partnership for change

EAST ASIAN BUREAU OF ECONOMIC RESEARCH | CHINA CENTER FOR INTERNATIONAL ECONOMIC EXCHANGES

PARTNERSHIP FOR CHANGE

2016Australia–China Joint Economic Report

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ustralia–China Joint Economic R

eport 2016

4606487817609

ISBN 9781760460648

WHH Aus China_cover vChinese.indd 1 21/07/2016 4:02 PM

PARTNERSHIP FOR CHANGEAustralia–China Joint Economic Report

ANU Press

East Asian Bureau of Economic Research, ANU, Canberra

China Center for International Economic Exchanges, Beijing

August 2016

Published by the ANU Press, East Asian Bureau of Economic Research and the China Center for International Economic Exchanges

© East Asian Bureau of Economic Research, China Center for International Economic Exchanges 2016

ISBN 9781760460648 (print) ISBN 9781760460655 (ebook)

A CiP catalogue record of this book is available from the National Library of Australia

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East Asian Bureau of Economic ResearchCrawford School of Public PolicyThe Australian National University Acton ACT 2601 Phone: +61 2 6125 6411 Email: [email protected]

This title is also available online at press.anu.edu.au

Design and artwork by Kylie Smith Printed by Prinstant, Canberra

ContentsForeword 1

Listofacronyms 5

Listoffigures 9

Listoftables 11

Listofboxes 11

Executivesummary 13

Chapter1:Strategicimportanceoftherelationship 25

Chapter2:TheeconomictransformationsinChinaandAustralia 45

Chapter3:Tradeingoodsandservices 71

Chapter4:Investment,humancapitalandlabourmovement 109

Chapter5:Financialintegration 137

Chapter6:Frameworkforcapturingopportunitiesandmanagingrisks 171

Chapter7:AustraliaandChinainregionaleconomicdiplomacy 207

Chapter8:Collaborationintheglobalsystem 233

Chapter9:Conclusions 269

References 283

iii

ForewordThisReportistheproductofajointstudyundertakenbytheEastAsianBureauofEconomicResearch(EABER)intheCrawfordSchoolofPublicPolicyatTheAustralianNationalUniversity(ANU)andtheChinaCenterforInternationalEconomicExchanges(CCIEE)inBeijing.Wewereprivilegedtoguidethisworkthroughtoitscompletionoverthepastyear.

TherearefewmoreimportanteconomicrelationshipsforAustraliathantheoneithaswithChina.MerchandiseandservicestradewithChinanowaccountsformorethanaquarterofAustralia’soveralltrade.ChineseinvestmentinAustraliaisgrowingfast.FormanyAustralianbusinesses,theChinesemarketrepresentsanenormouspotentialgrowthmarket.ForChina,Australiahasbeenareliableproviderofhigh-qualityinputsfromironoretoeducation.ButasChina’sgrowthmodelandpolicyfocuschanges,therearebigadjustmentsthatwillhavetobemadeintherelationshipandnewopportunitiesthatareemergingforbothcountries.

CapturingtheeconomicpotentialoftherelationshipwilldependonhowboththepublicandprivatesectorsinAustraliaandChinaengageupcloseandshapetherelationship.Gettingthemostoutoftherelationshipforbothcountrieswillrequireafunctionalunderstandingamongpolicymakers,corporateleadersandthebroadercommunityofthechangesthatwillshapeChinaandtheregionalandglobalenvironmentinthenext10years.

Thisisacriticalmomentinaonce-in-a-generationtransition.Thisisavitalopportunityforbothcountriestothinkabouthowtoshapethefuturecourseofourrelationshipinadeliberateway,establishingsomecommonreferencepointsratherthansimplymuddlingthrough.

WhatarethedynamicforceswithinChinathataredrivingitsnewgrowthmodel?OurjointstudylookedbothbackatwhathasworkedinthepastandforwardtowhatmightyieldthebestresultsforthefutureoftheAustralia–Chinarelationship,aftertheconclusionoftheChina–AustraliaFreeTradeAgreementandinthecontextofthebigchangesthataretakingplaceintherelationship.

ThisReportseekstodefinethepotentialofourtradeandinvestmentrelationships,economiccooperationeffortsandotherinteractions,andtoproduceatangiblemacro-andmicro-levelroadmapofthefuturerelationship.Wehavealsotriedtoidentifywheretheeconomicrelationshipislikelytodevelop,lookingatthesectorsandactivitiesinwhichtradeandinvestmenttiesarelikelytoconcentrate,andwhichindustrieswillthriveandwhichwilldeclineunderChina’snewgrowthmodel.

Thekindsofeconomicinteractionsandgovernmentpoliciesthathaveunderpinnedthebilateralrelationshipthusfararethestartingpoint:whethertheseareappropriateorsufficientastheeconomicrelationshipchangesanddiversifiesisthequestiononwhichthisReporthasfocused.

TheReportidentifieskeypolicychangesinChinaandAustraliathatwillbenecessarytopromoteadeepereconomicpartnership,notonlybilaterallybutalsothroughtheirregionalandglobalcooperation.SituatingthesereformswithinthebroadercontextoftheChinesereformagenda(forexample,financialandcapitalaccountliberalisationandderegulation)andtheeconomicchallengesfacingAustralia,thisReporthassetoutdetailedconclusionsforChineseandAustralianpolicymakers,withclearprioritiesforaction.

1

FOREWORD

ThisisanindependentjointstudybyleadingthinktanksinChinaandAustralia,butithasalsohadthewarmsupportofbothgovernmentsandthecooperationofthekeyeconomicministriesandotheragenciesinbothcountries.ItalsomarshalledbroadChineseandAustralianparticipationandinputfrombusiness,fromgovernmentsatalllevels,fromleadingresearchinstitutions,andfromthewidercommunitiesofbothcountries.

TheReportalsoengagedatopteamofexpertsinbothChinaandAustraliatoguideandassistinthepreparationoftheReportanditsargument.Weareverygratefulforthesupportandadviceoftheseverybusypeopleinthecompletionofourwork.

TheAustralianGroupofExpertsincluded:DrIanWatt,formerlysecretaryoftheDepartmentofthePrimeMinisterandCabinet;ProfessorGaryBanks,ChiefExecutiveandDeanoftheAustraliaandNewZealandSchoolofGovernmentandformerlychairoftheProductivityCommission;ProfessorAllanGyngell,DirectoroftheCrawfordAustralianLeadershipForumattheANUandformerlydirector-generaloftheAustralianOfficeofNationalAssessments;DrHeatherSmith,SecretaryoftheDepartmentofCommunicationsandtheArts;andDrPhilLowe,recentlyappointedtobethenextGovernoroftheReserveBankofAustralia;andwithadvicefromProfessorRossGarnautandDrGeoffRaby,bothformerAustralianambassadorstoChina,alongwithotherexpertinputs.

TheChineseGroupofExpertsincluded:ProfessorHuangYiping,Vice-PresidentoftheNationalSchoolofDevelopmentatPekingUniversityandadvisortothePeople’sBankofChina(PBoC)MonetaryPolicyCommittee;DrHeFan,ChiefEconomistoftheChongyangInstituteofFinanceattheRenminUniversityofChina,SeniorEconomicsFellowattheInstituteforNewEconomicThinkinginNewYork,andChiefEconomicsCommentatoratCaixinMedia;ProfessorZhangYunling,DirectorofInternationalStudiesattheChineseAcademyofSocialSciencesandamemberoftheForeignAffairsCommitteeoftheChinesePeople’sPoliticalConsultativeConference;DrChenWenling,CCIEEChiefEconomist;MrLiuZuozhang,formerminister-counsellorattheChineseEmbassyinAustralia;DrZhuBaoliang,DirectoroftheEconomicForecastingDepartmentoftheStateInformationCenter;andProfessorFanGang,afacultymemberattheHSBCBusinessSchoolofPekingUniversityandSecretary-GeneraloftheChinaReformFoundation;withadviceandinputfromMrZhaoJinjun,formerpresidentoftheChinaForeignAffairsUniversityandformerChineseambassadortoFrance;MsHuXiaolian,PresidentofExport-ImportBankofChinaandformerdeputy-governorofthePBoC;andMrXuChaoyou,DirectoroftheCCIEEDepartmentofExternalAffairsandformerlyoftheMinistryofForeignAffairs(MFA).

TheReporthasbenefitedfromthevaluablesupportoftheleadersofCCIEEandtheANU—MrZengPeiyan,ChairmanoftheCCIEE,andProfessorBrianSchmidt,Vice-ChancelloroftheANU.

ThisstudywouldnothavebeenpossibleattheAustralianendwithoutthegeneroussupportofbusinesssponsorswhofirstengagedwiththeANUthroughanAustralianResearchCouncilLinkageGrantprojectonChineseoverseasdirectinvestment.OurdeepestgratitudegoestoRioTinto,andespeciallyTimLane;toMMG,andespeciallyTroyHeyandAndrewPatterson;andtoCorrsChambersWestgarth,especiallyJohnDenton.

Thesuccessofthisprojecthasbeenmadepossiblebythecommitmentandcooperationofpublicserviceleadersonbothsides.InAustralia,theReportreceivedcashandsubstantialin-kindsupportfromtheTreasury,whotookcarriageofthisReportintheAustralianpublicservice.ChrisLegg,JohnKaratsoreosandLachlanCareywereconstantlyinvolvedin

2

PartnershiP for Change

advancingtheReport,andwealsothankLeesaCroke,AdamMcKissack,JyotiRahman,JohnSwieringa,NanWang,JustinIu,VeraHolenstein,HuiYao,AdamHawkinsandAaronVanBridgesfortheirsupport.

KeyofficialsupportersoftheprojectinAustraliaalsoincludedtheReserveBankofAustralia,particularlyIvanRoberts,EdenHatzviandChrisRyan;theDepartmentofPrimeMinisterandCabinet,particularlyMartinParkinson,DavidGruen,HKYu,JasonMcDonald,HughJeffrey,AlistairMacGibbon,LukeYeaman,JayCaldwell,AndrewForrest,ErnyWahandAnnaEngwerda-Smith;theDepartmentofForeignAffairsandTrade,particularlyPeterVarghese,JanAdams,JustinBrown,BrendanBerne,GrahamFletcher,FrancesLisson,MichaelMuggliston,JamesWiblin,JasonRobertson,MichaelGrowderandKevinThomson;theDepartmentofDefence,particularlyDennisRichardson,MarcAblongandScottDewar;theOfficeofNationalAssessments,particularlyRichardMaude,RodBrazierandJonathanOlrick;Austrade,particularlyBruceGosper,DavidLanders,MarkThirlwellandKellyRalston;TourismResearchAustralia,particularlyGeorgeChenandJaniceWykes;theAustralianBureauofAgriculturalandResourceEconomicsandSciences,particularlyShengYu;andFrancesAdamsoninthePrimeMinister’sOffice.

TheChinesesidewouldliketoextendtheirdeepthankstothosewhocontributedtothesuccessoftheReportfromtheChinesegovernment.AttheChineseEmbassyinCanberra,theyincludeAmbassadorChengJingye,ChargeD’AffairesCaiWei,Minister-CounsellorHuangRengangandFirstSecretaryLiFang.InChina,theyincludeZhaoWenfeiattheMFA;LiChaoattheNationalDevelopmentandReformCommission;FangHaoattheMinistryofCommerce;QinYuexingattheMinistryofFinance;andHuangXinjuatthePBoC.

ThisReportalsobenefitedgreatlyfromconsultationsconductedwithawiderangeofinstitutionsandindividualsinAustraliaandChinaundertakenthroughoutcourseofitswriting.WewouldespeciallyliketothankformerprimeministersBobHawke,PaulKeating,JohnHoward,KevinRudd,JuliaGillardandTonyAbbottfortheiradviceandsupport.

FromAustralianstategovernmentswewouldliketoofferspecialthankstoMartinHamilton-SmithandJingLiinSouthAustralia;SimonPhemisterandDavidLatinainVictoria;andSusanCalvertandMatthewRuddinNewSouthWales.

OurprincipalsupporterswithintheAustralianbusinesscommunityweretheGlobalEngagementTaskforceoftheBusinessCouncilofAustralia(BCA).WeextendspecialthankstoJohnDenton,LisaGropp,JasonChaiandthemanyleadingcompaniesengagedwiththisprocessthroughtheBCAbothinAustraliaandinChina,includingtheChinaDevelopmentBank.

Fromthebusinesscommunitywewouldalsoliketothank:theAustraliaChinaBusinessCouncil,withspecialthankstoJohnBrumby,SeanKeenihan,CameronBrown,DanielBisignano,MoyiZheng,AaronDuffandJetteRadley;TracyColgan,VaughnBarber,GlennCampbell,NickCoyleandOliverTheobaldattheAustralianChamberofCommerceBeijing;AmyAusterandMartinFooattheAustralianCentreforFinancialStudies;StephenJoskeatAustralianSuper;PaulBloxhamatHSBC;AndrewCharltonatAlphaBeta;MickKeoghattheAustralianFarmInstitute;NickBolkusatBespokeApproach;andTimothyCoghlanattheAustraliaChinaFashionAlliance.

Fromtheacademicandresearchspherewewouldliketothank:JennyMcGregor,MukundNarayanamurti,BernardineFernandezandClioZhengatAsialink;BobCarr,JamesLaurenceson,ThomasBoakandHannahBrethertonattheUniversityofTechnologySydney;

3

FOREWORD

HansHendrischkeandWeiLiattheUniversityofSydney;ChristineWongandAnthonyGarnautattheUniversityofMelbourne;PeterCaiattheLowyInstituteforInternationalPolicy;LindaJakobsonatChinaMatters;ChrisHeathcote,BillBrummittandMarBeltranattheGlobalInfrastructureHub;JuliaEvansattheAustralianAcademyoftheHumanities;JeanDongattheAustraliaChinaOBORInitiative;andJohnLeeattheInstituteforRegionalSecurity

WeareespeciallythankfulforthesubmissionspreparedbytheAustraliaChinaBusinessCouncil;EdwardKus,EllenEganandMerricFoleyattheAustralia–ChinaYoungProfessionalsInitiative;HenrySherrellattheMigrationCouncilAustralia;SallyLoaneattheFinancialServicesCouncil;andBelindaRobinsonatUniversitiesAustralia.

TheReportwouldnothavebeencompletedwithoutthededicatedprofessionalismofthetaskforcesattheANUandCCIEEwhoassistedwithdraftingtheReport.OntheAustraliansidethisincludedShiroArmstrong,AmyKing,RyanManuel,PaulHubbard,AdamTriggs,JiaoWang,OwenFreestoneandNeilThomas.OntheChinesesidethisincludedZhangYongjun,LiuXiangdong,ChenYingchunandLinJiang.

Thereweremanyotherpeoplewithinourrespectiveinstitutionsthatprovidedimportantinputduringthedraftingprocess.AcademicsattheANU,includingDongDongZhang,PaulGretton,RichardRigby,LigangSong,HughWhite,PhilippaDee,PeterMcDonald,ZhaoZhongwei,FrankJotzo,StephenHowes,DavidVinesandAnastasiaKapetas,providedvaluablecontributionsintheirrespectivefieldsofexpertise.TheANUsecretariatincludingTomWestland,RosemaryTran,AlisonDarby,PatrickDeegan,RosaBishop,SamHardwick,MichaelWijnen,NawaazKhalfan,PatrickWilliams,HitonaruFukui,OwenHutchisonandLukeHurstprovidededitorialadvice,researchsupportandlogisticalassistance.

WewouldberemissifwedidnotextendourwarmthankstoNeilThomas,whocoordinatedtheAustralianendoftheworkontheReport,andZhangYongjun,LiuJunandotherswhocoordinatedtheprojectattheChineseend.Theirdevotiontothistaskwasessentialtoitssuccessfulcompletion.

ThisReportistheresultofasignificantandunprecedentedexerciseinbi-nationalcollaboration.Wehavesoughttoprovidecommonreferencepointsinhowwecanconductourrelationshipandprinciplestowhichwecanappealwhenfacingtheinevitableuncertaintiesthatweshallhavetomanagearoundprofoundchange.WeareconvincedthattheeffortthatthisReporthascalledforthinbothourcountriestothinkthroughthefutureofourbilateraleconomicrelationshiptogetherisinitselfanencouragingharbingerofwhatAustraliaandChinacanhopetoachievetogetheroverthecomingdecades.

Peter Drysdale Zhang Xiaoqiang

August 2016

4


List of acronymsAALD Australian–AmericanLeadershipDialogue

ABC AgriculturalBankofChina

ABS AustralianBureauofStatistics

ACACA Australia–ChinaAgriculturalCooperationAgreement

ACC Australia–ChinaCouncil

ACCCI Australia–ChinaChamberofCommerceandIndustry

ACJER Australia–ChinaJointEconomicReport

ACOLA AustralianCouncilofLearnedAcademies

ACRI Australia–ChinaRelationsInstitute

ACT AustralianCapitalTerritory

ACYA Australia–ChinaYouthAssociation

ACYD Australia–ChinaYouthDialogue

ACYPI Australia–ChinaYoungProfessionalsInitiative

ADB AsianDevelopmentBank

ADS ApprovedDestinationStatus

AEC ASEANEconomicCommunity

AFTA ASEANFreeTradeArea

AIIB AsianInfrastructureInvestmentBank

AJBCC Australia–JapanBusinessCooperationCommittee

AJPPPD Australia–JapanPublic-PrivatePolicyDialogue

AMPC ASEANMasterPlanforConnectivity

AMRO ASEANPlusThreeMacroeconomicResearchOffice

ANZ AustraliaandNewZealandBank

ANZSOG AustraliaandNewZealandSchoolofGovernment

ANZUS AustraliaNewZealandUnitedStatesSecurityTreaty

APEC AsiaPacificEconomicCooperation

APRA AustralianPrudentialandRegulationAuthority

ARENA AustralianRenewableEnergyAgency

ARF ASEANRegionalForum

ARFP AsiaRegionFundsPassport

ASEAN AssociationofSoutheastAsianNations

ASIC AustralianSecuritiesandInvestmentsCommission

ASX AustralianSecuritiesExchange

ATC AustralianTradeCommission

ATSE AustralianAcademyofTechnologicalSciencesandEngineering

AWIC AustraliaWeekinChina

5

List OF AcROnyms

BCA BusinessCouncilofAustralia

BCIM Bangladesh–China–India–MyanmarEconomicCorridor

BIS BankofInternationalSettlements

BIT BilateralInvestmentTreaty

BRICS BrazilRussiaIndiaChinaSouthAfrica

CBA CommonwealthBankofAustralia

CCB ChinaConstructionBank

CCIEE ChinaCenterforInternationalEconomicExchanges

CEFC CleanEnergyFinanceCorporation

ChAFTA China–AustraliaFreeTradeAgreement

CISA ChinaIronandSteelAssociation

CITIC ChinaInternationalTrustandInvestmentCorporation

CMBA ChineseMedicineBoardofAustralia

CMI ChiangMaiInitiative

CMIM ChiangMaiInitiativeMultilateralization

CNTA ChinaNationalTourismAdministration

CPEC China–PakistanEconomicCorridor

CPPCC ChinesePeople’sPoliticalConsultativeConference

CSIRO CommonwealthScientificandIndustrialResearchOrganisation

CSRC ChinaSecuritiesRegulatoryCommission

DAF DepartmentofAgricultureandFood(WesternAustralia)

DIBP DepartmentofImmigrationandBorderProtection(Australia)

DDPP DeepDecarbonisationPathwaysProject

DFAT DepartmentofForeignAffairsandTrade(Australia)

DSDBI DepartmentofStateDevelopment,BusinessandInnovation(Victoria)

DSGE DynamicStochasticGeneralEquilibrium

EABER EastAsianBureauofEconomicResearch

EAS EastAsiaSummit

EGA EnvironmentalGoodsAgreement

EIA EnergyInformationAdministration

EPG EminentPersonsGroup

ESM EuropeanStabilityMechanism

EU EuropeanUnion

FASIC FoundationforAustralianStudiesinChina

FDI ForeignDirectInvestment

FinTech FinancialTechnology

FIRB ForeignInvestmentReviewBoard(Australia)

FSC FinancialServicesCouncil

6


FTA FreeTradeAgreement

FTAAP FreeTradeAreaoftheAsiaPacific

GATT GeneralAgreementonTariffsandTrade

GBP PoundSterling

GCI GlobalCompetitivenessIndex

GDP GrossDomesticProduct

GNI GrossNationalIncome

GTAP GlobalTradeAnalysisProject

GVA GrossValueAdded

HELP HigherEducationLoansProgram

HKMA HongKongMonetaryAuthority

HLD High-LevelDialogue(Australia-China)

