese coal consumption at 4.3Gt by 2020 and cap its share of the energy mix at 62 per cent (Cornot-Gandolphe 2014, p.3).17 How these factors will balance out precisely is unknown, but what can be said with confidence is that changing China’s (or any country’s) energy mix takes a great deal of time18 and reports of ‘King Coal’s’ demise are premature. Over the next decade or two, China will use a wide range of options to generate the power that it needs, and coal will contribute by far the largest share. Consumption of thermal coal may increase moderately over the medium term, though perhaps with temporary declines in response to changes in government policy or changes in the relative prices of different energy sources. And imports – that make up around 8 per cent of China’s coal supply – should remain substantial and volatile: policy changes (like the recent import tax and actions to ease transport blockages in the coal distribution system) and arbitrage between domestic and international prices can be expected to induce significant year to year movements. The key implication for Australia is that China will continue to require massive amounts of energy if it is to achieve core economic and social objectives. Part of those requirements will be sourced from the international market, just as over the last decade. Competition will continue to be intense. In the thermal coal market, Australia and Indonesia supply around fourfifths of total imports and countries like Russia, Canada, Mongolia, Vietnam, and North Korea supply the rest. Strong competition in this swing market underlines the importance for Australia of reducing costs and building on its strengths: our reputation as a reliable supplier, the high quality of our coal – the central government is likely to continue to encourage high quality coal imports as part of improving air quality – and the benefits that ChAFTA can confer, particularly in relation to removing imposts like tariffs and other import taxes and keeping Australian prices below domestic ones.

20


... reports of ‘King Coal’s’ demise are premature. Over the next decade or two, China will use a wide range of options to generate the power that it needs, and coal will contribute by far the largest share.

3 ChAFTA and the bilateral economic relationship Australia’s effectiveness in preparing for the opportunities and challenges of China’s ‘new normal’ will be critical for our long-term prosperity. China takes nearly one third of our total goods and services exports and the great bulk of our minerals, energy and metals exports (Box 1). It is a major source of FDI and was our largest source country for applications for foreign investment in 201314 (FIRB 2015).19 And it is likely to remain our most important trade and investment partner well into the future. Exchanging commodities, high value foods and sophisticated services for a widening range of Chinese manufactures forms the bedrock of the relationship. But it will be challenging to hold on to existing trade and investment opportunities while creating new ones in a market that is vastly bigger, wealthier and more open to market forces than when ChAFTA negotiations started a decade ago. China has signed FTAs with ASEAN, Chile, Costa Rica, the Republic of Korea, Iceland, New Zealand, Pakistan, Peru, Singapore, and Switzerland. It has completed FTA negotiations with Australia, and has ongoing FTA negotiations with Norway, the Gulf Cooperation Council, ASEAN (upgrading the agreement struck in 2002), and Sri Lanka. It is participating in the Regional Comprehensive Partnership (RCEP)21 negotiations and in the CJK (China, Japan and Republic of Korea) trilaterals. It is now the principal supporter of the Free Trade Area of the Asia-Pacific (FTAAP). And it is considering other FTAs – joint FTA feasibility

studies are underway with India, Colombia and the Maldives – and negotiations may be possible with the European Union depending on the outcome of China-EU bilateral investment discussions. In this very crowded space, ChAFTA is a big deal. It is part of China’s overall principal trade policy objective of accelerating its opening up to the outside world (WTO 2014, p.38), while increasing access to markets in the Asia-Pacific region and beyond and firming relations with resource rich economies. And it is a core element of Australia’s policy objective to take economic and strategic engagement with China to a new level. It also, potentially, is one of the keys to how effectively Australia responds to China’s ‘new normal’. The agreement creates immediate opportunities to strengthen commercial and broader economic relations. It highlights the willingness of both governments to expand the scope of negotiations over time as reforms and changing political circumstances create new opportunities to deepen economic relations. And ongoing ChAFTA-related interactions with numerous Chinese agencies, SOEs, private Chinese companies, think tanks, and civil society groups should reinforce Australia’s already good links into the Chinese system, and assist in creating institutional arrangements to deliver more liberalisation over time.