IBRD InternationalBankforReconstructionandDevelopment

ICBC IndustrialandCommercialBankofChina

ICT InformationandCommunicationsTechnology

IEA InternationalEnergyAgency

IFA InvestmentFacilitationArrangement

IMF InternationalMonetaryFund

IPCC InternationalPanelonClimateChange

IPO InitialPublicOffering

IT InformationTechnology

ITA InformationTechnologyAgreement

KBC Knowledge-BasedCapital

LED LightEmittingDiode

LNG LiquefiedNaturalGas

MFN MostFavouredNation

MoC MemorandumofCooperation

MOFCOM MinistryofCommerce(PRC)

MoU MemorandumofUnderstanding

MSR MaritimeSilkRoad

NAB NationalAustraliaBank

NAFTA NorthAmericanFreeTradeArea

NAIF NorthernAustraliaInfrastructureFacility

NDRC NationalDevelopmentandReformCommission(China)

NICM NationalInstituteforComplimentaryMedicine(Australia)

NIE NewIndustrialisedEconomy

NLA NationalLibraryofAustralia

NLC NationalLibraryofChina

7

List OF AcROnyms

OBOR OneBelt,OneRoad

OECD OrganisationforEconomicCooperationandDevelopment

PBoC People’sBankofChina

PLA People’sLiberationArmy(China)

PPP PurchasingPowerParity

PSC ProductionSharingContract

PTA PreferentialTradeAgreement

RBA ReserveBankofAustralia

RCEP RegionalComprehensiveEconomicPartnership

RFA RegionalFundingArrangement

RMB Renminbi

RQDII RenminbiQualifiedDomesticInstitutionalInvestor

RQFII RenminbiQualifiedForeignInstitutionalInvestor

SASAC State-ownedAssetsSupervisionandAdministrationCommission(China)

SBLF Australia–ChinaSeniorBusinessLeadersForum

SDR SpecialDrawingRights

SEC SecuritiesandExchangeCommission(USA)

SED StrategicEconomicDialogue(Australia–China)

SOE State-OwnedEnterprise

SSO SydneySymphonyOrchestra

STEM ScienceTechnologyEngineeringMathematics

TCM TraditionalChineseMedicine

TFA TradeFacilitationAgreement

TPP Trans-PacificPartnership

TRIM Trade-RelatedInvestmentMeasure

TTIP TransatlanticTradeandInvestmentPartnership

UKTI UnitedKingdomTradeandInvestment

UN UnitedNations

UNCTAD UnitedNationsConferenceonTradeandDevelopment

US UnitedStates

VECCI VictorianChamberofCommerceandIndustry

WA WesternAustralia

WOFE WhollyOwnedForeignEnterprise

WTO WorldTradeOrganization

8


List of figuresFigure1.1: Chineseandglobalsteelproduction 30

Figure1.2: SectoralvalueaddedasapercentageofChineseGDP 32

Figure1.3: China’sGDPgrowth(RHS)anditscontributiontoglobaloutput(LHS),1990–2020 33

Figure1.4: ExportstoChinaasashareoftotalexports,Australiaandothermajorexporters 34

Figure1.5: Asia’sweightintheglobaleconomy 41

Figure2.1: China’sshareoftheglobaleconomicaggregates 50

Figure2.2: InvestmentasashareofGDP 51

Figure2.3: Nationalsavingbysector 53

Figure2.4: China’sshareofglobalcommodityconsumption 53

Figure2.5: China’ssteelproduction 54

Figure2.6: MininginvestmentinAustralia 55

Figure2.7: Australia’sshareofChinesecommodityimports 55

Figure2.8: Growthinglobaltrade 56

Figure2.9: Wagesandhouseholddisposableincome 57

Figure2.10: ContributionstoChina’sGDPgrowth 58

Figure2.11: China’sexportmix1995–2015 59

Figure2.12: Domesticvalue-addedshareofChina’sgrossexports 60

Figure2.13: ContributiontoChina’sGDPgrowth 60

Figure2.14: China’ssteelproductionandironoreimports 64

Figure2.15: GrowthinAustralia’snationalincome 66

Figure2.16: Australia’sindustrialcomposition 66

Figure2.17: Australia’scompetitivenessranking 67

Figure3.1A: Exportshare

Figure3.1B: Importshare 74

Figure3.2: Ironorepriceandexportvalue 75

Figure3.3: ChineseimportsfromAustraliaandrestofworld 77

Figure3.3A: Coal(Tons) 77

Figure3.3B: LNG(Tons) 77

Figure3.4: AustralianagriculturalexportstoChina(A$million,2014–2015) 82

Figure3.5: AustraliangoodsexportstoNortheastAsianeconomies 83

Figure3.6: RealgrowthinexportsfromChinaandAustraliaunderthreeChinesegrowthscenarios 88

9

List OF FiguREs

Figure3.7: TotalaveragespendofforeignersvisitingfriendsandrelativesinAustralia,2015 95

Figure4.1: StockofforeigndirectinvestmentinAustraliabysource(2014A$billion) 115

Figure4.2: OECDforeigndirectinvestmentregulatoryrestrictivenessindex 117

Figure4.3: RecipientsofAustraliandirectinvestment,2014(A$billion) 125

Figure4.4: Workingholidayvisasgrantedfrom1July2014to30June2015 133

Figure4.5: StudentvisaholdersinAustralia,30June2015 135

Figure5.1: Grossvalueaddedbythefinancialservicesindustryasapercentageoftotaloutput 143

Figure5.2: OECDservicestraderestrictivenessindexforcommercialbanking,2015 144

Figure5.3: OECDservicestraderestrictivenessindexforinsurance,2015 145

Figure5.4: IndexofcontrolsonChina’scapitalaccount(ka)andcurrentaccount(ca)overrecentyears 149

Figure5.5: Nominalandnominaleffectiveexchangerates—theRMBagainsttheUSdollar 153

Figure5.6: Australia’sexportsoffinancialservicestotheAsiaPacificregion 154

Figure5.7: Australia’sexportsofinsuranceandpensionservicestotheAsiaPacificregion 154

Figure5.8: TotalsalesoffinancialservicesandinsuranceandpensionservicesbyAustraliabymodeofsupply,2009–2010 155

Figure7.1: AsiaPacificeconomies’shareoftradewithEastAsia,2014 214

Figure7.2: Wavesofregionalandglobaleconomicgrowth 219

Figure7.3: ASEAN,APEC,EASandARFmembershipcompared 222

Figure7.4: ASEAN,RCEP,TPPandpossibleFTAAPmembership 226

Figure7.5: GDPprojectionsofRCEPandTPPgroups,1980–2050,atpurchasingpowerparity 228

Figure8.1: AustraliaandChinaintheglobalgovernancearchitecture 238

Figure8.2: ShareofglobalGDP(ppp)

Figure8.3: Globaltradevolumneofgoodsandservices(1980=100) 240

Figure8.4: Globalcapitalflowssince1980 241

Figure8.5: IMFGDPforecastsforemergingmarketanddevelopingeconomies 246

Figure8.6: Thecomponentsoftheglobalfinancialsafetynet 249

Figure8.7: Totalresourcescomparedtoavailableresources 250

Figure8.8: AustraliaandChinawithintheglobaltradingsystem 254

Figure8.9: InvestmentasapercentageofGDP 259

Figure8.10: AustraliaandChinawithintheglobalenergygovernancearchitecture 261

Figure8.11: China’sannualgrowthinGDP,CO2emissions,energyandemissionsandenergyintensity,2005–2014 264

10


List of tablesTable2.1: China’ssteelusagebypurpose(percentageoftotal) 63

Table3.1: ActualandprojectedexportsofcommoditiestoChina 78

Table3.2: Simulatedeffectsofreducingremainingtariffstozero 86

Table3.3: DecompositionofChineseGDPgrowthunderthreegrowthscenarios 88

Table3.4: Actualandprojectedsharesofexportsbysector 89

Table3.5: Actualandprojectedshareofexportsbysectorinalternativescenarios 90

Table3.6: ThechangingnatureofChinesemanufacturingexportstoAustralia 92

Table3.7: Sisterstate–provincerelationshipsbetweenAustraliaandChina 102

Table4.1: Remainingbarrierstoinvestment 127

List of boxesBox2.1: Theglobalriseoftheinnovationeconomy 48

Box2.2: China’shighratesofnationalsaving 52

Box2.3: China’sprogressiontowardshigher-endandvalue-addedmanufacturing 59

Box2.4: China’seconomictransformationandthe13thFiveYearPlan 61

Box2.5: TheoutlookforChina’ssteeldemand 63

Box2.6: AnassessmentofAustralia’scompetitiveness 67

Box2.7: ReformprioritiesacrossAustralia’sservicessector 68

Box3.1: Morethanore 77

Box3.2: Resourcesecurityandglobaltrade 78

Box3.3: AlibabaGroupopensnewmarketsforAustralianexporters 84

Box3.4: Blackmores’Chinaentrystrategy 85

Box3.5: ChinesetourisminAustralia 94

Box3.6: AustraliantouristsinChina 97

Box3.7: Healthcareservices 99

Box3.8: TheAustralia-ChinaStrategicEconomicPartnership 101

Box3.9: Stateandprovincialties 103

Box3.10: CulturalconnectionsandbusinessopportunitiesfromtheChinesediaspora 106

Box3.11: BrandAustraliaandBrandChina 107

Box4.1: Thebenefitsofforeigndirectinvestment 111

Box4.2: Popularattitudestowardforeigninvestment 116

Box4.3: InfrastructureinvestmentinAustralia 119

11

List OF tABLEs, List OF BOXEs

Box4.4: ForeigninvestmentintheUnitedKingdom 120

Box4.5: UnderstandingChineseSOEs 121

Box4.6: Chineseglobalinvestmentsinironore 122

Box4.7: TheChinesediasporainAustralia 129

Box4.8: VisasforinvestorsandtourismintheUnitedKingdom 130

Box4.9: Collaborativeresearchandscientificexchange 134

Box5.1: China’sbigfourbanksinAustralia 151

Box5.2: Australia’s‘bigfour’banksinChina 155

Box5.3: AMPCapitalandChinaLife 157

Box5.4: TheAustralia–ChinaInvestmentCooperationFramework 159

Box6.1: Australia,Chinaandregionalinfrastructureinvestment 175

Box6.2: Experiencewithcommercialrisks 178

Box6.3: Australia’sreactiontoshocksfromshiftsinChinesemarketsentiment 180

Box6.4: LandbridgeGroupandthePortofDarwin 182

Box6.5: SinoGasinChina 183

Box6.6: China’saccessiontotheWTO 186

Box6.7: Deliveringprosperityandsecuritythroughthemarket 188

Box6.8: Modelsofbilateralcollaboration 195

Box6.9: RegionalsecurityandtheAustralia–Chinarelationship 201

Box6.10: Buildingpolicytrust 203

Box7.1: AsiaPacificregionalinitiativesandtheglobalsystem 216

Box7.2: ConsensusandthecreationoftheAsianDevelopmentBank 217

Box7.3: Buildingamultilateralregimeforgoverningforeigndirectinvestment 229

12


EXECUTIVESUMMARY

13

Executive Summary

Australia and China: forging a comprehensive strategic partnership for change

AustraliaandChina,twovastlydifferentnations,alreadyhaveahugeandjointpolitical,economicandsocialinvestmentinthesuccessoftheirbilateralrelationship.

Takentoahigherlevel,asthisReportrecommends,thisinvestmentintherelationshipcanhaveadramaticadditionalimpactonbotheconomiesandsocieties.

Thisuniquepartnershipstemsfromadeepalignmentofintereststhat,shortofhighlynegativepolicymaking,cannotbeundone.

Therelationshipisalreadylargeandwillundergoahugechange.Thescaleandcomplexityoftherelationshipisgrowingbecauseoftheincreasedroleofservicesandinvestment,aswellasitspoliticalandsecuritydimensions.

Thesecircumstanceslaidthefoundationforsupportfrombothgovernmentsforanindependentjointstudyofdevelopmentsintherelationshipinthedecadeaheadandhowtostrengthenthebilateralframeworkandthepolicysettingsformanagingit.

ThisReportistheproductofanindependentstudyjointlyledbytheChinaCentreforInternationalEconomicExchangesinBeijingandbytheEastAsianBureauofEconomicResearchatTheAustralianNationalUniversity.Itsaimistodefineaframeworkforpolicymakersandforstakeholdersinbusiness,media,researchinstitutionsandthecommunity;aframeworkthatenablesAustraliaandChinatoharnesstheopportunitiesthatarearisingfromtheprofoundtransformationsintheireconomies.

Why Australia and china are important to each other

ChinahasforsomeyearsbeenAustralia’slargesttradingpartnerandoneofitsmostimportantbilateralrelationships.ItisnowwidelyunderstoodthatAustralia’seconomicgrowthandcontinuedrisinglivingstandardsarestronglylinkedtoChina’seconomicsuccess.

IntheChinesepolicycommunity,thereiswideunderstandingandclearacknowledgementoftheeconomicandpoliticaladvantagesofopen,secureandcompetitiveaccesstoAustralianironore,coalandotherrawmaterials.

AsChina’seconomymaturesanditsmiddleclassexpands,ChinaisalsoenjoyingtheaddeddividendofaccesstoAustralianagriculture,institutionsandservices—everythingfrominfantformulatovitamins,buttertobeef,educationtotourism,aswellasadvancedscience,technologyandresearchcapabilities.Australia’sopensocietyprovidesChineseinvestmentswithsecurityinastableandwell-functioningmarketeconomythatguaranteestransparentrecoursetopolitical,legalandregulatoryinstitutions.

Thesenewavenuesofcommercialexchangeareatwo-waystreet.BothAustraliaandChinagainfromgrowinganddiversifyingtheireconomicrelationshipthroughnewflowsoftourists,students,investorsandmigrants.Formorethanadecade,Chinahasbeentheworld’smaineconomicgrowthengine.Despiterecentslowdowns,Chinawillremainakeydriverofglobalgrowthinthecomingdecade.IfChina’sreformagendasucceeds,itcanachieveannualGDPgrowthofaround6percentayearoverthenext10years.

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ButitisobviousthattheimpactofChina’sgrowthonAustraliaoverthenext10yearswillbeverydifferentfrominthepast.Australiawillnolongeronlybearemotesupplierofrawmaterials.ItcanbeapalpableanddistinctivepresenceinChinesedailylife,particularlyfortheurbanmiddleclasseswhoseaspirationsandincomeswillcontinuetoexpandforseveraldecades.

ThenewlyemergingpartnershipbetweenAustraliaandChinahasasignificantandvaluableextradimension.AustraliaisnotonlyeconomicallyenmeshedwithEastAsia,givingitahighstakeinChina’ssuccess.Italsohasstrongeconomic,culturalandstrategiclinkstotheUnitedStates,andthereforeacompellinginterestinapositiverelationshipbetweentheUnitedStatesandChina.

Australia’sgeopoliticalandgeo-economicpositionanditsmulticulturalsocietyarethusuniqueassetsinshapingChina’slinkswiththeWest.

ChineseandAustralianprosperityhasdependedontheliberal,rules-basedglobalsystem.Bothcountrieshaveacompellinginterestinthesuccessfuladaptationoftheinstitutionsofglobalgovernancetotheeconomicandsecuritychallengesofthe21stcentury.AdeeperpartnershipbetweenChinaandAustraliacanbeapowerfulforceforthestrengtheninganddevelopingoftheseinstitutions.Australia’slongstandingcommitmenttoglobalinstitutions,itsdeepengagementwiththeeconomiesofAsiaanditshistoricaltieswithEuropeandNorthAmericaarecomplementarytoChina’sstatusasamajoreconomicpoweranditsdeclaredwillingnesstohelpsupplyandshapetheinternationalpublicgoodsofthe21stcenturyinthetaskofreformingandstrengtheningtheregionalandglobalframeworksofcooperationandgovernance.

ThisaddssignificantweighttoAustralia’ssupportforChina’sgrowingroleintheprovisionofinternationalpublicgoods,suchastheAsianInfrastructureInvestmentBank(AIIB).BothcountrieshaveacommoncommitmenttoChina’sparticipationinglobalinstitutionsandrules.

Benefits of closer economic partnership

Chinaisshiftingitsgrowthdriversfrominvestment,exportsandheavyindustrytoconsumption,innovationandservices.China’sgrowthslowdowndoesnotthreatenthistransformation;itisasymptomofit.

Thistransformationwill,byitself,leadtofastgrowthintradebetweenAustraliaandChinainrealterms,muchofitinservices.Eveninapessimisticscenario,inwhichaverageChinesegrowthisbelow5percentoverthenext10years,ourestimatessuggestthatAustralianexportstoChinawouldstillgrowby28percentandChineseexportstoAustraliaby20percent.A‘baseline’scenariohasAustralianexportsgrowingby72percentandChineseexportsby41percentoverthesameperiod.

Thebiggestgains,however,wouldberealisedifAustraliaandChinaworktoimplementthesupply-sidereformsrecommendedinthisReport.Ifthisreformagendaisprosecutedsuccessfully,AustralianexportstoChinawillgrowby120percentinrealterms,andChineseexportstoAustraliaby44percent.ForChina,thisisconditionalontheimplementationofareformagendathatembracesfinancialandfactorreform,state-ownedenterprise(SOE)reform,increasedopennesstoforeigninvestmentandcapitalaccountliberalisation.ForAustralia,itmeansincreasedcompetitioninshelteredindustries,opennesstoforeigninvestmentandskills,andfacilitatinginvestmentinsocialandphysicalinfrastructure.

Increasedtradeandinvestmentwillmeanhighernationalincomes,moreemploymentandmoretaxrevenueforbothChinaandAustralia.

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EXECUTIVE SUMMARY

ThestructuralchangesintheChineseeconomypresageachangeinthestructureoftrade.TheprofoundcomplementaritystemmingfromAustralia’senergyandresourceabundanceandChina’sindustrialisationwillremainakeypillaroftherelationship,butwillbeincreasinglyaugmentedbyservicessuchaseducationandtourism,withinboundtourismfromChinasettotrebleby2025.Educationandtourismserviceswilljumpfrom8percenttoalmost20percentofAustralianexportstoChinain2025ineventhe“businessasusual”scenario.Machineryandequipmentwilljumpfromjustbelow20percentofChineseexportstoAustraliato28percent.

Chineseproductionisshiftingfromamodelbasedonadaptationandimitationofgoods,servicesandtechnologiesdevelopedelsewheretoamodelbasedondomesticinnovation.ThisisbeingdrivenbyasubstantialinvestmentinChina’sinnovationecosystem.Australia’shigh-qualitytertiaryeducationsector(alreadyamajorservicesexportertoChina)anditscommitmenttoitsownNationalInnovationandScienceAgendamakeitanaturalpartnerinthistransformation.Australia’sexperienceinbuildingahighlydevelopedfinancialsystemcanalsobeofvaluetoChina,whereasophisticatedfinancialsystemwillbecrucialforallocatingcapitaltothemostinnovativeandefficientfirms.ChinaseesspecialbenefitinthepartnershipwithAustraliafortriallingreformsininvestmentpolicyandservicesmarketsaswellasseekinggreateralignmentwithAustraliainitsgeopoliticalinterestsinAsiaandthePacific.

Inshort,thereiseveryreasontobelievethattheAustralia–Chinarelationshipwillbecomemore,notless,importanttobothcountriesastheChineseeconomycontinuestochangeandupgrade.

ForAustralia,thismeansenhancedlong-termeconomiccapacitythroughopportunitiesfornewtradeandproductivity-boostinginnovationaswellasthroughimprovingnationalinfrastructureandthedevelopmentofregionalAustralia.

ForChina,thismeansasustainablepaththroughmiddle-incomestatusonitswaytobecomingahigh-incomeeconomythrougheconomicupgradinganddiversification.

towards a new policy framework

Theneedforanupgradedpolicyframeworkisbroadlyacceptedinbothcountries.

ThatiswhybothgovernmentshavefinanciallyandinstitutionallysupportedtheproductionofthisReportandprovidedthenecessaryaccesstoallowwideconsultationswiththekeyeconomicministriesandagenciesonbothsides,aswellaswithsubnationalgovernments,keyresearchinstitutions,businessleadersandcommunityfigures.

Creatinganupgradedframeworkisacomplextask:itwillrequirebuildinganewsetofnationalcapabilitiesinbothcountries.Thesewillbestbefoundedonpastexperienceandachievements.

Inthe1980s,AustraliaandChinaestablishedwhattheycalleda‘modelrelationship’betweentwoeconomieswithdifferentpoliticalandsocialsystemsandatdifferentstagesofdevelopment.Thiswasthetwocountries’firstsignificantjointeffortatbuildingaframeworkfortheirrelations.Thisprincipleshouldcontinuetoguidethebilateralrelationshiptohigherlevels.

AustraliaembracedChina’sopennessandreformasacriticalfactorinregionalprosperityandstability.ChinaembracedthepartnershipwithAustraliaasacrucialpartofitsopeningpolicy,andAustraliaassumedakeyroleinChina’sforeigneconomicstrategy.Thispath-breakingpartnershipopenedmarket-basedresourcestrade,foreigninvestmentandregionalcooperationwithChina—leadingtopositiveengagementwithChinainAPECandworkingtogetheronChina’saccessiontotheWTO.

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AustraliaandChinahavesinceworkedtostrengthenregionaleconomiccooperationthroughAPEC,theASEANPlusframeworksandtheEastAsiaSummitinordertosecuretheframeworkofpoliticalconfidenceandsecuritynecessarytoeconomicprosperity.

AustraliaandChinaalreadyhaveaComprehensiveStrategicPartnership,agreedin2014,whichguaranteeshigh-levelattentiontothebilateralrelationshipthroughanannualLeadersMeeting,StrategicEconomicDialogue,andForeignandSecurityDialogue.AustraliaandChinaalsohavetheChina–AustraliaFreeTradeAgreement(ChAFTA),whichdeliverssignificanttradeliberalisationandopensthedoorinbothcountriestonewandwideraccesstoinvestmentandtheservicessector.Indeed,ChAFTAhasthepotentialtoserveasakeyagentintransformingthecommercialrelationshipbetweenthetwocountriesinthecomingdecade.

Butthefullopportunityofthesearrangementsisfarfrombeingrealised—bothcountriesmustnowprovideforthecomprehensivesettingofstrategicbilateralobjectivesinaforwardagenda.Thiswilldependonnewframeworksforinstitutionalisingactivecollaborationonpolicydevelopmentandreform.

Chinaisnowbuildingregionalandglobalinstitutionsthatarecommensuratetoitsplaceintheinternationaleconomicsystem.China’sleadontheAIIBandtheOneBelt,OneRoad(OBOR)initiativesrepresentChinaembeddingitsinterestsjointlywithotherspartnerstobolsterinfrastructureinvestmentandregionalconnectivity.

AustraliahasworkedcloselywithChinaintheIMFandotherinternationaleconomicbodiestosupporttheseChineseinitiatives.AustraliaisafoundingmemberoftheAIIB,andparticipatesinOBORthroughprogramsincludingthedevelopmentofNorthernAustralia.TherehasbeenclosecollaborationintheG20onsharedagendasforglobalgrowthandreformingthemultilateraltradingsystem.

managing new dimensions of the relationship: policy framework and programs

HowareAustraliaandChinagoingtomanagetheirincreasinglycomplexrelationship—arelationshipinwhichChinaisbyfarthebiggesteconomyinAsia,isthesecond-largesteconomyintheworld,isdeeplyenmeshedinacomplexrelationshipwiththeUnitedStates,andisprojectinggrowingpoliticalconfidence?

ClosecooperationwithAustraliashouldbeanintegralpartofthenextphaseofChina’seconomicreformandopening.Collaborationonservicesectorreform,financialrestructuringandcapitalaccountliberalisationwillhelpChinarealiseitsgrowthpotential.Asanadvancedregionalservices-basedeconomy,AustraliaisanaturalpartnerandapromisingtestbedforChinainitsreformeffort.

ThisReportoutlinesthekeyideasandprogramsfordealingwiththisquestion.Theconclusionsthatfollowareenvisagedasalong-termagendaofcooperationforbilateralrelations,andwillrequirecarefulconsiderationbybothgovernmentsandotherstakeholdersintherelationshipoverthedecadeahead.

ThisReportshowsthat,inordertorealisetheopportunitiesandcountertheriskstobilateralgrowth,theAustralianandChinesegovernmentsshouldsensiblyelevatetheirrelationshiptotheuniquelevelofaComprehensiveStrategicPartnershipforChange.Leadershipatthehighestlevelshouldsignalthepriorityattachedtodevelopmentoftherelationship.

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EXECUTIVE SUMMARY

Inparticular:

• ThenewComprehensiveStrategicPartnershipforChangethattheReportrecommendswouldbuildonChAFTAandthecurrentannualLeadersMeeting,andparallelministerialmeetings,throughestablishingjointpolicyworkinggroupsthatsupportthisworkandotherpolicyinitiativesstemmingfromtheleaders’dialoguesandadvanceongoingpolicydevelopmentandreform:forexample,inthenegotiationofanewAgreementonInvestmentwithintheframeworkofChAFTAoronaccesstoservicesmarketsandotherissues(seebelow).

• Jointpolicyworkinggroupscanwork,asneeded,withstateandprovincialauthorities,businesssectors,researchinstitutesandcommunity-basedinterestsonspecificinitiativestoadvancethetrade,investment,financial,regionalandglobalreformagendasofbothcountries.

– TheseworkinggroupscanassistineffectingthebilateralcommitmentstofurtherinvestmentliberalisationandexpandedaccesstoservicesmarketsmadeunderChAFTA.

– Thetwocountriesshouldalsoestablishaworkinggroupfordialogueandcooperationonthemaritimeeconomy,asthisisaparticularareaofpotentiallyproductivecollaborationbetweenAustraliaandChina.Bothcountriesaremaritimepowerswithcommoninterestsinseabornesupplyroutesandmanyothermaritimeissues.

• Bothgovernmentsshouldaim,overthedecadeahead,todrawonprecedentfromtheirotherbilateralrelationshipsandembedtheirnewpartnershipintoacomprehensivebilateralBasicTreatyofCooperation.

– Thistreatywouldlockinthepracticeandprinciplesforcooperation,and:committoregularhigh-levelgovernmentdialogues;setouttheprinciplesformanagingtherelationshipthatareenunciatedinthisReport;institutionaliseofficialbilateralexchangesandtechnicalcooperationprogramsbetweeneconomicandforeignaffairsministries,includingbranchesofthemilitary;includepolicyapproachesbetweenfederal–stategovernmentsinAustraliaandcentral–provincialgovernmentsinChina;provideforthecomprehensivesettingofstrategicbilateralobjectivesinaforwardagenda;enfoldtheagreements,mechanismsandreformsoftheChAFTAarrangement;andentrenchcooperationonimprovingeducational,culturalandpeople-to-peopleexchange.

• Bothcountriesshouldnurturethecapacitiesnecessaryfornewhigh-levelengagementthroughestablishingbytreatyagreementanewandwell-resourcedbi-nationalAustralia–China(Ao–Zhong)Commissionintheformofastatutoryentitythatoperatesindependentlyofbothgovernments.

– TheCommissionwillboostthelevelandrangeofpolicy,research,scientific,technology,education,culturalandpeople-to-peopleexchangesbetweenthetwocountries.ItsnearestparallelinAustralianexperienceisthetreatyarrangementbetweenAustraliaandtheUnitedStatesthatestablishedtheAustralian–AmericanFulbrightCommissionafterWorldWarII.

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• WithintheframeworkandprovisionsofChAFTA,AustraliaandChinashouldmovetonegotiateacomprehensiveAgreementonInvestment—incorporatinga‘negativelist’approach,effectivenationaltreatmentofforeigninvestors,respectforruleoflaw,resourceaccessguarantees,andgreatermobilityofpeople—aheadofChineseagreementswiththeEuropeanUnionandtheUnitedStates.TheAgreementonInvestmentcanserveasamodelforaregionalinvestmentregimeinEastAsia.InvestmentflowsfromChinatoAustraliaandfromAustraliatoChinawillplayacriticalroleinthedevelopmentoftheneweconomicrelationshipfromexchange,toinvestment,andnowtopartnership.

– ThiswillnotbeachievedifthebroadercommunitydoesnotgraspthebenefitsofforeigninvestmentinbothAustraliaandChina.InAustralia,thismeansacceptingequaltreatmentforChineseinvestmentandreconsideringattitudestowardsstate-ownedinvestorsfromallcountries.InChina,itmeansbuildingrespectforruleoflawtomakeinvestmentssecureandpredictableforalldomesticandinternationalparties.

• ThereengineeringofthebilateralarchitecturethatisproposedshouldbealignedwiththeAustraliangovernment’sNationalInnovationandScienceAgendaandtheChinesegovernment’sinnovationpriorityinits13thFiveYearPlan.

– Thiswouldseetheprioritisationofbilateralcooperationinfutureopportunitiesinresearchanddevelopment,capitalsourcing,STEMcollaboration,researchcommercialisation,techlandingpads,thedigitaleconomy,andexchangesbetweenAustralianandChineseentrepreneursandinvestors.

• AustraliaandChinashouldattachtopprioritytotheconclusionofahigh-standardagreementontradeandinvestmentliberalisationandongoingeconomiccooperationarrangementsintheAsiaPacificundertheRegionalComprehensiveEconomicPartnership.

• Thetwocountries’sharedinterestintheG20andconstructiveparticipationinglobaleconomicgovernanceshouldfocusonChina’sroleinmutualsupportamongthemajorcurrencies;securingtheinternationalfinancialsafetynettoprotectagainstthespreadoffinancialcrises;connectingreformtoeconomicgrowth;andintensifyingeffortstoreformthemultilateraltradingsystem.

• Importantly,ChinaandAustraliashouldinstigatetop-levelregionaldialogueswithJapan,SouthKorea,India,theUnitedStatesandotherkeyplayersintheregionontheenergytransformationthatisnecessarytomitigateclimatechangeandotherenvironmentalissues.ThisisafruitfulareaforregionalcoalitionbuildingonanissueinwhichChina,asitseekstoreconcileincreasingenergyusewithitsenvironmentalambitions,andAustralia,asamajorenergysuppliertotheregion,haveamajorstake.ItisalsoanareainwhichcooperationwithotherAsiaPacificcountriescouldbeveryproductivepolitically.

Ifthesestepsaretaken,theAustralia–Chinarelationshipwillbetakentoawhollynewlevel.Whilefullyrespectfulofeachother’sexistingrelationships(suchasAustralia’sANZUSrelationshipwiththeUnitedStates),thenewpartnershipwillbeapowerfulforceforthestabilityandprosperityoftheregion,andindeedfortheglobalsystem.ItcanserveasaprincipalvectorofAustralianandChineseengagementwithinarapidlychangingworld.Nurturedcarefullyandimaginativelybygovernments,businesses,researchinstitutionsandotherstakeholdersonbothsides,thisdeeperpartnershipcouldbecomeoneofthemoststrategicallyvitalandproductivebilateralrelationshipsthateithercountryhasintheworld.

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EXECUTIVE SUMMARY

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EXECUTIVE SUMMARY

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EXECUTIVE SUMMARY

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CHAPTER1strategic importance of the relationship

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Key messAges

ThereisnoeconomicorgeopoliticalfutureforChina,AustraliaortheworldthatwouldnotbeimprovedbyChina’ssustainedandbalancedeconomicgrowth.AndyetthefuturedirectionofChinesegrowthwillbeverydifferentfromthatoverthepastfourdecades.TheforcesofchangethathavealreadyunleashedawaveofconsumptiongrowthareaffectingtherelationshipwithAustraliaprofoundly.EconomicreformandliberalisationcanintensifytheongoingchangeinthestructureoftheChineseeconomyand,whilethesechangesimplyalessheavyrelianceinAustraliaontheresourcesectorforeconomicgrowth,thereareopportunitiesforgrowththatwillrequiresubstantialrepositioningofpolicyandcommercialstrategiesbybothcountriesandthedevelopmentofastillcloserrelationshipbetweenthetwocountries.

ThestructuraltransformationoftheChineseeconomyasitgrowstowardhigh-incomestatuswillbefuelledbydomesticreformsthatmaketheallocationofresourcesmoreefficientandbytheopeningofthecapitalaccount,astepthatshouldbeundertakenincrementallyandwithduecaution.Chinawillreorientitseconomytowardsdomesticconsumption.Australia’schallenge,meanwhile,istocounteractthefallinrealincomesthathasresultedfromthefallincommoditypricesasChinesedemandslows,andtoinvestinfillingtheinfrastructuregapsthatwillactasabrakeonproductivityandincomegrowthifleftunaddressed.

Therecenthistoryofthegrowingtiesbetweenthetwocountriesshowsthatthedeterminedpursuitofadeeperrelationshipyieldstangiblebenefits.TheinstitutionsandpolicyframeworksthathaveemergedtoprovidestructurefortherelationshipinrecentyearsprovideastrongstartingpointforthenextphaseoftheAustralia–Chinapartnership.

Bothcountrieshaveinvestedheavilyintheirpartnership.Thepath-breakingrecordoftheAustralia–Chinapartnershipinopeningtheresourcetrade,foreigninvestment,regionalcooperationinitiativesandChina’saccessiontotheWTOprovidesalegacyonwhichtobuildnewinternationalstandardsintotheirbilateraltrade,investmentandallotherdealings.Theirhigh-levelComprehensiveStrategicPartnershipandChAFTAaremajorinstitutionalassets(embodyingmutualtrustandpracticalcommitment)thatcanbedeployedtomanagechangeoverthedecadesahead.Stillcloserengagementandinstitutionalarrangementsareneededtocapitaliseontheopportunitiesthatthesefoundationspresent.

ChAFTAisablueprintforinitialchange,notanend-pointinthebilateralrelationship.Ajointworkplanforachievingchangewillnotonlydefineprogressinthebilateraltrade,investmentandcommercialrelationshipoverthecomingdecade;itwillalsoprovidethefoundationforAustraliaandChinapushingliberalisationandreformintheAsianregionandsettingoutthepathwaytowardsreformandstrengtheningoftheglobaltradeandeconomicsystems.Precedentexistsininstitutionalframeworkssuchasthe1976BasicTreatyofFriendshipandCooperationbetweenAustraliaandJapanforacomprehensivebilateraltreatytoprovideanoverallguidingstructurefortheAustralia–Chinarelationshipasitmatures.

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Thescaleandsignificanceofdevelopmentsthatarenowtakingplace—especiallyinChinathroughitstransformationtowardsahigh-incomeeconomy—recommenddeeperbilateralinstitutionalarrangementsbetweenAustraliaandChina.Thesewouldbuildonexistingbilateralframeworkswithboldnewbi-nationalinitiatives,includingintheareasofinvestment,tourism,peoplemovement,science,andeducationalexchanges.Theywillneedtocaptureopportunitiesintherelationship,andmanagetheinevitablerisksandprocessesthatareaconsequenceoflarge-scalechange.

Bothcountriesshouldworktogethertostrengthentheestablishedregionaleconomiccooperationarrangementsandtosecuretheframeworkofpoliticalconfidenceandsecuritywithinwhicheconomicprosperitycanbeattained.ButtherearegapsinregionalpolicystrategiesthatAustraliaandChinamustnowworkmoreactivelywithregionalpartnerstofill.TheAustralia–Chinarelationshipisanchoredinglobalinstitutionalandpoliticalarrangements.Australiahasadirectandimportantstake,inpartnershipwithChina,inworkingtoensureChina’ssuccessintheassumptionofitsroleofsharedleadershipinglobaleconomicaffairs.

Inthecomingdecade,Australia’srelationshipwithChinawillbeatoppolicypriority.TradewithChinaaccountsforalmostaquarterofAustralia’soveralltrade,withChinaabsorbingalmostathirdofAustralia’stotalmerchandiseexports(DFAT2016e).Chinaisthefifth-largestsourceofforeigndirectinvestmentintoAustraliaandformanyAustralianbusinessesChinarepresentsanenormousgrowthmarket(ABS2016f).WhileAustraliaisChina’sseventh-largestsourceofimports,Australiaisalsoamajorandreliablesourceofstrategicindustrialrawmaterialsandhigh-qualityinputs,fromironoretoeducation,whichChinaneedstofuelitsindustrialisationandurbanisation.TherelationshipbetweenAustraliaandChinaisintegraltotheirotherimportantinternationalrelationships.

WithremarkablesuccessintheachievementofhigherincomesandwagesinChina,thepaceofgrowthisslowingasreadysuppliesoflowcostlabourareexhausted.TheshiftinChinafromexport-andinvestment-ledgrowthtogrowthbasedondomesticdemand,andespeciallydomesticconsumption,hascontributedtothedeclineoftheAustralianresourcesboom.

AsChina’sgrowthmodelandfocusshiftsandAustraliaseekstodefineaprosperouseconomicfuturelessreliantonitsresourcebase,bigchangesareboundtooccurintherelationship.Somebigchangeshavealreadytakenplaceandnewopportunitiesareemergingforbothcountries.Thetransformationtowardsproductivityandinnovation-ledgrowth,financialmarketreformandcapitalaccountopennesswillpropelChina’sdeeperintegrationintotheglobaleconomy.AricherChinawithamoreopenservicesindustrywillgainnewstandingamongthemajoreconomiesoftheworld.Australia’sshifttomorehumancapital-drivengrowth,togetherwiththechangesinChina,providetheopportunitytoforgenewcomplementaritiesbetweenthetwocountries,profoundlyreshapingtheirbilateralrelationshipoverthedecadeahead.

AsproductioninsomeofChina’sheavy,resourceandenergy-intensiveindustriesispeaking,thepriceofAustralia’sexportsofcommoditiessuchasironoreandcoalhasfallen.Aseconomicrebalancingtowardsconsumptionandservicesector-ledgrowthcontinues,theshareofheavyindustryintheChineseeconomywillinevitablydecline.YetChinesedemandforresourcesandenergywillremainlargeasurbanisationcontinuesinChinaandAustralia’s

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CHAPtER 1: Strategic importance of the relationship

shareinChina’sresourceimports,whichhasrisenaspriceshavefallen,islikelytostayhigh.Asoneoftheworld’sleadingandmostcompetitivesuppliersofarangeofindustrialinputs,AustraliawillremainamajoranchorinChina’sexternalresourcesecurity.Increasingly,however,thetraderelationshipwilldiversifybeyondcommoditiesintoawiderrangeofgoodsandservices.Thetwocountries’investmentandfinancialintegrationwillbecomedeeperandmoresophisticated.Australiacanaimtobecomeamajorsupplierofknowledge,skillsandproductssupportingChina’snextstageofdevelopment,whichinvolvesanemphasisonhighvalue-addedindustries,innovationandcleanproductionprocesses.IndustrialrestructuringandupgradinginChinawillseeChina’smachineryandequipmentexportsbecomemoreimportanttoAustraliaandwilldiversifyChineseinvestmentintotourism,financeandinfrastructure.

AustraliaandChinahaveplayedakeyroleineconomiccooperationinAsiaandthePacific,regionswhichincludeeconomiesthatarethefastest-growingandmostdynamiccentresofglobaleconomicactivity.Throughregionalandmultilateralforums,bothcountrieshaveworkedcloselytopromotedevelopment,stabilityandstrongerregionalcooperation.Theyhaveadeepintersectionofinterestinstrengtheningestablishedregionalarrangements,suchasAPEC,theASEANPlusframeworksandtheEastAsiaSummit,andinglobalinstitutions,especiallytheG20.Theyalsohaveasharedinterestinsecuringtheframeworkofpoliticalconfidenceandsecuritywithinwhicheconomicprosperitycanbeattained.

ThegrowthofChina’simportanceintheworldeconomyhasoccurredveryrapidlyandhasbroughtwithitnewcapacity,responsibilities,expectationsandchallengesinmanagingitsinterdependencewiththerestoftheworld.

TheChineseeconomyaccountedforlessthan3percentofglobalGDPin1980(OECD2013a).Itisnowthesecond-largesteconomyintheworldinnominalterms,accountingfor13percentofglobalGDPincurrentUSdollars,anditsGDPislargerthanthatoftheUnitedStatesinrealpurchasingpowerparityterms(WorldBank2016).Chinabecamethesinglelargestcontributortoglobalgrowthin2007andhasmaintainedthatpositioneversince(Yueh2015).Chinaistheworld’slargestgoodstraderandisalsotheworld’ssecond-largestimporterofgoodsandservices,makingitamajorelementinglobaldemandfortradedgoodsandservices(Austrade2015a;WorldBank2016).