21

Box 1

Australia’s trade and investment relationship with China The prominence of Australia’s trade with China surged in the 2000s after rising from a low base through the 1990s. Exports rose especially strongly. From the mid-2000s to 2013, exports to China rose from less than one-sixth to nearly one-third of total exports. China’s demands for Australia’s resources drove much of this increase. In 2013 and 2014, China accounted for over 40 per cent of our minerals, fuels, gold and copper exports. Imports (mostly manufactures) also rose in importance, though by less and have held at around 15 per cent of total imports since 2010 (Charts 10, 11 and 12). China’s demand for iron ore and other resources drove a sustained rise in

Australia’s terms of trade, which reached historic highs in 2011, and appreciation of the Australian dollar. Since then, commodity prices, the exchange rate and the terms of trade have fallen back. Receipts from exports have been held up by the cushioning effects of the lower exchange rate and by substantially increased volumes of resources exports as the investment phase of the minerals boom has given way to the production phase. That said, big falls in prices, especially of iron ore, resulted in the value of exports to China retreating from over A$101 billion in 2013 to around A$98 billion in 2014.

China’s share of Australia’s trade in goods and services

Chart 10

Exports

Imports

% 35 30 25 20 15 10 5 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Source: DFAT Trade Time Series Data20

22


China’s share of Australia’s minerals and fuels exports

Chart 11

Total (A$65.3 billion)

Iron ores (A$50.6 billion)

Copper ores (A$0.7 billion)

Nickel ores (A$0.6 billion)

Aluminium ores (inc alumina) (A$0.6 billion)

Coal (A$8.3 billion)

% 90 80 70 60 50 40 30 20 10 0

2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: DFAT, Country and commodity pivot table 2006 to 2014. Totals of $A in legend are exports to China in 2014.

China’s share of selected metals exports

Chart 12

Copper (A$1.8 billion in 2014)

Gold (A$7.0 billion)

Zinc (A$0.2 billion) % 70 60 50 40 30 20 10 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: DFAT, Country and commodity pivot table 2006 to 2014. Totals of $A in legend are exports to China in 2014.


23

Box 1 (continued)

Australia’s FDI relationship with China was insignificant until the mid-2000s. It has since followed the same pattern developed in our commercial links elsewhere in Asia, including Japan and Singapore: inward investment followed growth in trade. With China, as with Japan 40 years ago, inward direct investment has been driven largely by Chinese concerns over resources security. FIRB approvals of foreign investment have been very high in

recent years. The level (stock) of inward direct investment is still low relative to the European Union, the United States and Japan but is now greater than for Singapore. Outward direct investment has developed more strongly and more quickly than with other Asian economies, including Japan but investment levels are still low as a proportion of total direct investment (Chart 13).

China’s share of Australia’s foreign direct investment levels

Chart 13

Inward direct investment (A$30 billion at 31 December 2014) Outward direct investment (A$12 billion at 31 December 2014) % 5

4

3

2

1

0

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Source: ABS 5352.0. Note: data for some earlier years not published.

24


3.1 Strengthening commercial and broader economic relations ChAFTA is an ambitious agreement that covers the breadth of Australia’s interests from goods, services and investment to issues like the movement of natural persons, protection of intellectual property, competition policy, electronic commerce, and dispute settlement. But inevitably it represents a compromise between what each party would ideally have wanted and what was achievable given political constraints and leadership-imposed deadlines. For Australia, this meant putting off intractable issues like liberalising access to China’s tariff rate quota (TRQ) products – wheat, rice, cotton and sugar – and achieving comprehensive outcomes in areas like services. And for China it meant accepting a deal on direct investment that sidestepped the interests of SOEs that are responsible for the great bulk of its outward direct investment.22 These and other issues will no doubt be addressed as part of ChAFTA’s built-in forward agenda – in many respects the crux of its ambition and potential – and advanced as political and economic circumstances allow.

Table 1

On minerals and energy, ChAFTA strengthens trade and investment opportunities through tariff reductions and elimination, liberalising arrangements on mining related services and investment, machinery to review and address non-tariff measures, and provisions on labour movement. Key tariff outcomes on minerals and energy are set out in Table 1.24 Tariffs on most commodities will be removed when the agreement enters into force, though the 6 per cent tariff on thermal coal will be phased to zero on 1 January 2017. These are substantial achievements and are in line with industry priorities at the outset of negotiations (MCA 2004): • Chinese tariff lines across-the-board were bound when China joined the World Trade Organization (WTO) in 2001, but rates were still significant for some commodities while Most Favoured Nation (MFN) applied rates rose and fell unpredictably. Binding all tariffs on mineral ores and other resources at zero over a short period will give Australian exporters more certainty about access to this key market.

ChAFTA – Australia’s exports of resources with tariffs to be eliminated China’s imports Tariffs

Australia World US$ billion

US$ billion

Share

0 & 2 years (a)

25.9

10.1

39.0%

1% & 2%

Immediate

25.0

1.8

7.1%

Aluminium oxide (alumina)

8%

Immediate

1.4

1.3

89.0%

Nickel mattes & oxides

3%

Immediate

0.30

0.28

92.7%

Zinc, unwrought

3%

Immediate

1.52

0.38

24.6%

Copper waste & scrap

1.5%

Immediate

4.37

0.36

8.2%

Aluminium, unwrought(b)

5% & 7%

0 & 4 years

0.48

0.09

19.1%

Aluminium waste & scrap

1.5%

Immediate

2.50

0.25

10.0%

Nickel, unwrought

3%

Immediate

0.17

0.01

5.9%

Titanium white & dioxide (c)

6.5% & 10%

4 years

0.6

0.2

33.3%

MFN rate

Elimination

Coal, coking & steaming

3% & 6%

Copper, unwrought & alloys

Sources: DFAT; UN Comtrade Database. (a) Immediate elimination of the 3 per cent tariff on coking coal; the 6 per cent tariff on steaming (non-coking) coal is to be eliminated within 2 years. (b) Aluminium, unwrought (not alloyed): 5 per cent tariff eliminated on entry into force. The 7 per cent tariff on aluminium unwrought (alloyed) eliminated over four years. (c) Trade data are for titanium ores and concentrates.


25

• Eliminating tariffs could reduce costs to minerals and energy exporters by about $600 million per year, including around $380 million for exporters of thermal and metallurgical coal.25 • Hang-overs from China’s trade deals with ASEAN, New Zealand and Chile will be neutralised. For example, Indonesia faces zero tariffs on thermal coal while Australia currently faces a 6 per cent tariff; Chile faces zero tariffs on commodities like aluminium and nickel while Australia currently faces tariffs of up to 8 per cent; and New Zealand has duty free access for copper and aluminium scrap while Australia faces nuisance tariffs.

Eliminating tariffs could reduce costs to minerals and energy exporters by about $600 million per year, including around $380 million for exporters of thermal and metallurgical coal.

China’s commitments on services go further than in any other of its other FTAs (except with Taiwan, Hong Kong and Macau, which China regards as part of domestic arrangements) and reflect the impact of continuing domestic reform. They are important generically – services value added contributes around two-fifths of our gross exports 26 – as well as specifically to mining related services and investment. At the generic level, ChAFTA secures equivalent treatment for Australian firms in most areas and goes further in some like financial services. It has a partial MFN clause on services and investment that allows additional liberalisation achieved through China’s ongoing FTA negotiations with ASEAN, Norway and others to flow on to Australia in sectors like financial securities, education services and mining services. And it locks-in liberalising commitments in the Shanghai Free Trade Zone (SFTZ) in areas like construction, legal services and telecoms – an important aspect of positioning Australia to engage with the emerging ‘new’ China. The SFTZ is a test bed for new regulatory initiatives, financial reform and ways to increase efficiency and boost innovation.27 Other special economic zones have followed hard on the heels of Shanghai in Guangzhou, Fujian and Tianjin, presumably to test systems and approaches that are relevant to their own economic circumstances prior to rolling out successful outcomes across the nation. Locking in their liberalising reforms represents unfinished business. At the level of mining services, ChAFTA guarantees that mining-related services can be delivered through commercial presence in China (along with other services such as legal, some financial, architectural, and health services) and that domestic reforms will be