Untilrecently,Chinawasmainlyarule-takerintheglobaleconomicsystem.Sincethelate1970sithasbenefitedenormouslyfromopeningitseconomyandparticipatinginthepost-BrettonWoodssystem.China’sroleinglobaleconomicgovernanceremainedpassive,constrainedbythesmallsizeandlowcapacityofitseconomy.NowChinaisgrowingoutofthisstageandisthereforebecomingmoreactiveintheprovisionofglobalpublicgoods.Thetransitiontojoiningtheranksofglobalrule-makersisnotautomaticoreasyforeitherChinaortheglobalsystem.ButChinaisnowactivelyparticipatinginglobalgovernanceandactivelyassumingitsinternationalresponsibilitiesandduties.AnimportantopportunityisChina’schairingoftheG20in2016.

Australiahasadirectstakeinworking,inpartnershipwithChina,toensureChina’ssuccessintheassumptionofitsroleofsharedleadershipinglobaleconomicaffairs.ThereisspecialvalueinthedevelopmentofthispartnershipbecauseofAustralia’suniqueroleintheregionaswellasitsclosenesstotheUnitedStates.ThevalueofthepartnershipincludesthechanceofworkingwithChinainthedevelopmentofitscontributiontotheprovisionofinternationalpublicgoods,boththroughestablishedinternationalinstitutionssuchastheIMF,theWTO,theWorldBankandnewinternationalinstitutionssuchastheAIIB.ItalsoincludesAustralia’s

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workingtogetherwiththeestablishedandemergingpowerstobuildnewplatformstocoordinatearangeofglobaleconomicpolicieswithintheG20andtomanagethechallengestosustainablegrowthfromclimatechangeandotherenvironmentalissues.

Thisisacriticalmomentinafar-reachingglobaleconomictransition.AustraliaandChinahaveavitalopportunitytodefinehowtheywillshapethefuturecourseoftheirrelationshipinadeliberateway,establishingsomecommonreferencepointstohelpmanageitpurposefully,astheyhavewithsomesuccessinthepast,ratherthanmuddlingthroughinthefuture.

CapturingthefullbenefitoftheeconomicrelationshipwilldependonhowboththepublicandprivatesectorsinAustraliaandChinaengageinanddeveloptherelationship.Managingtherisksanduncertaintiesthatcanimpactontheeconomicrelationshipwillbeimportant.Asastartingpoint,gettingthemostforbothcountrieswillrequireafunctionalunderstandingamongpolicymakers,corporateleadersandthebroadercommunityofthechangesthatwillshapeChinaandAustraliainthenext10years.ThisReportcanplayaroleinthis.Theunderstandingthathasbeenbuiltthroughthisworkcanbeembeddedininstitutionalformstohelpfacilitatebettermanagementoftherelationship.ChAFTArepresentsamajorstepinputtinginplacestrongerinstitutionalarrangementsforthedevelopmentoftradeandinvestmentlinks.Butarelationshipofthekindthatwillberequiredbythechangesinbotheconomies,theireconomiccooperationintheregionandtheirpartnershipinglobalaffairsincomingdecades,demandssubstantialjointpolicyinitiativeandstrengthenedinstitutionalframeworks(bothgovernmentandprivate).

In1976,AustraliasignedaBasicTreatyofFriendshipandCooperationwithJapan,anagreementwhichsetouttheprinciplesunderpinningtheirbilateralrelationship,definedkeyareasofcooperation,andpledgedtoenshrineandpreservetheprincipleofnon-discriminationineconomicrelations.Sinceitssigning,theTreaty,andthemutualconfidencethatitgavebothJapanandAustralia,hasprovidedtheframeworkwithinwhichclosertieshaveforged.TheopportunityforevolvingasimilarframeworktounderpintheAustralia–Chinarelationshipshouldnotbepassedup.ChAFTAcanprovidethebeginningsforsuchaframework.

economic transformation in China and Australia

china

TheChineseeconomyisundergoingamajortransformationafternearly40yearsofhigh-speedeconomicgrowth.China’srapideconomicrisehasbeenfuelledbymarket-orientedreformsandeconomicliberalisationthathelpedreducethedistortionsinresourceallocationintheeconomy.Thereformwasmorethoroughinthegoodsmarketthaninfactormarketsforland,labour,capitalandenergy,whichremainedundertighterstatecontrol.Thisgrowthmodelencouragedinvestmentinmanufacturingcapacityandinfrastructure.

WithrealGDPgrowthataround10percentperannumfromthe1980s,manufacturingoutputisnowlargerthanthatinanyothereconomyintheworld.Chinaaccountedforaquarterofworldmanufacturingoutputby2015,upfromlessthan3percentin1990.Chineseconsumptionhasdominatedtheglobalmarketsforindustrialrawmaterials(WorldBank2016).Theexpansionoftheironandsteelindustry,forexample,whichproducedover800milliontonsofcrudesteelin2015,ormorethansixtimesasmuchasitdidin2000,liftedtheChineseshareinworldironoreconsumptionfrom14percentin2000toanestimated65percentin2015(Figure1.1).ThissurgeinChinesedemanddroveamorethanfive-foldriseofpricesintheyearsfrom2000–2008inthescrambleforadditionalsuppliesofironore(RBA2012).

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Australia’sestablishedcompetitivenessininternationalresourceandenergymarkets,relativegeographicproximityandcloseengagementsinceChina’seconomicopeninginthe1970s,madeAustraliaanaturalandcomplementarypartnerinChina’stradeandindustrialtransformation.AustraliahasbeenananchorinNortheastAsianresourcesecurityandapioneerintheexportofhighqualityresourcestoChina.AustraliabecameChina’sprincipalsupplierofimportedironore,coalandarangeofotherindustrialrawmaterialsovertheseyears.In2015,Australiasupplied64percentofChina’simportedironore,forexample,comparedwiththe43percentitsuppliedin2010(Ng2016).TherelationshipwithChinasawmassiveinvestmentintheAustralianresourcesectorinthefirstdecadeofthe21stcentury,andstronggrowthinAustraliathroughouttheglobalfinancialcrisiswhengrowthinotherindustrialeconomieslanguished.

WhileChina’sinvestment-ledgrowthdeliveredastonishingoutcomes,italsoledtostructuralimbalancesthatincreasinglythreatenedsustainablegrowthandstability.

China’sreformsnowaimtoremovethosedistortions,especiallyinthefinancialmarket,andnurtureconsumption-andservice-ledgrowth.TheChinesegovernmentisalsoimplementingmeasurestoclosedowncapacityinheavyindustries,suchasironandsteel,thatdoesnotembodybest-practiceproductiontechnologyorenvironmentalprotection.Thisentailssubstantialcostsofadjustmentandtheneedtomanageeconomicaswellassocialdislocation.Thefocusofgrowthisnowonthe‘neweconomy’.Thechangeingearfromdouble-digittosingle-digitgrowthisexpectedtoputtheeconomyonamoresustainable,butstillrelativelyhigh,long-termgrowthtrajectoryoverthecomingdecade.

Figure 1.1: Chinese and global steel production

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AmongthenationaleconomicpolicycommitmentsthatarelikelytohavethemostprofoundeffectonChina’srelationswithAustraliaandothercountriesistheChinesegovernment’s13thFiveYearPlancommitmenttobuildanopeneconomicsystem,deepenfinancialsystemreform,liberalisefinancialmarketsandacceleratetherealisationofChinesecapitalaccountconvertibility.

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CapitalaccountliberalisationisessentialtomakingChina’srenminbiatrulyglobalcurrencyandincreasingChina’sroleininternationalfinance.InclusionoftherenminbiintheIMF’sSpecialDrawingRightsbasketisafirststepinthisprocess.Fortherenminbitobecomeatrulyinternationalcurrency,however,Chinaneedstohaveanopencapitalaccount.Butthesignificanceofcapitalaccountliberalisationismuchmorewide-rangingthanrenminbiinternationalisation.

FinancialreformandcapitalaccountliberalisationarecentraltorebalancingtheChineseeconomyandfosteringinnovationandproductivitygrowth.Marketreformsandmarket-determinedinterestratesandexchangerateswillcorrectthemisallocationofcapitalthathasuntilnowfavouredparticularregions,state-ownedenterprisesandthestatebankingsector,andcrowdedoutfinancingandinvestmentfromthemoredynamicprivatesector.Healthyandwell-managedfinancialinstitutionsareattheheartoffinancialandeconomicstability.ThesechangeswillhelpChinatomovethroughtheso-called‘middle-incometrap’andtobecomeahigh-incomesociety.Capitalaccountliberalisationcouldalsoassistwithgeopoliticalstabilityintheregionthroughgreatereconomicandfinancialintegration.

ThescaleofChina’scross-bordertradeandinvestmentpaymentsandtheimportanceofusingmarketmechanisms(inparticularafullyflexibleexchangerateandarobustandmoreefficientfinancialmarket)tomanagetheinteractionbetweenthedomesticandinternationaleconomieseffectivelyrequirethemovetoanopencapitalaccount.

LiberalisingChina’scapitalaccountisanenormouschallengeanditwilltaketime.ThenervousnessininternationalmarketsaboutChinesestockmarketvolatilitiesandthemovetoanewforeignexchangerateregimewithmoreflexibilityagainstacurrencybasketoverthepastyearisaharbingerofthedifficultiesinmanagingthispolicychange.Theoverridinglessonoffinancialhistoryaroundtheworldisthattransitionsarenevereasyorsmooth.ThishasbeennolesstrueinChinathanithasbeeninothereconomiesthatareintheprocessofprofoundtransformation.Therehastobepolicytrialanderror,andtherewillinevitablybesomemissteps,butallcountrieshaveaninterestinensuringthatChina’sreformssucceed.

Theprocessofcapitalaccountliberalisationneedstobeincremental,builtonrobustinstitutionsandmarkets,andcarefullystagedandtimedtoavoidpotentiallysubstantialfinancialandforeignexchangerisks.Thisisnotjustatechnicaleconomicchallenge.IntegrationofChinaintointernationalcapitalmarketsrequiresChinatohaveamuchmoreopen,transparentandpredictablesetofinstitutionalarrangementstobuildinternationalconfidenceindealinginChinesefinancialassets,andthiswillpushattheenvelopeofpoliticalreform.

Thetrajectoryofgrowthisslowinginthistransition.Manufacturingandexportgrowthisslowing.WhileChinawillremainabigexporter,exportgrowthislikelytoslowasthestructureofexportsisupgraded.ThemassiveurbanisationthathasalreadytakenplaceinChinawillcontinueastherateofurbanisation—nowat56percentofthepopulation—stilllagsbehindthatinmanydevelopingeconomieswithsimilarincomelevels,letalonethatinadvancedeconomies(CCTV2016).Thisrequirescontinuing,albeitslower,expansionofinfrastructureinvestment.Newinvestmentwillalsobedrivenbytheneedforcleanenergyandenvironmentalprotection.

HigherChinesewagesasthelabourmarkethastightened,aswellastheremovalofsomedistortionsthatfavouredinvestmentratherthanconsumption,havemeantthatgrowthisincreasinglydrivenbyconsumerdemand.Thistrendhasbeenunderwayforsometime,with

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consumptionnowovertakinginvestmentasthemaingrowthdriver(Prasad2015).Servicesalreadyaccountforover50percentofnationaloutput,whilemanufacturinghasfallentowards30percent(Figure1.2).

Theconstraintsonlabourmobility,andinter-provincialfiscalandincomedisparities,continuetobifurcatethegeographicpatternofChineseeconomicdevelopment,meaningthatinnerprovinceshavelowerincomesandlowerratesofurbandevelopment.Ifeconomicconstraintswithanegativegeographicalimpactwererelaxed,theseinnerprovincescouldbecomeasourceofstrongpotentialfuturegrowth.ThetimingofpolicyandinstitutionalreformsthatreducethesedistortionswillaffecttheimpactoffuturegrowthonChina’sexternaleconomicrelations,includingwithAustralia.

China’s‘newnormal’growthpath—withitsstructurallydecliningbutstillrelativelyhighgrowthrate,partiallytighteninglabourmarket,shifttoconsumption-ledgrowth,andsteadyshifttoservicesawayfrommanufacturing—willfundamentallychangeChina’sinteractionwiththeinternationaleconomy.

TherewillcontinuetobegrowthopportunitiesintheChinesemarketoverthenextdecadeasnewbusinessopportunitiesemerge.China’sgrowthwilllikelyremainatmorethantwicetheglobalaveragegrowthrate.Despitemoderatingratesofgrowth,Chinawillcontinuetomakeasizeablecontributiontoglobalgrowth,asitwillbegrowingoffamuchlargerbasethanafewyearsago.SevenpercentgrowthinChinanowisequivalenttoanadditiontoincomeof10percentjustfiveyearsago.China’sgrowthratewas6.9percentin2015,muchlowercomparedtogrowthof10.6percentin2010,butinbothyearsChinastilladdedRMB3.8trilliontoglobalGDP(inconstant2010RMB).Since2008,China’scontributiontoglobalGDPeachyearhasbeenequivalenttoaneconomyaroundthesizeofMexicoorthree-quartersthesizeofAustralia.

Figure 1.2: sectoral value added as a percentage of Chinese gDP

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AsFigure1.3suggests,theIMFexpectsthatChinawillcontinuetoaddmoreeachyeartoglobalGDPoverthecomingdecade(inUSdollars).ChinaislikelytoremainthebiggestcontributortoglobalGDPgrowthforthenextfiveyears,addingmoretoglobaloutputthantheUnitedStates,ormorethanIndiaandalloftheotherAsianeconomiesputtogether.

ThehugescaleofChina’seconomytoday,nonetheless,needstobeunderstoodinthecontextofitsambitionsforgrowthinthefuture.China’spercapitaincomeisstillnothigh,beingonly24percentofthatoftheUnitedStatesor34percentoftheOECDaverage(OECD2014a).Chinesepolicymakershavetomanagethetransitiontohigherincomesandkeepclosingthisgapinthecomingdecades.

Australia

China’sremarkableexpansionthroughthefirstdecadeofthecenturybroughtstronggrowthinAustralia’sminingsector.GrowthinWesternAustraliaapproachedgrowthratesinChinaduringsomeoftheseyears.Australianincomegrowthandhouseholdlivingstandardsbenefitedfromtheterms-of-trade-inducedstrengthoftheAustraliandollarasimportpricesfell.HalftheriseinAustralianincomesduringtheminingboomresultedfromtheboosttoAustralia’stermsoftrade(Downesetal2014).ItwasnotonlytheAustralianminingsectorthatbenefitedfromChinesegrowth:Australia’seducationexportsandtourismservicesgrewstrongly,accompaniedbysharprisesinChina’sshareofthesemarkets(Austrade2015b).China’sshareofAustralianexportsgrewstronglyandishigherthanthatofothermajorexportcustomers(Figure1.4).Whiletheeconomyasawholeunambiguouslybenefitedfromtheminingboom,somesectors,suchastrade-exposedmanufacturers,sawdemandfortheirproductsfallbecauseofAustralia’selevatedexchangerate.Asdramaticastheywere,thesechangeswerepartofalong-termstructuraladjustmentintheAustralianeconomythatwasalreadywellunderwayandwouldhavesubstantiallyoccurredevenwithouttheminingboom.

Figure 1.3: China’s gDP growth (RHs) and its contribution to global output (LHs), 1990–2020

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Figure 1.4: exports to China as a share of total exports, Australia and other major exporters

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SlowergrowthinChinesedemandfor,andincreasedglobalsuppliesof,industrialrawmaterialshavesentironoreandothercommoditypricesdramaticallylower.ThedropinpriceshascausedtheshareofcommoditiesinChina’simportstocontract.ButAustraliahasincreaseditsshareinChina’simportsofindustrialrawmaterials(althoughimportvalueshavedroppedsharply)becauseAustraliacontinuestobeoneoftheworld’smostcompetitivesuppliersofcommoditieslikeironore.Newenergyprojects,inthegasanduraniumsector,willalsocomeonstreaminthenearfuture.ButgrowthinresourceexportstoChinaisunlikelytoreturntotherateseenduringthe2000s,andpricesarelikelytoremainsubdued.

Asinpastcommoditycycles,priceshavefallen(alongwiththetermsoftrade)asnewmineshavecomeonlineinAustraliaandaroundtheworld,draggingAustralianrealincomesdownatthesametime.Thistrendislikelytocontinue,althoughthereislikelytobevolatilityaroundthistrend.Australiawillovercomethisdragonincomegrowthonlythroughitsowneconomictransformationandthroughliftingproductivityacrossthewholeeconomy.

SuccessfuladjustmentandsustainedgrowthoverthecomingdecadewillrequireashiftinAustralia’seconomicstructurebacktoamorenormaltrajectory:awayfromanabnormalexpansionoftheresourcesector(evenifenergydemandcontinuestogrow)towardsresumptionofgrowthintheshareofservices,high-endmanufacturingandhighvalue-addedagriculturalproduction.Thisstructuralchange,aswellasAustralia’sstrongpopulationgrowththroughmigration,willneedlarge-scalerenovationofurbaninfrastructure,investmentininter-urbantransportandcommunications(becauseofgrowingurbancongestionandnationalconnectivitydeficiencies),newinfrastructureinvestmentandintegratedlanduseplanninginthenorthofthecountry(becauseofthelocationofnewagriculturalanddevelopmentopportunitiesthere),andinvestmentininnovation,researchandeducation.

Thesechanges,througharelativelyflexiblelabourmarketandresponsivecapitalmarket,arealreadytakingplace,butmajorchallengesremaininundertakingtoughreformsthatmaketheeconomymoreflexibleandhelptorestructureandupgradeindustry.Moreover,themarketsinwhichtheseopportunitieslieforAustraliaarefiercelycontestedinternationallyandAustraliadoesnothavethesameestablishedadvantageasithasinnaturalresources.Unless

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Australia’sprivateandpublicsectorinvestmentbecomessmarter,andunlessAustraliacanmobilisecapitalathomeandfromabroadtoinvestmoreefficientlyininfrastructure,itisunlikelytoachievethe3percentGDPgrowththatithascommonlyenjoyedoverthepastfewdecades.Itwillnotbeaneasytask—totalproductivitygrowthhasbeenstagnantforsomeyears—andwhiletherearesignsofimprovement,itneedstoimprovefurther.

HoweffectivelythesechangesaremanagedwillshapethefutureoftheAustralia–Chinaeconomicrelationship.

strategic partnership for change

Inmanagingthechangeanticipatedoverthecomingdecade,boththepublicandprivatesectorscandrawuponsubstantialassetsthatalreadyexistintheestablishedbilateralrelationship.TheAustralia–Chinarelationshipisdistinguishedbyahistoryofpoliticalcommitmentatthehighestlevels,sincediplomaticrecognition,toapartnershipthathasembracedChina’sopenness,itsreformanditseconomicrise.DevelopmentoftherelationshiphasalsobeenfacilitatedbyAustralia’sopeneconomy,stronginstitutionsandrichmineralendowment,ChineseperceptionsofAustralia’sbusiness-friendlyenvironment,aswellasAustralia’sgoodstandingwithothercountries.Thoughtheyhavedifferentpoliticalandsocialsystems,bothcountriesacceptthisdifferenceandrespecteachother’sachievements,includingtheremarkableelevationoflivingstandardsandimprovementinsocialconditionsthrougheconomicreformsandliberalisationthatbothcountrieshaveputinplaceoverthepastfourdecades.

Thedeepcomplementarityoftheestablishedeconomicrelationshipandthehighpoliticalcommitmenttoitsdevelopmentbybothcountriesprovideasecurefoundationonwhichtobuildanewanddynamicpartnership.

AustralianandChinesepoliticalleadershaveinvestedheavilyintherelationshipandarenowcommittedtoitselevationasastrategicpartnershipthroughregularhigh-levelleadershipdialogues.

Maintainingtheclosenessintherelationshipatthetopleadershiplevelisapriorityforbothgovernments.Itisasignalofpoliticaltrustandgoodintentioninthepartnership.

ChAFTAisinplace—themostopenandliberalisingsucharrangementthatChinahasenteredintowithanydevelopedeconomyandonewhichgoesfurtherinitspartnercountryliberalisationthanAustralia’spreviousagreements.

Whatdothebigchangesinthestructureofbotheconomiesmeanfortheirbilateralrelationshipanditsmanagementoverthecomingdecade?