26


incorporated in the agreement on a rolling basis. It further guarantees access to technical consulting and field services linked to local coal bed methane and shale gas extraction – in line with the Chinese Government’s Catalogue for Guidance of Foreign Investment Industries – and encourages cooperation with Chinese partners in developing iron, copper and manganese resources. Certain approval processes also are being streamlined with more decision making at the local level. Three other generic provisions have important implications for minerals and energy. First, ChAFTA bans the use of export subsidies. Second, it sets up a review mechanism to address non-tariff impediments – product standards, import licensing requirements, border processing arrangements and the like – on a case-by-case basis. The process is ongoing, is independent from formal reviews of the agreement and can involve officials and ministers. In the normal course of events, niggling issues would be dealt with by officials or elevated to ministers if they assume greater importance to one or both of the parties. ChAFTA sub-committees also can address a range of other issues, such as approval processes for joint ventures and business licensing arrangements. Third, through a Memorandum of Understanding alongside ChAFTA, Chinese investors operating companies registered in Australia will be able to secure the skilled occupations they need to run their Australian projects. According to the DFAT website, Investment Facilitation Arrangements (IFAs) will ‘provide greater flexibilities for companies to respond to unique economic and labour market challenges’ and will be available for large infrastructure projects valued at over $150 million. They will operate within the framework of Australia’s existing 457 visa system and ‘will not allow Australia’s employment laws or wages and conditions to be undermined.’ IFAs will allow for negotiating increased labour flexibilities consistent with Australia´s immigration and employment frameworks for specific projects on a case by case basis. IFAs are innovative ‘umbrella’ project-wide agreements designed to promote increased investment in large infrastructure projects above $150 million, leading to increased jobs and economic prosperity for Australians. They respond to Chinese companies’ concern that they were unable to secure skilled staff for projects in a timely way during the mining boom.

3.2 Creating a ‘living agreement’ Re-negotiating, reviewing and expanding the scope of ChAFTA will begin virtually as soon as the agreement enters-into-force. The next tier of services liberalisation will occur one year after entry-into-force in financial services, for example in relation to increasing equity limits in securities management and accounting. And both countries have committed to commence negotiations for further investment protections. The investment chapter commits both Parties to MFN treatment at the market access and post-establishment stages from entry-into-force of ChAFTA, meaning that Australian investors will be entitled to treatment no less favourable than that which China accords to other foreign investors under any future investment arrangements. The review three years after entry-into-force will be the focal point for expanding the scope of the agreement. Broad architectural issues will be considered for services and investment. ChAFTA clearly falls short of the liberalisation Australian business seeks. As a rule of thumb, the sorts of services and investment outcomes achieved in relation to the SFTZ would be the sorts of outcomes that Australia might seek to build on for China as a whole or, at least, to extend to other special economic zones if outcomes have not been rolled out nationally. China appears to be moving towards a negative listing approach on services. This plausibly would be part of the review, as would progress on China’s TRQ products. The Chinese Government also will want substantial outcomes from the review process. It will, no doubt, continue to press hard on labour issues. China has been keen for a wide range of Chinese project teams to work on major infrastructure projects in Australia since well before FTA negotiations started (Adams, Brown & Wickes 2013, p. 297). And the Chinese Government will continue to press for an outcome on FIRB screening levels that are relevant to SOEs and their investments across mining, services and manufacturing. In its own way, this is as difficult for Australia as liberalising access for rice and sugar is for China. Possible options on investment screening may include making assessments of SOEs on the basis of degrees of separation from government (e.g. listings on stock exchanges) or on size or on more general criteria relating to institutional reorganisations underway in China. But whatever choices are