Asconsumerincomesriseandpreferencesshift,thenewpatternsofChineseconsumptionwilldrivehighergrowthinimportsofrecreationalservices(liketourism),educationalservices,healthservicesandfinancialservices.Theconsumptionandimportofhighvaluefoodstuffs,inwhichAustraliahasastrongcomparativeadvantage,areexpectedtogrowrapidlyoverthenextfewdecades.Forexample,therealvalueofbeefconsumptioninChinaisprojectedtorise236percentbetween2009and2050(ABARES2014).ChAFTAopensthedoorwidertogrowthetradeinmarketsforhighvaluegoodsandservices.ChAFTAofferstheprospectofsignificantgainsinAustralia’sshareinmarketsforimportsacrosstheboard,fromdairyproductsandhealthproductstoeducationandtourism(seeChapter3).

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ChAFTAopensthedoortonewopportunitiesintheservicestrade,ininvestment,intourismandinthecommoditytrade;buttherearemanyobstaclestorealisingtheseopportunitiesthatstillneedtobeovercome.Theobstacleshavetodowithhowcommercialpartiesrelatetoregulatoryinstitutionsbeyondnationalborders.Theyalsohavetodowithbuildingdeeperprivatebilateralbusinessnetworksandassociationstofacilitatebusinessbetweenthetwocountries.ThereisareviewprocessbuiltintoChAFTA—inthissense,ChAFTAisalivingagreement.Yetthenatureofthearrangementembeddedintheagreementisthatitisreactivetospecificproblemsolving—ratherthanstrategicinitspurpose,seekingopportunitiesthroughtheagreementandbeyond(seeChapters4,5and6).

AsChina’sindustrialupgradinggatherspace,Australia’simportsfromChinawillbeincreasinglydominatedbyhigher-valueappliances,equipmentandmachinery.ManyofChina’sexports,ofcourse,involvesubstantialvalue-addfromothercountriesintheregion,includingJapan,SouthKoreaandtheUnitedStates.AlargeproportionofJapanesebrandimports,fromexample,nowarriveinAustraliaviaChina.

China’scommitmenttofreeingupinvestmentabroadinthepastdecade(the‘goingout’strategy)sawAustraliaemergeasaleadingdestinationforChineseoutbounddirectinvestment.ThereformsthatarenowbeingputinplaceinthefinancialmarkethavealreadyseenChinesebanksandnon-financialenterprisesliftinvestmentinAustralianassets.Inthecomingdecade,thesereformsandwiderliberalisationofthecapitalaccountcouldfundamentallychangethestructureofeconomicrelationsbetweenthetwocountries.

FinancialmarketreformandcapitalaccountliberalisationwillalsofundamentallychangeChina’sstandingandroleintheglobaleconomy—anditsinfluenceandimportanceintheAustralianeconomy.ItwillincreasethesizeandrangeofChineseassetsheldbyAustralianinstitutionsandcorporations,aswellastheportfolioofAustralianassetsheldbyChineseinstitutionsandenterprises.ItwillseeChina’scurrencyusedmoreextensivelyininternationaltransactionsandborrowing.Chinesehouseholdsandinstitutions,notonlyenterprises,willincreasetheportfolioofassetstheyholdinAustraliaandelsewhere.

Arrangementsthatbuildconfidenceinundertakingforeigninvestmentineachcountryareapriority.DespitetheprogressmadeinChAFTA,thereremainsconfusionaboutthetreatmentofAustralianandChineseinvestorsundertheothercountry’sforeigninvestmentregimes.Policiesthatenshrinenodiscriminationagainstthesameclassofforeigninvestmentacrossforeigninvestmentsourcesandentrenchthenationaltreatmentprincipleneedtobetheanchorsofeachforeigninvestmentregime.Mechanismsfordirectcollaborationinsharinginformationanddataoninvestmentandinvestoractivitiesneedtobeputinplacebetweentherelevantagenciesineachcountry.

ThenewphasesofChineseandAustraliangrowthandtheirchangedinternationalcircumstancesrequireanewmodelofeconomiccollaborationwhichencompassesanupdateandoverhauloftheinstitutionalarrangementsthatsupportAustralia–Chinaengagement.

Aninstitutionalframeworkthatdynamicallydrivesbilateralstrategicengagement,promotingthenewopportunitiesfortradeandinvestmentintherelationshipthroughandbeyondChAFTA,willprovidesubstanceattheworkingleveltothestrategicpartnershipbetweenthetwocountriesatthetop.

Thetaskistocapitaliseonandmanagechange.ItwillrequireenergisinganddeepeningtheinstitutionalarrangementsthatarealreadyinplacebetweenAustraliaandChinato:

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buildtrustaroundcommoninterestsineconomicandpoliticalrelationships;managetheuncertaintiesthatinevitablyarisethroughchange;anddeveloptheup-closecommercialandbusinessengagementneededasthestructureoftheeconomicrelationshipshiftstowardsservicesandconsumers.

Thisisanationaltaskforeachcountry.Itisalsoabi-nationaltaskthatembracesnewundertakingsandagreements.

TheframeworkofanewmodelforeconomiccollaborationwouldincludejointmechanismsandworkinggroupsthatbuilduponestablishedpartnershipsingovernmentsuchastheComprehensiveStrategicPartnership,theStrategicEconomicDialogueandtheJointMinisterialEconomicCommissionattheleaderandministeriallevels,aswellasofficialagencypartnershipssuchasthatbetweentheAustralianTreasuryandChina’sNationalDevelopmentandReformCommission(NDRC)andthetiesthataregrowingbetweentheReserveBankofAustralia(RBA)andthePeople’sBankofChina(PBoC).Thesepartnershipsshoulddrawuponbusinessandoutsideexpertise,asrequired,to:

• adviseinthedevelopmentoftheComprehensiveStrategicPartnershipdialogues;

• supportjointtaskforceorworkinggroupactivityonissuesflowingfromthedialoguesorotherbilateralinitiatives;

• workwithstateandprovincialauthoritiesindevelopinginitiativesintherelationship;

• encourageprogramsofresearchwithinandbeyondgovernmentonallaspectsoftherelationship;

• engagewiththebusinesssectorsinbothcountriesinundertakingitswork;

• promotejointtrainingandthedevelopmentoflong-termworkingassociationsinkeyareasamongtheofficialsofbothcountries;and

• reflectuponcommunityinterestsandconcerns.

Thisframeworkwouldalsoincludeabi-nationalinitiativetoestablishanAustralia-China(Ao–Zhong)Commissionforboostinghigh-levelresearch,scientific,politicalandcommunityexchangestobuildthecapacitiesinbothcountriesforcomprehendingandrealisingtheopportunitiesinwhatwillbecomeanincreasinglyup-closerelationship.Thisbi-nationalgovernmenteffortwillbepartneredbybusiness,governmentdepartments,statesandprovinces,asitisinasimilarthoughlesscomprehensivewaythanenvisagedherebytheAustralian–AmericanFulbrightCommission.

ThesearrangementswillunderpintheAustralia–ChinaStrategicPartnershipforChange.Theinitiativesandstandardsthatbothcountriesdeveloppragmaticallywithinthatframeworkshouldalsobeconsistentwiththeirinternationalandregionalambitionsandresponsibilities.

Thisframeworkwilltaketimetoputinplace,butthisprocesscanbeginimmediately.

Itwillrequireinstitutionalinnovationinbuildingthecapacityforengagementstep-by-stepineachbureaucracy,throughtrainingandexchange.ButthisReportdemonstratesthewillandtheincentivetomakeitwork,intheinterestsofbothcountries.Itwillrequirepartnershipwiththebusiness,academicandthinktanksectors.TheframeworkmustbeguidedbyenunciationoftheunderstandingsandprinciplesidentifiedinthisReporttowhichbothpartnersaspireintheconductoftheirrelationship.ThecollaborationestablishedbetweentheChinaCenterfor

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InternationalEconomicExchanges(CCIEE)andtheEastAsianBureauofEconomicResearch(EABER)andtheirgovernmentandnon-governmentpartnersinbothcountriesthroughthisReportprovidesanaturalandusefulfoundationforcontinuingthisinitiative.

Strengtheningtheframeworkfornationalgovernmentinstitutionstodeveloptherelationshipwillbeineffectiveifitisnotcomplementedbyongoinginitiativesatthestateandprovinciallevel,andbybuildingcapacitiesthrougheducationalandresearchinstitutionsandacrossthecommunity.MuchoftheinteractionbetweenChineseandAustralianbusinessandgovernmentsineachcountrytakesplaceatthelocallevel.Muchofthecommunityengagementtakesplacethroughstateandprovinciallevelprogramsandthroughsister-cityrelationshipsandeducationalexchangesdeliveredatthegrassrootslevel.Thepeople-to-peopleassociationsestablishedthroughtheseprogramsarefrequentlythefoundationsofbusinessandcommunitypartnershipsthatdriveinitiativeandthedevelopmentoftherelationship.Thesharpgrowthintourismbetweenthetwocountriesisfullofpotentialtostrengthenpeople-to-peoplelinks,understandingandappreciationofeachother’sculture,circumstanceandcountry.

Thereisarangeofmodelsofsuccessfulengagementacrosslevelsofgovernmentandacrossthecommunity—throughtheorganisationofstateandprovinciallevelprograms,businessassociations,youthandprofessionaldialogues,academicinstitutionsandprograms,culturalandartisticcommunities,andcommunityandschool-levelexchanges.Thesearetargetsfordevelopmentandpromotionthroughthenationalandbi-nationalinitiativesheadlinedabove(seeChapters3,5and6).

Opportunities and risks

AcriticalelementinthesuccessoftheAustralia–Chinarelationshipoverthecomingdecadeswillbetheunderstandingof,andmanagingtheuncertaintiesfrom,thehugechangestakingplaceinbotheconomies.Thesearechangesthatwilltransformbothsocieties—withthenationalambitioninChinatobeonthewaytolivingstandardsequivalenttosomeadvancedcountriesbytheendofthisperiod—althoughtheircourseisimpossibletopredictexactly.In2025,China’seconomywillbemuchbiggerthanitistodayanditsinstitutionswillcontinuetoevolvefromwhattheyaretoday.Australiawillalsohavechangedsignificantly.Apremiseintheconductoftherelationshipiscommitmenttosharedambitionsfornationalchangeandtoengagebilaterallyinregionalandglobalaffairsinawaythatmanageseffectivelytheadverseconsequencesofunforeseenorunwelcomechangethatwillinevitablyoccurfromtimetotime.TheprinciplesandcommonunderstandingsoutlinedinthisReport,andthearrangementsandinstitutionsthatitrecommends,aredesignedtomanagebothproactiveengagementandunexpectedshocks.Themanagementofadversechangebecomeseasierwhenbothcountriesarecloselyengagedandhavethebestaccesstoinformationandanalysisthatispossiblethroughsucharrangements.

TheopportunitiesintherelationshipwithaneconomythesizeofChina’sarehugeformanyofAustralia’sbiggestcorporations,includinganincreasingnumberoffirmsandenterprisesthatwerenottouchedbyChina’searliergrowthphase.Nonetheless,theyhavetomanagetherisksofcyclicalandstructuralchangeintheChineseeconomy,astheydoinothermarkets.Chinesepolicymakersusedtoworryaboutover-dependenceonAustraliansuppliersofironoreintheup-phaseofthecommodityboom,althoughthoseanxietieshavesubsidedinitsdown-phase.Insuranceagainstriskfromhighlevelsofresourcetradedependence,ofcourse,

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isprovidedbydeepandintenselycompetitiveinternationalmarketsforthesecommodities(includingenergy).Chineseenterprisesthatundertakelarge-scaleinvestmentinAustralia,especiallywhensuchinvestmentisneworunfamiliar,inevitablyfacethesamerisksthatotherlarge-scaleinvestors,Australianorforeign,havetofaceintheAustralianorothermarkets.Theserisksareanormalpartofanycommercialrelationship.

Therearealsorisksassociatedwithpolicyandinstitutionaluncertainties.IneconomicandpoliticalsystemsthatareevolvingasrapidlyasthoseinChina,theserisksareanimportantpartofcommercialcalculation.InAustralia,eventhoughtherearerobustmarketandlegalinstitutions,thereareresidualrisksthatrelatetopolitical,policyandinstitutionaluncertainty,althoughmostofthemarelegallycontestablebyforeignaswellasnationalentities.China’saccessiontotheWTOaswellasitsongoingmassiveeconomicandlegalreformservestoamelioratetheserisksinChina.Animportantobjectiveinthedevelopmentoftherelationship,nonetheless,istoreducegovernance-relateduncertaintiesforenterprisesandpersonsdoingbusinessintheothercountry.Agoalintherelationshipoverthelongertermshouldbetoembedtheseprotectionsinacomprehensiveagreementorbasictreatybetweenthetwocountries.

Thereisstrongprecedentforsuchatreatyframework.TheBasicTreatyofFriendshipandCooperationbetweenAustraliaandJapan,signedin1976,committedbothcountriestocooperateonissuesofmutualconcern.FollowingdecadesofpopularuneaseandpoliticalcautionintheAustralia–Japanrelationship,thisTreatyhadalargeandanalyticallymeasurableimpactongrowingtheoverallbilateraleconomicrelationshipevenaftertheresourcesphaseofbilateralexchangebeganlevellingoff(Drysdale2006).Itimprovedwhatwerethenpoliticallycontroversialinvestmentflowsandledtoconsequentimprovementsinpeoplemovement,servicestradeandregionalcooperation.TheAustralia–JapanReportthatledtoandwasassociatedwiththeconclusionoftheTreatychangedtheinstitutionalstructuresthoughwhichbothcountriesengagedwitheachother,andlaidaframeworkofcollaborationoneconomicissuesthatledtotheformationofAPEC.ApplyingasimilarapproachtotheAustralia–Chinarelationshipcouldyieldsimilareconomicandpoliticalbenefits.

ThemacroeconomicrisksofvolatilityinChina’slargereconomycanbemanagedwithinthemacroeconomicandflexibleexchangeratepoliciesthatcushionthedomesticimpactinAustraliaofsuchinternationaleconomicshocks.Focusingonbuildingstrongerbalancesheetsoffinancialinstitutionsandcompanies,bothstate-ownedandprivate,isafoundationforcrisispreventionandcrisisresolution.

Systemicfailuressuchasfinancialmarketcrisis,shouldtheyoccurinChinaastheydidintheUnitedStatesduringtheglobalfinancialcrisis,willneedtobemanagedthroughdomesticandinternationalmechanismsthatprovidelinesofcreditandregulatorydisciplinestoameliorateoravoidthem.TheadequacyofthesemechanismsisdiscussedinChapter8.ActivepartnershipwithChinainregionalandglobaleconomiccooperation,andindiplomacytosecuredynamicpoliticalstabilityinAsiaandthePacific,arekeyinstrumentsforhandlingtheserisks.

Partners in regional and global affairs

Morethanonanyotherfactor,economicandpoliticalstabilityinthe21stcenturywilldependonhowglobalgovernanceadaptstotheriseofChinaandotheremergingeconomies,andtotheroletheyplayinshapingthearchitectureofglobalgovernanceinthefuture.Australiaand

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ChinahaveadeepstrategicinterestinensuringthisinternationaltransitiontakesplaceinamannerthatisconstructiveandbenefitsChina,regionaleconomiesincludingAustralia,andtheworldatlarge.

Strong,inclusive,rules-basedandmarket-promotingglobalinstitutionsareimportanttoeconomicprosperityinbothAustraliaandChina.BothcountrieshavebenefitedgreatlyfromglobalinstitutionsthatwereputinplaceattheendofWorldWarII.TheUnitedNationsframeworkandtheBrettonWoods-inspiredeconomicinstitutionscontinuetoserveasthefoundationsofglobalgovernanceandhaveprovidedaframeworkforglobalstabilityandeconomicprosperity.

Thesystemofglobalgovernancethattheseinstitutionsunderpinisnotstatic.Itmustcontinuetoevolvesoastocomprehendnewissuesandstakeholders.Therapidchangeinthestructureoftheworldeconomyanddepthofglobalintegrationthathasbeendeliveredbyeconomicopennessandthecommunicationsandtransportationrevolution,hascreatedenormouspressuretochangeandstrengtheninstitutionsforglobalgovernance.TheglobalfinancialcrisissawtheG20Summitemergeasthepreeminentforumforguidingthischange.

Nocountryalonecandictatethischange:itmustbeforgedthroughaconsensusamongallthecountriesthatareaffectedandfeeltheneedforchange.ButtherearesomeareasinwhichcollaborationbetweenChina,Australiaandtheirpartnersinglobalinstitution-buildingwillbeofspecialimportanceinthecomingdecades.

Globalgovernanceisinparttheresultofwhatlargeeconomiesdobetweenthemselvestomanagetheirinteractionwithothereconomiesandpolities,aswellasbeingtheresultofcooperativeorcollectiveactionamongtheeconomicpowers,largeorsmall.InmanywaysChina’sownchoicesininternationaleconomicpolicystrategynowexertinfluenceontheshapeofglobaleconomicgovernancealongsidetheactionsandinitiativesChinatakesdirectlyincollaborationwithothercountriesthroughinternationalforumsandinstitutions.TherelationshipbetweenAustraliaandChinawillthusbeshapedbyChina’sowneconomicpolicystrategiesalongsidethecommitmentsthataremadebybothcountriesinglobalandregionalsettings.AustraliaandChinahaveinthepast,andshouldseekevenmoreactivelyinthefuture,tobestrategicpartnersinboththeatres.ThereisnomoreobviousexampleofthisinthepastthanChina’schoicetoseekaccessiontotheWTOandconformtoitsmultilateralobligations.BilateralpoliticalinitiativesopeneduptradewithChinabeforeWTOaccession.ButparticipationintheWTO,notnarrowlybilateralarrangements,isthecornerstoneofthelargeandconfidenttraderelationshipsthatAustraliaandothercountrieshavewithChinatoday.ThissystemisundersomechallengeandbothcountrieshaveaprofoundeconomicandpoliticalinterestinworkingtogetherandwithpartnerstoensurethatpreferentialregionalandbilateralarrangementsdonotcorrodethemultilateralframeworkthatisanchoredintheWTO.

China’seconomicintegrationintotheEastAsianandglobaleconomyhasoccurredwithinaglobalframeworkthatpromotesfreetradeandinvestment.Australiahasprosperedunderthesameframework.CooperationintheAsiaPacificregionhasbeensignificantlydirectedtoreinforcingglobalgoalsandobjectives,suchaswhenAPECwasfounded,tolendweighttotradeliberalisationintheinterestsofAsia’semergingeconomiesandagriculturalexporterssuchasAustralia.RegionalcooperationinAsiaandthePacificfosteredmarket-ledintegration.Asianeconomiccooperationhasbeeninclusive,hasavoideddiscriminatoryarrangementsthatweakentheglobalsystemandhasledregionalpoliticalcooperation.

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Figure 1.5: Asia’s weight in the global economy

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Withthehugechangethathastakenplace,andthatwilltakeplaceoverthecomingdecade,inthestructureofregionalandglobaleconomicpower(Figure1.5),thereisaneedtorethinktheroleofregionalcooperationasapillarthatsupportsaninclusiveglobaleconomicsystemandmanagesneweconomicandpoliticalchallenges.

APECandtheASEANPlusregionalarrangementsprovidethefoundationalframeworkforregionalcooperation.Thesearrangementsandtheirevolutionhavebeenconsensus-driven.Theyarecharacterisedbyinclusiveness,intermsoftheglobaldimensionoftheiragendasandtheirroutineopennesstodialogueswithothers.Theseprinciplesareanenduringfoundationforregionalcooperation.

WiththeglobalprocessesoftradereformstalledandproliferationofpreferentialbilateralandregionalFTAs,animmediatepriorityistoensurenewandexistingtradingarrangementssuchastheTrans-PacificPartnership(TPP),RegionalComprehensiveEconomicPartnership(RCEP)andFreeTradeAreaoftheAsiaPacific(FTAAP),areinclusiveandcomplementary.Inthiscontext,bothAustraliaandChinahavealargestakeinthesuccessoftheASEANEconomicCommunity(AEC),whichwasestablishedbeforetheTPPwassigned.TheAECwillbefurtherdevelopedinparallelwithTPPdomesticratificationprocesses.ThereisacrucialopportunitytosimultaneouslyconcludeRCEPandadvanceopennessoftheregionaltraderegimebystrategiccommitmentstocomprehensivetradeandinvestmentliberalisationthatissupportiveofthegoalsofASEANandinclusivenessacrossthePacificandtheworld.Theeconomicimperativesforcooperationhavebecomemoreimportantand,sofar,theflexibilityofAsianregionalarrangementsprovidesanopportunitytoconnectexistingarrangementsinwaysthatallowthemtoaddressnewchallengesandopportunities.

Theshifttowardsamorecomplex,multipolarorderhascreatedsomenewtensions,anddifferentpoliticalallegianceshavebecomeacomplicatingfactor.

ThemajorchallengesnowfacingtheinternationalcommunityrequireinnovativesolutionspromotedbyeffectiveregionalcoalitionsthatincludeChinaandtheUnitedStatesandtherebymanagetheUS–Chinarelationship,whichisarguablythemostimportantbilateralrelationshipintheworld.

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Fourforcesunderscoretheneedforpower-sharing,cooperationandpolicyadaptationinourregionoverthecomingdecade:transitioninthegeopoliticalorder;theshiftinthestructureofthefinancialgeographyoftheregion;theopportunitiesofchangingtechnology;andtheimpactofclimatechange.

Geopolitically,territorialdisputesandstrategicrivalrieshaveopeneduptensionintheAsiaPacificregion.ManagingcompetinginterestsintheSouthChinaSeaexemplifiesthechallengethereisasChinaprojectsitsperipheralpower.ThisisatestingtimeinwhichitwillbecriticaltoexertcommonsenseonthesharedinterestbetweentheUnitedStatesandChinainmaintainingmaritimesecurityandregionalstability,whilemanagingstrategicdifferences.

Australia’sroleasahistoricalallyoftheUnitedStates,combinedwithitsgeographicalpositioninAsiaanditsdeepinterestinitseconomicrelationshipwithChina,opensaspaceforitsleaderstoplayavitalroleasaninterlocutorwithacompellingandsincereinterestinthepeacefulaccommodationofChinaasanewpowerwithintheregionalandglobalorder.

TwomajordevelopmentsinthetransitiontoanewfinancialgeographyoftheAsiaPacificunderlinetheneedforgreaterregionalcooperation.ThefirstwasChina’smovetoestablishtheAIIBasanadditionalchannelofdevelopmentfinance.Thebank’screationcameinthecontextofUSdelayintheimplementationofthe2009G20agreementtowidenIMFreform,includingexpandingChina’svotingrightsintheIMF,andtheobstaclestocontributingadditionalequitytomultilateralfinancialinstitutionstofillthehugegapindevelopmentfinancing.In2015,theIMFagreedtoincludetherenminbiintheSpecialDrawingRightsbasket.TheAIIBoffersopportunityforproactiveAustralianpartnershipwithChinainbuildingexperienceintheprovisionofanimportantinternationalpublicgood,andinvestmentininfrastructuredesignedtopromoteregionaleconomicintegration.Itisanopportunitythatcannowbeactivelyembraced.

Thesecondeventwasdivergenceinindustrialcountries’quantitativeeasingstrategies,withtheUSFederalReservebeginningtoreverseeasingandtheEuropeanCentralBankandBankofJapanbothstillcommittedtofurtheraggressiveeasing.Thisdivergenceinmonetarypolicybetweenthemajorreservecurrencycountriesopenstheprospectofaphaseofdollarstrengthening.AstheBankofInternationalSettlementshaspointedout,theLatinAmericandebtcrisesofthe1980sandtheAsianfinancialcrisisofthe1990swerebothassociatedwithperiodsofstrengtheningoftheUSdollar.Astrongdollar—particularlywhentheUSeconomyisnolongertheengineofimportgrowthitwasinthepast—createshugetensionsandadollartrapforemergingmarkets.Capitalflowsbacktoadvancedmarketstendtoputadeflationarypressureonemergingassetmarkets.Thiswillputpressureonregionaleconomiesandwillrequiretheirclosecooperationintheregion.

Regardingtechnologyadvancement,technologicaldisruptionhasprovedmorepervasiveanddamagingoftraditionaleconomiesthanwasanticipatedbecauseitdiffusedpowertonewcentresandweakenedincumbents.AsianandMiddleEasternoil-producers’wealthisbeingundercutbyinnovationsinshaleoilandrenewableenergytechnologies.TheseareissuesonwhichthereisacloseintersectionofinterestsbetweenAustraliaandChina,andtheirregionalpartners.Asrobotisationreducestheneedforcheapandunskilledlabour,governmentsaroundtheworldarefindingitdifficulttogeneratenewjobsforgrowingpopulationsofunemployedyouthandlow-skilledworkers.Atthesametime,non-stateplayersareusingtechnologytocreatecentresofsocialchangeordisruptionorconflictthatcannotbedealtwithbynationalpowerwithconventionaltools.Thesearealsoissuesonwhichbothcountriescanencouragebothregionalandglobaldialogue.

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Climatechangeisalsoresponsibleformajorsocialupheaval,resultinginahigh-pressureyearforglobalgovernanceinstitutionsintheleaduptotheParisagreements.Aswaterstresses,airpollutionandElNinoeffectsbecamemoremarkedacrosstheworld,globalopinionswungenoughtohelptheParisCOP21negotiationsonclimatechangereachconsensusinDecember2015.Thisoutcomehelpfullyembedsconcertedunilateralmitigationandisatestamenttotheurgencyofconsensusandcooperationinthewaronpollutionandclimatechange.ThenewconsensusprovidesabasisforAustraliaandChinatoworkwithregionalpartnersindevelopingcooperativestrategiesonputtinginplacetheinstitutional,technologicalandpolicyinnovationsneededtoaddresstheseproblems.

Twopriorityareasforcollaboration,buildingonChina’sG20presidencythisyear,aredevelopingamorecohesiveglobalfinancialsafetynetandstrengtheningthemultilateraltradingsystem.Whiletheseprioritiesrelatetotradeandfinance,otherimportantareasforcollaborationareonglobalenergygovernanceandclimatechange.AustraliaandChina’sactiveparticipationwithintheG20iscrucialtoalloftheseambitionsandbothcountrieshaveincentivestobolstertheG20andbuilditsroleasthepreeminentforumforglobaleconomiccooperation.CollaborationalsoneedstoextendbeyondtheG20,forexampleindevelopinganewandproactiverolefortheWTOnowthatpreferentialarrangementsareovertakingthemultilateraltradingsystemandtradeliberalisationattheborderisnolongertheprimaryprobleminthepromotionofmoreopenandcontestableinternationalmarkets.ThequestionofhowdifferentregionalarrangementssuchastheTPP,RCEP,AECandtheproposedFTAAPaffecttheglobaltradingsystemaremattersthattheG20shouldconsiderintheareaofinternationaltrade.

TheG20is,however,thepremierforumthroughwhichChinacanarticulateitseconomicpolicymakingstrategiesandintentions.Thisismoreimportanttoothereconomies,whichnowneedmoreinformationandanalysisofdevelopmentsintheChineseeconomytoincorporateintotheformationoftheirowneconomicstrategies.ThisisnotaboutsecuringChina’splaceagainstothercountries.ThestepsthatChinatakestodaywillbeofimportancetoIndonesia,IndiaandAfrica,withthelastinglegacyofamorerobustglobalsystem.

Inthecontextofthebigforcescurrentlyshapingthefinancialgeographyoftheregionandoftheworld,amorecohesiveapproachtotheissueofinfrastructureinvestmentneedstobetakenwithafocusonimprovingintermediationbetweeninfrastructureinvestmentopportunitiesandglobalsavings(particularlyfromAsiaandthebigpensionandsuperannuationfundsinadvancedeconomies)aswellasprojectpreparationandprioritisation.Moresensitively,theG20andregionaldialoguesprovideanopportunitytoopeninformalpoliticaldialogueonsomeofthestressesoftechnologicalprogress,likeenergytransformationandcybersecurity.

ThecurrentpressuresininternationalfinancialmarketsreinforceChinaandAustralia’sinterestinastrong,inclusiveandresponsiveglobalfinancialsafetynet,centredontheIMF.Fragmentationhaspresentlyreducedthesafetynet’scapacityandagilitytorespondtocrises,whichreducesmarketconfidence,actstoconstraintradeandinvestmentflows,anddiscourageseconomicopenness

Ontrade,thereisanopportunitytoadvanceglobaltradereformandeconomiccooperationthroughleadershipinAsianreformandliberalisation.WhileAustraliaandChinacooperateatalllevelsoftheglobaltradingsystem,bothcountriesgainthemostfromthemultilateraltradingframeworkandfromtradeliberalisationwhenitismultilateralratherthanbilateral

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orpreferential.AustraliaandChinahaveaparticularinterestinensuringtheglobaltradingsystemsupportsregionalandglobalvaluechainsbyfacilitatingtradeandinvestmentflowsacrossallborders,notjustthoseconfinedtoparticularbilateralorregionalarrangements,andworkingwithregionaleconomiesindefiningapathwaytoglobaliseachievementsinregionalliberalisationandreform.

TheEastAsianmembersoftheG20canstepforwardindefiningwhatroletheregioncanplayinreshapingglobaltradegovernanceandensuringasustainedandeffectiverecovery.

ThereisopportunitytouseregionalarrangementssuchasRCEPtoraisethestandardforcohesiveregionalagreements,topushforbettercollaborationbetweentheWTOandregionalagreements,andtodeliverambitiouscommitmentsundertheTradeFacilitationAgreementbygivingthestructuralreformsthathavebeenpledgedintheG20growthstrategiesastrongertradefocus.

Finally,onenergy,theG20hasdevelopedhigh-levelprinciplesonenergycollaborationundertheleadershipofAustralia,ChinaandtheUnitedStates.Existinginstitutionsandmechanisms,liketheInternationalEnergyAgency(IEA)andthestockpilingobligationsunderitstreaty,aredramaticallyweakenedthroughexcludingChinaandotheremergingmarketeconomies.Butthesecountries,quiterightly,willwantasayintherulesandnormsthatapplytothem.Amongotherthings,theG20recognisedtheimportanceofmakinginternationalenergyinstitutionsmorerepresentativeandinclusiveofemerginganddevelopingeconomies.Chinacanbuildonthesesmallstepsand,alongwiththinkingaboutlow-emissionstransformationofenergy,useitsG20hostyeartobolsterglobalenergysecuritythroughreformstoglobalenergygovernance.

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CHAPTER2the economic transformations in china and Australia

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Key messAges

TheAustralia–Chinaeconomicrelationshipisenteringanewphase,shapedbythebigchangesnowunderwayinbotheconomies,whichareseeingtheservicessectorandinnovationemergeaslargerdriversofgrowth.

TheChineseeconomyisinthemidstofamajortransformationafterdecadesofrapidheavyindustrialgrowth.Itisnowshiftingtowardstheservicessectorandadvancedmanufacturing,industriesthatwillbecrucialinsustainingChina’sprogressiontoahigh-incomeeconomy.Atthesametime,China’slargeandincreasinglywealthymiddleclasswilldrivemassivegrowthinconsumerspendinginthecomingyears.

• Tosupportthistransformation,Chinamustprioritisesupply-sidereformsthatallowinefficientindustriestoshrinkandmoredynamicandinnovativesectorstogrow.Thiswillrequirefinancialmarketreformstoimprovetheefficiencyofinvestment,moreprivatesectorinvolvementinanumberofstate-dominatedsectorsandsupportingthemanufacturingsectortomoveuptheglobalvaluechain.

• China’stransformationwillhaveprofoundimplicationsforAustraliaandtherestoftheworldasrisingdemandfromChina’shugemiddleclasscreatesvastnewexportmarketsinareasfromfinancialservicestofood.Likewise,China’stransitiontowardsamoreopencapitalaccountwillcontinuetoreshapetheglobalinvestmentlandscape,asChinesesaverslookforinvestmentopportunitiesabroadandforeigninvestmentexpandsintonewsectorsofChina’seconomy.

InAustralia,theendofthemininginvestmentboomandsteepcommoditypricefallshavealsonecessitatedstructuralchangetowardsbroaderdriversofgrowth,especiallygivencompetitivepressuresintheregion.ThishassharpenedthepolicyfocusonliftingAustralia’sproductivity,especiallyinthelargeservicessector,whichexperiencedarelativedeclineagainstinternationalbenchmarksoverthepastdecade.

• AbetterproductivityperformancewillbecrucialforAustraliatocaptureashareofemergingexportmarketsandsupporthigherlivingstandards.Amongotherthings,thiswillrequireremovingprotectionforlessproductivefirms,greatercompetitioninshelteredservicesindustriesandfacilitatingcost-effectiveinvestmentinnewinfrastructure,includingbyattractingfurtherChineseinvestment.

WhiletheAustralia–Chinarelationshipwillcontinuetobeunderpinnedbythetraditionalareasofcomplementarityincludingcommoditytrade,newareasfortrade,investmentandbroadercooperationareemerging.Besidesthegrowingprominenceoftheservicessectorinbotheconomies,thisalsoreflectsthebroadershifttowardsinnovation-drivengrowth,whichwillrequirehighly-skilledworkforcescapableofdevelopingandabsorbingnewtechnologies.

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TheAustralia–Chinaeconomicrelationshipisenteringanewphase,shapedbytheverybigchangesthatarenowtakingplaceinbotheconomies.Whilethedynamicofthesechangesisdifficulttopredictexactly,somethingsareclear.

InChina,thestructureoftheeconomyisshiftingtowardstheservicessectorandhigher-valuemanufacturing,andthesenewdriversofgrowthwillbecrucialinsustainingChina’sprogressbeyondmiddleincome.Householdconsumptionisbecomingamoreimportantsourceofdemand,underpinnedbyrisingwagesandincomes.

China’seconomictransformationwillhavefar-reachingimplicationsfortheworld,givenChinanowaccountsforaboutone-sixthofglobaloutputandglobalincome,andhasafast-growingmiddleclassthatisprojectedtoreach630millionpeopleby2022(WorldBank2016;Barton2013).AsChineseconsumersdemandanincreasinglybroadrangeofgoodsandservices,vastnewexportmarketswillopenupinareassuchasprofessionalservices,healthandagedcare,andagriculturalproducts.

ForChina,thedevelopmentofmoreadvancedmanufacturingindustrieswillallowitsexportsectortomoveuptheglobalvaluechain,whilestrongertransportandinfrastructureconnectivitywiththeregioncansupportdemandforChina’straditionalmanufacturingexports.

Meanwhile,China’songoingfinancialsectorreformsandcapitalaccountliberalisationwillcontinuetorecasttheglobalinvestmentlandscapeoverthenextdecade.AccordingtoWorldBankprojections,China’sshareofglobalinvestmentflowscouldincreasedramaticallyoverthenexttwodecades,asChina’sdomesticratesofinvestmentmoderateanditshugepoolofdomesticsavingslooksoffshoreforbroaderinvestmentopportunities(WorldBank2013).

China’seconomictrajectoryoverthecomingdecademaynotbesmooth.AchangeofthekindtowhichChinesepolicymakershavecommittedisunprecedented,andmanagingtheeconomy’stransformationpresentsarangeofdifficultchallengesforpolicymakers.Amongotherthings,Chinamustpushaheadwithsupply-sidestructuralreformsthatfacilitateindustrialrestructuring,allowingoutdatedfirmsandindustriestoexitandencouragingnewandinnovativefirmstoflourish.Furtherfinancialmarketreformwillbecrucialtothisshift,byallowingmoreproductivebusinessesinemergingsectorstosecurefinanceforinvestment.Facilitatingmoreprivatesectorinvolvementwithinindustriescurrentlydominatedbystate-ownedenterprises(SOEs)—suchasenergy,utilities,transportandbanking—willbesimilarlyimportant.

Afterdecadesofeconomicgrowthdrivenbyincreasingthenumberofworkersandtheamountofcapital,thesesupply-sidestructuralreformswillbenecessarytopromotegreaterefficiencyandachievesustainedincreasesinmultifactorproductivity,andthereforeincomes,overthenextdecade.

Muchasinthepastdecade,theChineseeconomywillcontinuetohavealargeinfluenceonAustralia’seconomicprospectsinthecomingdecade.

AustraliacapitalisedontheChina-ledincreaseinglobalcommoditydemandinthelastdecade,thankstoanabundanceofeconomicallyprovenmineralreserves,agloballycompetitiveminingindustryandpolicysettingsthatfacilitatedalarge-scaleexpansionoftheresourcesindustry.

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CHAPtER 2: the economic transformations in China and Australia

However,Australia’sincomegrowthhasnowslowed,partlyasaresultofChina’seconomictransformationtowardslessresource-intensivegrowth.Inthenextdecade,Australiawillneedtobroadenitsexportbasebeyondminingbytappingintothefast-growingmarketforconsumerandcommercialservicesthatiscurrentlyemerginginChinaandacrosstheregion,whilecementingitspositionasareliable,low-costsupplierofabroadrangeofenergyandindustrialcommodities.

Succeedinginthesenewmarketsforservicesintheregionwillnotbeeasy.Australiawillfacefiercecompetitionfromservicesuppliersglobally,withoutthenaturalandgeographicadvantagesitpossessesinmineralsproduction.Australiawillneedtoreinvigorateitseconomicreformagendatohelpdriveinnovationandproductivity,particularlyinAustralia’slargeservicessectorwhereproductivitylagsbehindtheglobalfrontierinmanycases.Improvingproductmarketefficiencythroughouttheservicessector,includingbystrengtheningandextendingcompetitionpolicy,willbeessentialifAustraliaistoexpanditsserviceexportsandmaintainprosperityinthenextdecade.

ForbothChinaandAustralia,drivinginternaleconomicreformwillalsorequireengagingfurtherwiththerestoftheworld.InChina’scase,thismeansallowingtheChineseeconomytobecomemorecloselyintegratedwithglobalfinancialmarketsasawayofimprovingtheallocationofcapitalinternally,andopeningupitsexpandingservicessectortogreaterforeigntrade,investmentandtechnologies.

ForAustralia,increasingcontestabilityincurrentlyshelteredserviceandinfrastructuremarketswillhelpattractawiderrangeofChineseandotherforeigninvestment.Asarelativelysmall,openeconomy,thiswillbecriticalinfinancingnewinfrastructureandAustralia’sbroaderinvestmentneeds.

InbothAustraliaandChina,theservicessectorisbecomingalargerdriverofgrowth,especiallyinprofessionalserviceareasandintheinformationeconomy,wherenewtechnologiesarefundamentallychangingthewaybusinessisbeingdoneacrosstheworld(Box2.1).

BOx 2.1: THe gLOBAL Rise OF THe innOvATiOn eCOnOmy

ChinaandAustralia,liketherestoftheworld,arelookingtowardsinnovationandtheinformationeconomyaskeydriversofinvestmentandgrowthinthecomingdecade.

Rapidlyemergingdisruptivetechnologiesarereshapingthewayconsumersandbusinessesinteract,includingthroughtheadventofthesharingeconomy,thegrowingcapacitytocollectandanalyse‘bigdata’andthroughtheshifttowardsknowledge-basedcapital(KBC).

KBCincludesinvestmentindigitalinformation(softwareanddata),innovativeproperty(patents,copyrights,trademarksanddesigns)andorganisation-specificcompetencies(brandequity,trainingandorganisationalcapital).TheOECDestimatesthatinvestmentinKBCnowrepresentsalmosthalfofallinvestmentintheUnitedStatesandotheradvancedeconomies(OECD2013b).

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Bothcountriesarerightlyfocusedonfosteringaninnovativebusinessclimatethatsupportsnewanddynamicfirmstoexpandandcreateemployment.Theirleadershipsopenedanewdialogueabouttheircountries’innovationstrategiesinAprilthisyear.Aspartofthis,policymakersmustensurethatlocalworkforceshavetheskillsandcapabilitiestotapintothelatesttechnologiesandbusinesspracticesdevelopedabroad.Buttherearedeepertrendsdrivingtheglobalenvironmentinwhichinformationandbigdatabusinessesarereshapingtheworldeconomyandinternationalbusiness,andthesetrendswillneedtobeontheiragendaforcooperationoverthecomingdecade.

Althoughmerchandisetrade—includingincommodities—willremainafoundation,theChina–Australiaeconomicrelationshipwillincreasinglybedefinedbyeachcountry’stransitiontowardsmoreservices-andinnovation-basedeconomies,andthebilateralcollaborationsthatcanhelpbringthisabout.

Thiswillmeangreatertradeinservices,butalsoabroadeningofpeople-to-peopleengagementtosharetechnologies,businesspracticesandinstitutionalknow-howaseachcountrynavigatesitsreformchallenges.Theseareasforgreaterbusinessandgovernmentcollaborationarediscussedinfollowingchapters.