27

made, if any, will be impacted by a possible outcome to Trans Pacific Partnership (TPP) negotiations – because Australia is a party to the negotiations and the draft agreement includes rules on SOEs – and, most of all, by domestic political considerations. Polling consistently shows considerable unease about Chinese investment in Australia. The latest Lowy poll, for example, shows that over half the population believes that the Australian Government is too lax on Chinese investment (Oliver 2014). This is part of a bigger issue in relation to FDI that centres on fears of foreigners figuratively buying up the family farm. Changing such perceptions will hinge on being able to demonstrate – and build a narrative around – the relationship between inward and outward direct investment, growth, jobs, and higher living standards.28 And finally, and beyond bilateral matters, ChAFTA may have a continuing role to play in emerging regional economic architecture, particularly in regard to RCEP. RCEP negotiations are still at a preliminary stage – at the time of writing there is still no agreement on the modalities for negotiating goods access or on the final shape of services commitments – and it is not clear how open parties to the negotiations might be to models like ChAFTA. But if they were open, ChAFTA would be useful in several ways. For example, it could provide: • A baseline for some services, like in the case of providing for 100 per cent Australian ownership of certain manufacturing services. This liberalising approach would be relevant to RCEP because of the importance of advanced services as business inputs and their role in economic development as technological change gathers pace. • A useful approach on trade facilitation because it locks in elements of the WTO trade facilitation agreement. This also would be relevant to RCEP parties because of its implications for increasing efficiency across regional supply chains. The evolving Australia-China partnership also may have a role to play beyond the region. The potential of the bilateral trade relationship depends fundamentally on the continuing good health of the regional and global trading system because a significant part of the manufactures China produces from our coal and iron ore depends on access to markets for finished products in Japan, Europe and North America.

28


Rivalry between the United States and China – and how this spins through trade policy – is a defining issue of our times. Without trying to over emphasise Australia’s influence, it is profoundly in our interests to use whatever influence we have with the United States, China and others in the region and beyond to support continuing trade liberalisation and, to the extent practicable, prevent competing forms of regionalism from congealing into competing blocs that reduce the effectiveness of value chains. This, of course, gets back to how both parties to ChAFTA view the relationship and how it might develop over the medium term. A close collaborative relationship between the parties that includes how they might approach and respond to common regional and global economic challenges, is very much in the interests of Australian business.

4 Conclusion China’s slowing economy has generated considerable concern among some sections of the media, industry analysts and academics that it will lead to a sharp contraction in import demand for iron ore, coal and other commodities, and that Australia will be caught in the cross winds. The slowing economy is not the main China story but is business-as-usual as a large economy shifts gear from investment- and export-led growth to consumption-led growth and as priorities shift from the volume of growth to its quality. And it is business-asusual that these shifts will produce long term changes in the composition of imports as an economy becomes wealthier. China will continue to depend on large volumes of imported commodities as it builds a modern, urbanised economy. But it must first work through the post-GFC investment binge that produced so much excess capacity and turbulence across its heavy industries.

• Market forces with more emphasis on the price of imported commodities and the costs of moving them to points of consumption.

The main China story is the reform process and its centrality in building a modern, open and prosperous society and underpinning long term solid, sustainable economic growth. Negotiating ChAFTA provides a good lesson in Chinese economic reform. At one level, reform appears to be very slow but its scale and substance become clear if looked at over an extended period like the time taken to negotiate an FTA. Negotiations for ChAFTA started in 2005. Ten years on, negotiations are in a different place in large part because the opening-up process has produced a different China that can contemplate different trade and investment possibilities. And in ten years’ time, incremental reform will create new platforms for engagement, underlining ChAFTA’s core importance as a ‘living agreement’.

ChAFTA reflects the first two themes and shows promise with the third in the context of possibly contributing ideas and models of engagement that may be of interest to the parties negotiating RCEP. But regardless of how precisely ChAFTA evolves and how, and if, it contributes to emerging regional architecture, it is important for the mining sector and business generally to stay engaged in the process and not wait for formal reviews. Negotiations on some aspects of services and investment are on-going. Niggling issues will inevitably emerge for discussion and resolution in the review mechanism for non-tariff impediments. And preparations for the major review of the agreement in three years’ time can be expected to begin in the not too distant future. Once ChAFTA enters-into-force, Australia and China will soon be back at the start of a new negotiation to expand and refine the agreement.