ThischaptersetstheeconomiccontextfortherestoftheReport.ItbeginswithasummaryofChina’sriseandimpactontheglobaleconomyoverthepastfewdecades,withthenextsectionfocusingonChina’sinfluenceoncommoditymarketsandAustralia.ItfirstexaminestheeconomictransitionthatisnowoccurringinChinaandtheimplicationsforAustraliaandtherestoftheworld.Thisincludesadiscussionofthekeyeconomicreformsthatwillberequiredinbothcountriestohelpsustaineconomicgrowthandprosperityoverthenextdecade.

KBCwillbeakeyfactorinspurringnewsourcesofgrowth,byallowingfirmsandorganisationstoprosperinacompetitiveglobaleconomyandcreatehigh-wageemployment.ThisisparticularlyrelevantforAustraliaandChinaastheylooktoreplacethetraditionalsourcesofexportgrowthoverthepastdecade.AstheOECDnotes:‘KBCallowscountriesandfirmstoupgradetheircomparativeadvantagebypositioningthemselvesinhighvalue-addedindustries,activitiesandmarketsegments’.New,innovativefirmsarealsobecomingthemaindriversofemploymentcreation,with‘high-growth’firmsaccountingforuptohalfofalljobsgrowtheventhoughtheyonlyaccountforaround5percentofallbusinesses(OECD2012).

Thatsaid,theriseofKBCiscreatingnewchallengesforpolicymakersandbusinesses,notleastthedifficultiesinvolvedinmeasuringeconomicactivityassociatedwithKBC.Forexample,theriseofKBChasmadeacountry’sintellectualpropertyregimeevenmoreimportant,apointhighlightedinAustralia’srecentReviewofCompetitionPolicy.

KBCbusinessesarealreadydrivingmassiveinnovationintheAustralia–Chinarelationshipthroughinnovativedeliveryofgoodsandfinancialservicesviae-commercethatisleapfroggingoldbarrierstoeconomicintegration.Whatweseesofarisjustthetipoftheiceberg(seeChapter3).

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China’s rise and its impact on the world economy

China’seconomictransformationsince1978hasbeenremarkable.Atthecommencementofthereformperiod,China’sGDPpercapitawaslessthan5percentoftheUnitedStates’(TheConferenceBoard2015).AccordingtoWorldBankDevelopmentIndicators,since1978,China’seconomyhasgrowninsizebyanannualaveragerateofaround10percentandisnowalmost30timeslargerthanitwasin1978(WorldBank2016).Thisreflectsasubstantialincreaseinlabourproductivity,whichhasrisenfrom3percentoftheUSlevelin1978tomorethan20percentnow(TheConferenceBoard2015).

ThisperformancehasresultedinChinarapidlycatchinguptohigher-incomeeconomies,which,combinedwithahugepopulation,hasseenChina’sshareofglobaloutputandincomerisefromlessthan5percentin1990to17percenttoday(Figure2.1).

Whileuniqueinscale,China’seconomicconvergencebroadlymatchesthepreviousexperienceofotherAsianeconomiessuchasJapanandSouthKorea.Indeed,theprinciplefactorsbehindChina’ssuccessaresimilartothosethathavedriveneconomicconvergenceelsewhereinAsia.Theseincludeveryhighratesofphysicalcapitalaccumulationandmassmobilisationoflabourtowardsanexport-orientedmanufacturingsector,supportedbyongoingimprovementsinhumancapitalandtechnologicalcatch-up.

ThescaleandspeedofChina’seconomicriseoverthepastfourdecadesalsoreflectsthesizeanddemographicprofileofChina’spopulation,whichsawtheworking-agepopulationgrowsignificantlyfasterthantheoverallpopulation.Thiscoincidedwiththemassmovementofruralsurpluslabourfromthelowproductivityagriculturalsectortohigherproductivityindustrialandservicesectors.

China’sexport-orientedgrowthmodelhasunderpinnedalargeandrapidexpansioninitsinternationaltradeandintegrationwithglobalmarketssince1978.

Figure 2.1: China’s share of the global economic aggregates

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Inthepast15yearsalone,China’sexportshaveexpandedmorethan10-fold,facilitatedbyaccessiontotheWTOin2001.HavingsurpassedboththeUnitedStatesandGermany,Chinaisnowtheworld’slargestexporterbyvalue,accountingfor12percentofglobalmerchandisetrade(Figure2.1).

GreaterinternationalopennessallowedChinatoabsorbforeigntechnologiesandknow-how,drivingimprovedproductivityacrossthebroadereconomy.Amoreopeneconomyalsoincreasedcompetitiveforcesdomestically,promotingefficiencyandinnovationintrade-exposedsectors.

Figure 2.2: investment as a share of gDP

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Sincethemid-1990s,China’srapideconomicconvergencehasreflectedverylargeinvestmentsinphysicalcapital.Chinacommencedthereformperiodwithrelativelylowcapitalperworker,allowingforinitiallylargelabourproductivitygainsandhighreturnsoninvestment.Growthinthecapitalstockisestimatedtohaveaveraged10percentannuallyfromthe1980s,accountingforsignificantlymorethanhalfofGDPgrowthoverthistime(Wu2014).

ThesetrendshaveresultedinChina’sinvestmentasashareofGDPreachingveryhighlevels,bothhistoricallyandevencomparedwithotheremergingeconomies(Figure2.2).

China’selevatedratesofinvestmenthavebeensupportedbygovernmentpoliciesthathaveincentivisedpropertydevelopmentandinfrastructureinvestment,andexpansionsinmanufacturingcapacity.Thisincludesthestructureofthefinancialsystem,whichhaschannelledsubsidisedcapitalfromsaverstolargeprivateandstate-ownedenterprises,andanexchangerateregimeinpreviousdecadesthatencouragedexportsoverdomesticspending.China’sveryhighratesofinvestmenthavebeensupportedbyveryhighratesofnationalsaving(Box2.2).

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The impact of China’s rise on global commodity markets and Australia

ItisnotjusttherapidgrowthandtransformationoftheChineseeconomythathasaffectedopportunitiesglobally;itisalsothesheerscaleofChina’simpactthathasmatteredtotheworldeconomy.

TheunprecedentedscaleofChina’sindustrialisationhasresultedinChina’sconsumptionofmetals,otherrawmaterialsandenergyexpandingmassivelyoverrecentdecades.Chinaisnowtheworld’slargestuserofarangeofindustrialandenergycommoditiesincludingsteel,copperandcoal(Figure2.4).

BOx 2.2: CHinA’s HigH RATes OF nATiOnAL sAving

China’svaststockofsavings,togetherwithitscapitalaccountcontrols,hasplayedanimportantroleinhighratesofinvestment.SavingasashareofGDProsefromlessthan40percentinthe1980stoapeakof50percentinthelate2000s.Whilethenationalsavingratehaseasedinthepastfewyearstoaround48percent,itremainsveryhighbyhistoricalandinternationalstandards(Figure2.3).

Thehouseholdsectorhasmadeasignificantcontributiontohigherratesofnationalsaving,reflectingagrowingworking-agepopulationwithanincreasingcapacitytosave.Incompletedomesticfinancialmarketsandrestrictedaccesstoforeignfinancialassetshavealsoencouragedhighhouseholdsavingrates,ashasthelimitedstateprovisionofsocialsecurityandhealthinsurance.

CorporatesavinghasalsomadealargecontributiontoChina’shighratesofnationalsaving.AflexibledividendpolicyhasallowedSOEstoretainandthenreinvestmostoftheirprofits,ratherthandistributingdividendstothestate.Financialunderdevelopmenthasalsomadeitdifficultfortheprivatesector,especiallysmallbusinesses,toaccessintermediatedfinancing,inducinghighersavingratesinthatsector.

Plannedreformstofinancialmarkets(includinginterestrates)andtotheregulationofSOEs,aswellasthebroaderprovisionofsocialinfrastructure,shouldsupporthigherhouseholdconsumptionandcorrespondingdeclinesinhouseholdandcorporatesavingrates.Likewise,China’sageingpopulationislikelytoplayapartinreducingsavingrates,asanincreasingshareofChina’sadultpopulationmovesintoretirementageandbeginstodrawdownsavings.

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Figure 2.3: national saving by sector

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Government Corporate Household Total

% o

f GD

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Source:ChinaNationalBureauofStatistics2015.

China’sgrowthinsteelconsumptionhasbeenparticularlydramaticoverthepasttwodecades,drivenbyrisinginvestmentinsteel-intensivebuildingsandinfrastructure,aswellaslargeexpansionsinthemanufacturingsector.Chinaisnowthelargeststeelconsumer,accountingfor45percentofglobalsteelusagein2015(WorldSteelAssociation2015).China’sincreasingsteelrequirementsnecessitatedamassiveexpansioninitssteelindustry,whichisestimatedtohaveproducedover800milliontonnesofcrudesteelin2015—morethansixtimesasmuchasitdidin2000(Figure2.5).

Figure 2.4: China’s share of global commodity consumption

0 10 20 30 40 50 60

Gas

Crude Oil

Thermal coal

Copper

Steel

1990 2014 % of global consumption

Source:WorldSteelAssociation2015;WorldBank2015;BP2016.

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China’sincreasingproductionofsteelhashadflow-oneffectstoitsdemandfortherawingredientsusedinsteelmaking,namelyironoreandmetallurgicalcoal.Mostnotably,China’sshareofworldironoreconsumptionrosefrom14percentin2000toanestimated65percentin2015.

Whilehavinglargequantitiesofitsownresources,Chinahasbecomeincreasinglyreliantonimportedinputsasstrongcommoditydemandhasdrawninlower-cost,higher-qualitycommoditiesfromabroad.Tradedependencycontinuestoriseascommoditypricesfall,andtheshareofimportedindustrialinputsindomesticconsumptionisatanall-timehigh.

Figure 2.5: China’s steel production

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Annual output (LHS) Global share (RHS) Source:WorldSteelAssociation2015.

RespondingtothesharpriseinglobalcommoditypricesandgrowthinChina’sdemandforrawmaterials,Australia’sminingindustryinvestedheavilyinnewexportcapacityoverthepastdecade(Figure2.6).Thisinvestmentwasinitiallyconcentratedintheironoreandcoalsectors,butwasfollowedbyanevenlargerinvestmentinliquefiednaturalgas(LNG)capacity,whichwillmakeAustraliathelargestexporterofLNGwithinafewyears.Atitsheightin2013,theminingindustry’sshareofprivateinvestmentinAustraliareachedone-third,morethantriplethetypicalhistoricalshare.

Therewasalagintheresponseofinvestmentandcapacitytorisingpricesbecauseofitsgestationperiod.Butasthisnewcapacitycameonline,Australia’sexportvolumesoftheseproductsalmostdoubledcomparedtothepreviousdecade.Intheironoremarket,Australianowaccountsforalmostone-thirdofglobalproductionandone-halfofseabornetrade,significantlyhigherthanadecadeago.

AlmostallofAustralia’sadditionalironoresupplyhasbeenabsorbedbyChina,withAustraliaincreasingitsshareofChineseimportstoover60percentaslessefficientglobalsupplyhasbeendisplaced,includingwithinChinaitself.Australia’sshareofChina’scoalimportshasalsoincreased,fromaround10percentin2009toaroundone-thirdnow(Figure2.7).

By2018,theminingindustry’scapitalstockwillbealmostfourtimeslargerthanitwasin2004,amassiveinvestmentinnewcapacitythatwillunderpinAustralia’sminingexportsfordecadestocome.

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Extensivereservesofironore,coalandothercommoditiesmeantthatAustraliawaswellpositionedfromtheoutsettobenefitfromChina’srisingcommoditydemand.ButthemereexistenceofthesenaturalresourcesdidnotguaranteeAustralia’ssuccess.Instead,Australiaowesitssuccesstothecompetitivenessofitsminingindustryaswellastheflexibilityofthewidereconomythatallowedresourcestobeefficientlyreallocatedtoexpandthemineralssector.

Figure 2.6: mining investment in AustraliaPanel A: By commodity type Panel B: share of total private investment

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Sources:GovernmentofAustralia2014.

Australia’swell-establishedmacroeconomicpolicyframeworks,includingafloatingexchangerate,playedanimportantroleinaccommodatingtheexpansioninAustralia’sminingcapacitywithlimiteddisruptionstothebroadereconomy.Alongwithasufficientlyflexiblelabourmarket,thesesettingshelpedinflationexpectationstoremainanchoredwhenthetermsoftraderosesharply,avoidingmanyofthemacroeconomicdifficultiesthataroseinprevioustermsoftradeboomsinAustralia(Gruen2011).

Figure 2.7: Australia’s share of Chinese commodity imports

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Coal Iron ore

%

2015 2008 Source:ChinaNationalBureauofStatistics2015.

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China’s economic transformation to new drivers of growth

Afteralmostfourdecadesofrapidgrowth,theChineseeconomyisundergoingamajortransformation,broughtaboutbyacombinationofinternalandexternaleconomicforces.

Ontheexternalfront,substantiallyslowergrowthininternationaltradehasseenacorrespondingmoderationindemandforChina’straditional,labour-intensivemanufacturedexportsinrecentyears(Figure2.8).ThisslowdownpartlyreflectsChina’salreadysignificantmarketshareinsomeglobalmanufacturingsegments,aswellasamorefundamentalshiftinglobaltradetowardsinformationandservices,consistentwiththeriseofe-commerceglobally.

Figure 2.8: growth in global trade

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Merchandise trade Commercial services trade Source:WTO2016a.

Domestically,aswagesandincomesrise,householdconsumptionisemergingasamoreimportantdriverofeconomicactivity.Atthesametime,China’sgrowthdriversinrecentdecades—investmentinphysicalcapitalandlabour-intensivemanufacturedexports—areslowing.Thelowergrowthininvestmentinthesesectorsreflectsoversupplyinthepropertymarketandtheexcesscapacitythathasemergedacrosssegmentsofthemanufacturingsector,andthelowerprofitabilityinthesesectors.

DemographicforcesandlabourmarketdynamicsarealsoplayingtheirpartinChina’sshiftawayfromfactor-drivengrowthtowardsmorebalancedgrowth.Aftergrowingstronglyfornearlyfourdecades,China’sworking-agepopulationisnowshrinking,whichisdirectlyreducingChina’sgrowthpotentialvialowergrowthinthelabourforce.

China’sageingpopulationhasimplicationsthatgobeyondtheimpactonaggregateeconomicgrowth.Forexample,therewillbeanextra110millionpeopleagedover65by2030,whichwillincreasethedemandforaged-careservicesandputpressureonChina’sstilldevelopingsocialsafetynet.

Inthelabourmarket,theslowergrowthinthelabourforceandshrinkingpoolofsurplusrurallabouriscontributingtohigherwages.Higherwagescombinedwithasignificantappreciationoftherealexchangerateoverthepreviousdecadeishelpingtoshiftthecompositionof

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demandfromexportsandinvestmenttowardsconsumption.Thisisbeingsupportedbyashiftineconomicresourcestowardsconsumers,illustratedbytheuptickinthewageandhouseholdsectorsharesofGDPinrecentyears(Figure2.9).

Similarly,consumptionexpenditurehasnowovertakeninvestmentspendingasthemaincontributortoeconomicgrowth.Whilethispartlyreflectsslowergrowthininvestmentinrecentyears,thecontributionfromhouseholdconsumptionalsorosein2015(Figure2.10).

Withinconsumption,theshifttowardsservices,aswellasdiscretionarygoods,isoccurringasChinesehouseholdsbecomewealthier.Thischangingpatternofdemandisgivingrisetofasteremploymentgrowthintheservicessector.Overthepasttwoyears,employmentinChina’sservicessectorhasgrownstronglyandnowaccountsforalittlemorethan40percentofemploymentacrosstheeconomy,upfrom30percentadecadeago(WTO2016).

TheappreciationofChina’srealexchangerateisalsoencouragingemploymentcreationinChina’snon-tradedservicessectors,whichultimatelywillbeattheexpenseofemploymentinChina’sexport-orientedsectors.ThisdynamicisconsistentwiththeexperienceofotheremergingeconomiessuchasJapaninthe1970sand1980swhereincreasesintherealexchangeratereinforcedashifttowardsdomesticallyorientedindustriessuchaseducation,healthandfinancialservices(Dorruccietal2013).

WhileinvestmentasashareofGDPhasfalleninrecentyears,andmayfallfurther,China’stransformationtowardsservices,higher-endmanufacturingandthedigitaleconomywillstillinvolvesubstantialnewinvestmentinthesegrowingindustries.Forexample,China’sentryintonew,higher-technologymanufacturedsegmentswillrequirelarge-scaleinvestmentinplant,equipmentandhumancapital,asillustratedbytherecentplantoestablishasemi-conductorindustryinChina.

Figure 2.9: Wages and household disposable income

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% o

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Household income Wages Source:ChinaNationalBureauofStatistics2015.

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ThetypesofassetsattractinginvestmentarealsolikelytoevolveasChina’sindustrybecomesmoreadvanced.ThisreflectsthegreaterneedforinvestmentininnovationandinformationtechnologyasChineseindustrydevelops,inlinewiththeglobaltrendtowardsknowledge-basedcapital(OECD2013b).ForChina,thismeansagreaterproportionofinvestmentislikelytobedirectedtowardsintangibleassets,suchasdigitalinformation,computersoftwareandresearchanddevelopmenttosupportChina’sprogressionintohigher-technologymanufacturing(Box2.3).

Figure 2.10: Contributions to China’s gDP growth

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1982

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%

Consumption Investment Net exports Overall GDP growth

Source:ChinaNationalBureauofStatistics2015.

ThatisnottosaythatinvestmentintraditionalformsofphysicalcapitalwillnotremainessentialinsupportingChina’scontinuedurbanisationandraisingthequalityoflifeinurbancentres.Thisincludesfurtherinvestmentinpublictransportnetworksandurbanamenities,whichinmanycitiesremainunderdeveloped.Notwithstandingthecurrentareasofoversupply,continuedurbanisationwillalsorequiresubstantialnewinvestmentinresidentialandcommercialbuildingoverthecomingdecade.

Reforms to assist China’s economic transformation

Tosustaineconomicgrowthinthenextdecade,China’spolicyenvironmentwillneedtosupporttheshiftinactivitytowardstheservicessector,higher-techmanufacturingandenergytransformationtoaddressenvironmentalchallenges.Itwillalsoneedtoalloweconomicresourcestoshifttowardsthesemoreinnovativeandfast-growingsectorsoftheeconomy.

Thisfocusonliftingmultifactorproductivityrecognisesthatthelongperiodoffactor-drivengrowthChinahasexperiencedoverthepast40yearscannolongerbesustained.Thisreflectsfallingratesofreturnandthebuild-upofexcesscapacityinsignificantpartsoftheindustrialsector,ashrinkingworking-agepopulationaswellasbroaderqualityoflifeconsiderations,includingreducingthepollution-intensityofgrowth.Inthiscontext,China’seconomicperformanceoverthecomingdecadewilldependinlargepartonwhetherChinacanimproveuponthelimitedgrowthinmultifactorproductivityachievedsince2007(Figure2.13).

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BOx 2.3: CHinA’s PROgRessiOn TOWARDs HigHeR-enD AnD vALue-ADDeD mAnuFACTuRing

ThepaceandscaleofChina’sriseasamanufacturingexporterhasbeentrulyremarkable.SinceaccessiontotheWTOin2001,China’sshareofglobalmanufacturingexportshasgrownfrom5percentto18percent,makingastrongcontributiontoeconomicgrowthbothdirectlyandthroughtechnologyspilloverstothewidereconomy.

However,growthinChina’sexportsoftraditional,labour-intensivemanufacturingproductshasslowedinrecentyears,reflectingarangeoffactors—includingthatglobalmarketsmayhavereachedsaturationpointfortheseproducts.Forexample,China’sshareofinternationalclothingexportshasremainedatalmost40percentinrecentyears,havingrisencontinuouslyoverthepreviousfewdecades(WTO2016).

Inthenextdecade,Chinawillthereforeneedtobuilduponitstraditionalexportcategoriesbycontinuingtoprogressintohigher-technologymanufacturing,followinginthefootstepsofcountriessuchasJapan.Thisprocesshasbeenunderwayforsometime,withtheshareofmedium-andhigh-techmanufacturinginChina’smerchandiseexportsnowsubstantiallyhigherthanwhatitwas20yearsago(Figure2.11).

Figure 2.11: China’s export mix 1995–2015

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%

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High-tech Medium-tech Low-tech Resource-based Commodities

Source:OECDandUnitedNation’sComtradedatabase.