In the minerals space, the Chinese Government is re-examining its approach to international trade and investment in resources and energy. Major themes that have emerged – or are emerging – are that China needs to be more open to:

• Inward FDI, foreign technology and skills in improving resources and energy efficiency and strengthening areas like environmental protection. • And regional and multilateral cooperation. This has a long way to go. Trust has to be built up but there is a growing understanding on the part of China’s leaders that efficient, open markets are a key part of enduring security.


29

30


Endnotes 1

2

Recognising a country’s market economy status is important in determining how Australian authorities treat its goods in an anti-dumping case. Where this status is recognised, relevant agencies like the Australian Customs Service would normally base their investigations on the good’s selling price in the country of manufacture. Where the status is not recognised, agencies could have recourse to alternative methodologies for determining the good’s normal value, such as using surrogate price information from third countries. This could be detrimental to the exporting country’s interests. China is the hub of ‘factory Asia’. Chinese gross exports incorporate a large share of foreign value added and nearly half of all imported intermediates are used as inputs for exports (OECD/WTO Trade in Value Added data base).

3

According to Maddison (2007), China last held this position at the end of the nineteenth century.

4

This point was made recently by Chinese Premier Li Keqiang in an interview with the Financial Times. He said that China cannot restructure its economy without boosting domestic consumption. Increasing exports was important, but to be sustainable this would depend increasingly on quality of product and not on price (Financial Times, 15 April 2015).

5

This is discussed further in Section 3.

6

A sharp slowing seems unlikely because there are substantial buffers: there is scope for a substantial fiscal stimulus, monetary policy is being eased and China has around $3.9 trillion in foreign reserves that could be drawn upon as needed (World Bank 2015, p.28).

7

Only 0.3 per cent of inward FDI went into mining in 2013. Most went into manufacturing (38.7 per cent) and real estate (24.5 per cent).

8

In Australia, much of the debate has centred on whether the Government and the mining industry have under-appreciated Asia’s, and in particular China’s, energy and climate mitigation policies in estimating future growth in Australia’s minerals and energy exports.

9

China’s per capita GDP in PPP terms has increased rapidly in recent years. It was around $US5000 in 2005, $9000 by 2010 and is close to $US14 000 in 2015. It is estimated to rise to around $US20 000 by 2020 (IMF 2015 World Economic Outlook Database).

10

The Republic of Korea has the highest per capita consumption of steel of any major country. Its consumption appears to have peaked at a much higher level of per capita income.

11

The IMF (2014, pp. 36-40) examined these relationships for 41 countries (advanced, emerging, developing) over the period 19802013. The results are essentially in line with Charts 7 and 8.

12

Authors’ calculations used to convert earlier years data of constant $s statistics to 2011 prices.

13

China increased its applied tariffs on coal as follows: 3 per cent for anthracite and bituminous coking (metallurgical) coal, 6 per cent for other (non-coking) bituminous coal (thermal), and 5 per cent for other coal and coal briquettes.

14

China’s coal imports surged from 41Mt in 2008 to 327Mt in 2013. For most of the time from 2010, imported coal was cheaper than domestically sourced coal. Chinese imports were “driven by coal price arbitrage between domestic and international coal prices” (Cornot-Gandolphe 2014, p.2).

15

The ambition of the Silk Road projects is massive. The maritime component includes building deep water ports in Pakistan, Myanmar and Bangladesh. The overland component includes a new freight line linking China and Europe via Russia; power plants, factories and gas pipelines in Central Asia in return for gas supply contracts; and blueprints for a new railway and highway linking China with the Arabian Sea with connections to Europe and the Horn of Africa (Stephens 2015). Major developments beyond Eurasia also are being considered such as the Cross Andes Railway linking Brazil’s Atlantic coast to Peru’s Pacific coast (Anderlini 2015).

16

The United States and Canada are leading the world in developing CCS, hosting


31

the bulk of operational schemes. China is increasingly interested in CCS and is reviewing operations in North America. It will probably host the next wave of sizeable CCS projects (Mapstone 2015). 17

18

This is true for the world as well as for China. Fossil fuels contributed 82 per cent of global energy in 1990. Their share is precisely the same a quarter of a century later (IEA 2014a, p. 52).

19

Countries like the United States and United Kingdom account for most of the stock of FDI in Australia, but China’s direct investment has risen steeply over the last decade. From 2007-08, China moved into the top 10 source countries, quickly moving in the top three. Investment in minerals exploration and development was the primary focus, but it has now widened to include real estate, services and manufacturing. China’s elevation to the top source country in 2013-14 was driven mostly by real estate investment (FIRB Annual Reports, various years).

20

21

32

For comparison, China consumed around 3.7Gt of coal in 2013 and coal accounted for around two-thirds of total primary energy consumption (TPEC). Its contribution to TPEC has varied between 70-80 per cent over the past three decades.

Official data for direction of services trade in 2014 were not available at time of writing. Data for 2014 were derived using percentages of total services trade with China in 2013-14. These calculations indicate that total exports to China in 2014 were around A$98 billion and imports were A$54 billion. The negotiating parties to RCEP are ASEAN (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore Thailand, and Vietnam) and Australia, China, India, Japan, New Zealand, and the Republic of Korea.

22

ChAFTA raises the Foreign Investment Review Board (FIRB) screening threshold for non-sensitive investment by private Chinese companies from $252 million to $1094 million. This is in line with undertakings Australia has with the United States, New Zealand, Japan and the Republic of Korea. But FIRB will continue to screen all Chinese SOE investments.

23

ChAFTA does not have a dedicated chapter on minerals and energy cooperation, like


the Japan-Australia Economic Partnership Agreement, or provide for a Committee on Energy and Minerals Resources Cooperation, like the Korea-Australia FTA. Having such arrangements was not a priority for China – as it was for Korea and Japan – and Australia has long argued that energy security is best guaranteed through international markets working efficiently. 24

On entry-into-force of ChAFTA, 92.9 per cent of China’s imports of resources, energy and manufacturing products from Australia (by value in 2013) will enter China duty-free, with most remaining tariffs eliminated within four years. On full implementation, 99.9 per cent of Australia’s current resources, energy and manufacturing exports (by value in 2013) will enter duty free.

25

These are very approximate estimates. For example, the $380 million figure assumes that Australian coal exporters capture all of the revenue from duties applied in 201314. In reality, the gains would be shared by buyers and producers, with shares depending in part on the elasticities of supply and demand. The impact of increased competitiveness compared with other suppliers might also mean, all other factors remaining constant, that Australia would make quite big volume gains from having duty free access.

26

This estimate is based on the OECD/WTO TiVA database and applies to 2009.

27

For example, the SFTZ is using a negative list approach on investment, which identifies sectors where foreign investment is restricted or prohibited, but everything else is opened up. The list is liberalised every few months.

28

A useful ‘ballpark’ estimate of Australian employment in enterprises with inward FDI and majority foreign ownership can be gleaned from ABS publications. These sources include publications on selected characteristics of businesses (ABS 8167.0), counts of businesses (ABS 8165.0), general industry statistics (81550), and the labour force (6202.0). Preliminary calculations indicate that around one in ten Australian jobs are in businesses with FDI and one in eleven are in businesses with majority foreign ownership. These estimates do not include jobs elsewhere in the economy that depend on providing goods and services to businesses with foreign ownership.

References Adams, M, Brown, N, & Wickes, R 2013, Trading Nation: Advancing Australia’s interests in world markets, UNSW Press, Sydney. Anderlini, J 2015, ‘China’s Li Keqiang seeks big deals in Brazil’, Financial Times, 18 May. Bureau of Resources and Energy Economics 2014a, Australian Thermal and Metallurgical Coal Export Supply Outlook, Australia-Japan Coal Conference, 16 October. __ 2014b, Australian Energy Projections to 204950, Commonwealth of Australia, November. Coates, B and Nghi, L 2012, ‘China’s emergence in global commodity markets’, Economic Roundup Issue 1, The Treasury, Canberra. Cornot-Gandolphe, S 2014, ‘China’s coal market: can Beijing tame King Coal’, The Oxford Institute for Energy Studies, OIES Paper CL1, December. CPC (Communist Party of China) 2013, Communique of Third Plenary Session of the 18th Central Committee of the Communist Party of China, 12 November. Financial Times 2015, ‘Interview with Prime Minister Li Keqiang’, 15 April. Foreign Investment Review Board 2015, FIRB Annual Report 2013-14, Commonwealth of Australia, Canberra.

__ 2015, Global Economic Outlook, IMF, April. Maddison, A 2007, Contours of the World Economy 1-2030AD, Oxford University Press, Oxford. Mapstone, N 2015, ‘China’s interest in carbon capture and storage schemes grows’, Financial Times, 20 April. Minerals Council of Australia (MCA) 2004, Submission: Issues for consideration in an Australia-China FTA Feasibility Study, July. Oliver A 2014, The Lowy Institute Poll 2014, Lowy Institute for International Policy, Sydney. Organisation for Economic Cooperation and Development (OECD) 2014, Global Trade and Specialisation Patterns, OECD Economic Policy Paper, No 10, OECD Publishing, Paris. __ 2015, Economic Surveys: China: Overview, OECD Publishing, Paris. Powley, T 2015, ‘Steelmakers brace for China slowdown’, Financial Times, 20 April. Roache, S 2012, ‘China’s Impact on World Commodity Markets’, IMF Working Paper, WP/12/115, May. Sikorski T 2014, ‘China: The upcoming global gas giant’, Forum, The Oxford Institute for Energy Studies, No 95, February. Stephens, P 2015, ‘Now China starts to make the rules’, Financial Times, 28 May.

Garnaut, R 2015 ‘Australia has not recognised the change in Chinese demand for iron ore and coal’, Australian Financial Review, 6 April.

Szewczyk, A (World Steel Association) 2015, ‘World Steel Outlook 2015-16’, Metal Experts’ Conference, Kiev, 20-21 April.

Hume, N 2014, ‘Falling oil prices help aid coal miners’, Financial Times, 15 December.

Tobin, D 2014, ‘Strong growth and economic re-balancing in China’, Forum, Oxford Institute for Energy Studies, Issue 95, February.

Heston, A, Summers, R, & Aten, B 2012, Penn, World Table Version 7.1, Center for International Comparisons of Production, Income and Prices at the University of Pennsylvania, July. International Energy Agency (IEA) 2014a, World Energy Investment Outlook, OECD/IEA, Paris. __ 2014b, Coal: Medium-Term Market Report, OECD/IEA, Paris. International Monetary Fund (IMF) 2014, World Economic Outlook: Recovery Strengthening, Remains Uncertain, IMF, April.

Treasury 2014, Long-Term International GDP Projections, Treasury Working Paper 2013-02 (modified January 2014), Commonwealth of Australia, Canberra. __ 2015, Budget 2015-16, Budget Strategy and Outlook, Budget Paper No 1, Statement 2: Economic Outlook, Commonwealth of Australia, Canberra. United Nations Conference on Trade and Development (UNCTAD) 2014, World Investment Report 2014, United Nations, New York & Geneva.


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Wildau, G 2015, ‘China’s ‘migrant miracle’ nears an end as cheap labour dwindles’, Financial Times, 4 May. Wolf, M, ‘China will struggle to keep its momentum’, Financial Times, 7 April. World Bank 2015, East Asia and Pacific Economic Update: adjusting to a changing world, World Bank Group Washington, April. World Bank/Development Research Center of the State Council PRC 2013, China 2030: Building a Modern, Harmonious and Creative Society, World Bank Group, Washington DC. World Trade Organization (WTO) 2014, Trade Policy Review – China, WT/TPR/S/300, 27 May, Geneva. Xu Qinhua 2014, ‘Decoding the changes in China’s foreign energy policy after the Third Plenary Session of the Chinese Communist Party: from national to international, Forum, The Oxford Institute for Energy Studies, No 95, February.

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