Atthesametime,China’smanufacturingsectorwillneedtocapturealargershareofthegrossvalueofitsmanufacturingexports,bymovingupthevaluechaininlinewiththeMadeinChina2025initiative,anofficialinitiativeaimedatpromotingadvancedmanufacturing.ThiswillbeessentialifChina’sexportsectoristocontinuetomakeastrongcontributiontoeconomicgrowthoverthenextdecade.Again,therearesignsthatChinaisalreadymakingprogressinthisrespect,havingcapturedalargershareintheglobalvaluechainacrossmanymanufacturingsub-categoriesoverthepasttwodecades(Figure2.12).Thisincludesparticularlylargeincreasesinthedomesticeconomy’sshareofthevalue-addedofcomputers,electricalmachineryandapplianceexports.

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Figure 2.12: Domestic value-added share of China’s gross exports

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%

Tota

l

manufactu

res

Food products

,

bevera

ges and to

bacco

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xtile pro

ducts,

leath

er and fo

otwear

Wood, paper,

paper pro

ducts,

printin

g and publishing

Chemica

ls and non-m

etalli

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minera

l pro

ducts

Basic m

etals

and

fabricate

d meta

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and

equipment, n

ec

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r, electr

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and optical e

quipment

Electrica

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inery

and apparatu

s, nec

Transp

ort equipm

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Manufacturin

g nec;

recy

cling

2011 1995 2005

Source:WTOandOECD2016.

WhileChina’sprogressiontoamoreadvancedandhigher-incomeeconomywillnotbestraightforward,the13thFiveYearPlanrecognisestheseeconomicimperatives,buildinguponthereformstrategiesassetoutintheThirdPlenumofthe18thPartyCongressinlate2013.Thisincludestheneedtosupportgreaterhouseholdspending,improvetheefficiencyofinvestment,encourageamoreinnovativescience-ledeconomyandexpandintohigher-technologymanufacturing(Box2.4).

Figure 2.13: Contribution to China’s gDP growth

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2

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%

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1977-84 1984-91 1991-01 2001-07 2007-12

Capital Total factor productivity Labour GDP Source:ConferenceBoard2015;Wu2014.

Mostimportantly,thePlan’sfocusonsupply-sidestructuralreformsrecognisestheneedtoencourageanexpansioninChina’smoredynamicprivatesectorwhilelimitingfurtherinvestmentinthosepartsoftheeconomythatarenowexperiencingover-capacity.Thiswillencompassabroadrangeofreformsincludingopeningupmonopolyindustriestoprivatesectorparticipation,reducinggovernmentinvolvementinanumberofsectorsstilldominatedbySOEsandimprovingmarketexitmechanisms.

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Financialmarketreformswillalsoplayaroleinallowingmoredynamicandefficientfirmstoexpandbyprovidingbetteraccesstofinanceatlowerrates.Thiswillrequirepushingaheadwithbankingsectorreforms,includingliberalisinginterestrates,aswellasencouragingagreaterrolefornon-traditionalbanking(includingthroughemergingonlinecreditproviders)anddirectequityfinancing.

BOx 2.4: CHinA’s eCOnOmiC TRAnsFORmATiOn AnD THe 13TH Five yeAR PLAn

The13thFiveYearPlan(‘thePlan’)presentsaroadmapforChina’seconomictransformationtowardsahigherincomeeconomy.ThePlanprioritisesarangeofareasincluding:improvingdevelopmentqualityandefficiency;supply-sidestructuralreforms;bettermatchingsupplyanddemand;encouragingamoreinnovativeeconomy;fosteringmorecoordinated,greenandinclusiveeconomicdevelopment;andacceleratinginstitutionalreformstosupportChina’scontinuedeconomicdevelopment.ThePlanfocusesonthethreeeconomicgoalsofliftinghouseholdconsumption,transformingindustrytowardsservicesandhighervalue-addedmanufacturing,andpromotingthedevelopmentofaninnovation-andtalent-basedeconomy.

Strengtheningconsumption-ledgrowth.Chinawillpromoteconsumptiontobecomeamoreimportantcontributortoeconomicgrowth.ThisencompassespoliciesthatpromoteanindustrystructurethatbetterreflectsdemandfromChineseconsumersforhigher-qualityproductsandencouragesanexpansioninChina’sconsumer-orientedservicesindustries,includinghealthandagedcare.Consistentwithagreaterdomesticcapacitytoproducehigher-endconsumerproducts,Chineseconsumerswillbeencouragedtoconsiderswitchingtheirspendingfromoverseastodomesticmarkets.

Encouragingtheservicessectorandhigher-endindustry.Chinawilllifttheshareoftheservicessectorintheeconomyandencouragehigher-endmanufacturing.Whileaggregatedemandwillbeadjustedappropriately,theemphasiswillbeonsupply-sidestructuralreformsthatenabletheChineseeconomytomeettheChinesepeople’sgrowingmaterial,cultural,ecologicalandenvironmentalneeds.Consistentwiththe‘MadeinChina2025’initiative,thetransitionintohigherendmanufacturingwillallowChineseindustrytocapturealargeshareofvaluechains.Tohelpacceleratethedevelopmentofamodernservicesector,thesepartsoftheeconomywillbeexposedtogreaterforeigncompetition.The‘InternetPlus’actionplanwillhelptopromotebetterandbroaderuseoftheinternet,withgreateraccesstoinformationandbetterinformationnetworksfacilitatingtheadoptionofmoreefficientproductionmethodsandorganisationalstructureswithinindustry.

Fosteringscientificandtechnologicalinnovation.Chinawillaimtoimprovemultifactorproductivity,underpinnedbyscientificandtechnologicalinnovation,investmentinhumancapitalandgreaterentrepreneurship.Marketreformswillbeundertakentoensurethatresearchandinnovationisgearedtowardsthemostvaluableareas,supportedbyclosercollaborationbetweenresearchersandindustry.Whileabsorbingandintegratingforeigninnovationwillremainimportant,thePlanprioritiseswaysofencouraginglocallygeneratedtechnologiesandnewideas,tohelpgenerateself-sustainingeconomicdevelopment.

Atthesametime,thePlanhighlightstheneedtoaddressdistortionsinpolicyandinstitutionalarrangementsandtheneedtopromotefurthercompetitionamongfirmsinsomeindustriesaspartofagenerallyopenandcontestablemarketsystem.

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Capitalaccountliberalisationcanalsoassist,byprovidinganotherchannelthroughwhichChinesefirmscanaccessfinanceatmarketrates,whilealsosubjectingdomesticprovidersoffinancetoexternalcompetition.

BesideshavingthepotentialtoimproveChina’sefficiencyofinvestment,capitalaccountliberalisationcanalsosupporttheshifttohouseholdconsumption.Astheconstraintsonoutboundinvestmentareloosenedfurther,Chinesehouseholdswillbeabletoinvestinawiderrangeofassetswithhigherrisk-adjustedreturns.Thiswillbereinforcedbyestablishingmarket-determinedinterestratesandamoremarket-determinedexchangerate,helpingtoreallocateincometowardsthehouseholdsector.

AlthoughitisinChina’slonger-terminterests,thetransitiontonewdriversofgrowthwilltaketime,andthepaceofeconomicgrowthmaymoderatemorethananticipatedinthetransitionalperiod.Alternativegrowthscenariosareexaminedinlaterchapters(seeChapters3and6)toconsidertheeffectofdifferentChinesegrowthtrajectoriesandstructuresontheAustralia–Chinaeconomicrelationship.Forexample,China’sprogressionintohigher-techmanufacturing,whichisadifficulttransitioninitsownright,maynotoccurquicklyenoughtooffsettheimpactofslowergrowthintraditionalmanufacturingsegments.Likewise,China’sconcernabouttheenvironmentalimpactofheavyindustryandtheminingsectormayweighfurtheronindustrialproductionasnewpoliciesintheseareasbegintotakeeffect.

Duringthistransition,Chinamuststriketherightbalancebetweenpoliciesthatsupportnear-termgrowthandpoliciesthatpromotetheeconomy’slonger-termgrowthpotential.

Inparticular,excessivelyloosemonetarystimulustosupportshort-termgrowthwouldhavethepotentialtoencouragehigherborrowingandleverageinthecorporatesector,whichcouldcreatefragilitiesinthefinancialsystemandundercutlonger-termreformstoimprovetheefficiencyofinvestment.Chinashouldbeextremelycarefulinmanagingfinancialrisksassociatedwithhighlevelsoftotaldebt,whichreached237percentofChina’sGDPinthefirstquarterof2016,from148percentattheendof2007.Deleveragingisoneoffivetopprioritiesfortheworkofthegovernmentfor2016.DeleveragingwillhelpChinaachievemoresustainablegrowthinthelongertermbutcanputdownwardpressureintheshortterm.

implications of China’s transition

implications for the global economy

Firstandforemost,thesheersizeoftheChineseeconomymeansopportunitiestodobusinesswithChinawillcontinuetoexpandevenifaggregatesratesofeconomicgrowtharelower.TheIMFprojectsChina’sgrowthratetoremainmorethantwicetheglobalaverageinthenextfewyears,whileitscontributiontoglobalgrowthwillbemuchlargerthanitwas10yearsagogivenitisnowasignificantlylargershareoftheworldeconomy.

ButthetransformationunderwayintheChineseeconomymeansthatChina’simpactontheworldeconomywillbeverydifferentfromwhatitwasinthelastdecade.Theincreaseinpercapitaconsumption,urbanisationandtheemergenceoftheserviceseconomy,aswellasthefurtherliberalisationoffinancialmarketsinChina’seconomy,willfundamentallychangehowChinainteractswiththerestoftheworld.

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Thelargerroleforconsumerspendingandtheshifttoamoreservices-basedeconomywillprovideChina’stradingpartnerswithvastexportopportunitiesinnewareasoftheChineseeconomy.China’smiddleclassisprojectedtoreach630millionpeopleby2022,providingahugeandexpandingmarketforinternationalprovidersofconsumergoodsandservices,inareasspanninghealthcare,educationandfood(Barton2013).

China’sdemandforhigh-valuefoodstuffsisexpectedtorisedramaticallyoverthecomingdecades,withtheconsumptionofbeefandothermeatsdoublingoreventriplingaccordingtosomeprojections(Hamshereetal2014).WhilethemajorityofthisincreasedfooddemandwillbemetbyexpandingChina’sdomesticproduction,therewillbesignificantunmetdemandthatinternationalfoodexporterswillbeabletoexploit.

Likewise,theopeningupofChina’sdomesticservicessectorwillpresentnewopportunitiesforforeigninvestors,inareassuchasfinance,insuranceandtheutilitiessector.

TheshareofChina’slabour-intensivemanufacturingsegmentislikelytodeclinegoingforward.However,buildinggreaterconnectivityandinfrastructureprojectswithAsianandEuropeanexportsmarketsviatheinfrastructureinvestmentprojectsassociatedwiththeOneBelt,OneRoad(OBOR)initiativecansupportdemandforChina’straditionalexportcategories.

TheOBORinitiativecanalsoassistinabsorbingChina’sconstructioncapacity(includingforinfrastructure),whilesimultaneouslysupportingeconomicandtradenetworksacrossparticipatingeconomies.

BOx 2.5: THe OuTLOOK FOR CHinA’s sTeeL DemAnD

Havinggrownstronglyoverthepreviousdecade,China’sapparentsteelconsumptionfellby3percentin2014andisestimatedtohavefallenbyanother5percentin2015.ThisraisesthequestionofwhetherChina’ssteelconsumptionhaspeakedorwhetherthisweaknessreflectsmainlycyclicalfactorsthatwillgivewaytofurtherincreasesinChina’ssteelconsumptionoverthecomingdecade.ThisquestionwillhaveimportantimplicationsforChina’slargesteelindustryaswellasironoreproducersinChinaandoverseas.

Inthepast,largerisesinChina’ssteeldemandweredrivenbyconstructioninvestmentanddemandfromthemanufacturingsector,whicharethemainusersofsteel(Table2.1).

Table 2.1: China’s steel usage by purpose (percentage of total)

2000 2010 2014

Construction 56 56 55

Machinery 15 18 19

Automobile 6 7 7

HomeAppliance 3 1 1

Rail 2 1 1

Energy 7 4 5

Shipping(a) 3 5 2

Other 8 8 11

Source:ReproducedfromHamshereetal2016.(a)Shippingisdefinedasthesumofthe‘container’and‘shipbuilding’categories.

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ThelargecontributionfromtheconstructionindustryreflectsthesubstantialsteelrequirementsassociatedwithChina’surbanisation,includingforhigh-densityresidentialandcommercialbuildingsandforurbaninfrastructuresuchasrailways,highwaysandbridges.

China’sincreasedsteelconsumptionoverrecentdecadeshasbeensuppliedbyexpansionsinitsdomesticsteelindustry.Overthedecadeto2013,China’sdomesticsteelproductionincreasedalmostfour-foldtoaround820milliontonnes.Thishashadflow-oneffectstoironoreandmetallurgicalcoal—therawingredientsusedbyChina’ssteelmakers—withdemandfortheseinputsalsogrowingstrongly.Inthecaseofironore,China’sdomesticsupplies,whilesubstantial,areofrelativelypoorgradeandlocatedinlessaccessiblepartsofthecountry.ThishasmeantthatChinahasincreasinglyturnedtotheseabornemarket,includingAustraliansupply,toaccommodateitsgrowingironoreneeds(Figure2.14).

Inrecentyears,thedownswinginthehousingmarket,combinedwithweakerconditionsinChina’smanufacturingsector,havebothcontributedtolowerdemandforsteel.ThishasresultedinChina’ssteelconsumptionfallingoverthepasttwoyears.Steelproductionwasflatin2014andfellby2.3percentin2015despiteastrongincreaseinsteelexports.

Inthenearerterm,theoutlookforChina’ssteeldemandwilldependinlargepartonthestateofChina’shousingmarket,wherethereissignificantoversupplyacrossanumberofregions.Growthinrealestateinvestment,whichisanimportantdriverofoverallsteeldemand,isthereforelikelytoremainweakuntilthesepocketsofunsoldhousingareabsorbedbythemarket.

Similarly,excesscapacityinthemanufacturingsectorisweighingonproducerpricesandprofitability,andthiswillcontinuetolimitmanufacturing-relatedinvestment,andthereforesteelusageinthissector,untilthisexcesscapacityisabsorbed.

Notwithstandingcontinuedstrengthininfrastructure-relatedsteelusage,thesefactorsmeanthatChina’ssteelindustryislikelytofacecontinuedchallengingdemandconditionsincomingyears.Asaresult,China’sdemandforironoreisalsolikelytogrowatasignificantlyslowerratethaninthepreviousdecade,althoughtheremaybescopeforlow-costglobalsupplierssuchasAustraliaandBraziltoexpandtheirmarketshare.

Figure 2.14: China’s steel production and iron ore imports

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Source:Robertsetal2016.

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China’seconomictransitionisalsolikelytoresultinlessresource-intensivegrowththaninthelastdecade.Already,slowergrowthinindustrialproductionandrealestateinvestmenthascoincidedwithsignificantlyslowergrowthinChina’sdemandforsteelandothercommoditiesinrecentyears.Whilesomeofthisweaknessmayprovetobecyclicalratherthanstructural,theoutlookforChina’ssteeldemandremainsacentralsourceofuncertaintyforglobalsteelandironoremarkets(Box2.5).

Beyondthenearterm,China’ssteelandbroadermetalusagewillbeunderpinnedbyanumberoflonger-termdrivers,notwithstandingtherebalancingcurrentlyunderwayintheeconomy.Theseincludefurtherurbanisation,withChina’surbanisationrateofjust55percentsuggestingthattheneedforinvestmentinnewconstructionisstillsubstantial.Likewise,China’spublicinfrastructureremainsunderdevelopedinanumberofareas,includingurbanamenitiesandnationaltransportnetworks.Withrisingincomes,Chinesehouseholdswillalsodemandagrowingnumberofdurablegoods,includingmotorvehicles(withChina’spercapitalvehicleusagestilllowbyinternationalstandards)andhomeappliances.

TherearealsodownsideforcesthatcouldaffectChina’ssteelindustryanditsdemandforironore.Thisincludesthepolicyobjectiveofconsolidatingthesteelindustrytohelpeliminateexcesscapacityandimproveenvironmentaloutcomes,whichisagrowingfocusforauthorities.ThepotentialforgreateruseofscrapsteelcouldalsosignificantlyaltertheoutlookforChina’sdemandforironore,notingthatscrapusageinChinaremainslowbyinternationalstandards.

WhiletheoutlookforChina’ssteelproductionandironoredemandishighlyuncertain,Australiahassomeofthelowest-costironoreproducersintheworldandwillthereforeremainamajorsourceofChina’sironoreimportsinthecomingdecade.

implications for the Australian economy

FortheAustralianeconomy,theslowergrowthinChina’scommoditydemandinrecentyearshascontributedtoamorechallengingglobalenvironmentjustastheinvestmentphaseoftheminingboomhasnearedcompletion.Combinedwithlargeincreasesinglobalsupplies,softerglobaldemandhasresultedinAustralia’scommodityexportpricesfallingsharplyinrecentyears.ThishasreducedAustralia’stermsoftradeandgrowthinnationalincome,withAustraliafacingtheprospectoflowergrowthinincomesoverthecomingdecadeunlessproductivitygrowthcanbeliftedabovehistoricalaverages(Figure2.15).

Whilegrowthhasbeenslowinrecentyears,establishedmacroeconomicpolicyframeworks,includingafreelyfloatingexchangerate,haveservedAustraliawellinmanagingthedownswinginglobalcommodityprices,reinforcingthepositiverolethesemechanismsplayedincushioningtheAustralianeconomyfromtheAsianfinancialcrisisinthelate1990sandtheglobalfinancialcrisisinlate2000s.Likewise,Australia’slabourmarket,whilestillover-regulatedinsomeareas,hasbeenflexibleenoughtoallowthenecessaryadjustmentsinrealwagestotakeplaceinrecentyears,helpingtosustainemploymentgrowth.

ButAustralia,likeChina,isnowsearchingfornewsourcesofgrowthastheoldonesfade,andthestructureoftheAustralianeconomyisrevertingbacktoamorenormalpatternofgrowthinwhichtheservicessectorwillagainbethemaindriverofgrowth.

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Australia’sservicessector,whichaccountsforaroundthree-quartersofoutput,comprisesadiverserangeofindustries.Thisspanstraditionalareassuchasutilitiesandgoodsdistribution,servicestohouseholdssuchashealthcareandrecreation,aswellasservicesmainlydirectedtowardsotherbusinessessuchasprofessionalservices(Figure2.16).

Figure 2.15: growth in Australia’s national income

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Labour utilisation Terms of trade Labour productivity National income per person

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Figure 2.16: Australia’s industrial composition

29%

19%

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Administrative and support services

Distributionof goods and utilities

Services to households and businesses

Commodities, manufacturingand construction

Arts and recreation services

Other

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Information media and telecommunications

Financial and insurance

Rental, hiring and real estate

Professional, scientific and technical

Public administration and safety

Education and training

Health care and social assistance

Source:ABS2015a.

Whileitisimpossibletopredictexactlywhichindustrieswillprosperinthecomingdecade,China’stransitiontowardsamoreconsumer-driveneconomywillundoubtedlyseeChina’simportstilttowardsservicesandhigher-valuefood.TheongoingliberalisationofChina’sfinancialmarkets,aswellaslatentdemandofChinesehouseholdsandfirmsforabroaderrangeofinvestmentandcreditproducts,willpresentaraftofopportunitiesforAustralia’sfinancialservicessector.TheseopportunitiesarediscussedfurtherinChapter5.

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Exportopportunitiesarelikelytoextendwellbeyondfinancialservices.SupportedbyChAFTA,therewillalsobeopportunitiesforprovidersofotherservicestoaccessthegrowingChinesemarketinareassuchaseducation,tourism,healthcare,accountingandlegalservices.

However,unliketheexperienceofthelastdecade,Australiawillhavenoparticularnaturaladvantagesincapturingthesenewexportmarkets,andwillfaceformidablecompetitionfromotheradvanced,service-basedeconomies.

Infact,productivityinsomeofAustralia’sserviceindustrieslagswellbehindtheglobalfrontier,partlyreflectingarelativelypoorperformanceoverthepastdecade.ThispictureisconsistentwithmeasuresofAustralia’srelativeinternationalcompetitiveness,whichalsopointtoanunderlyingdeteriorationoverthepastdecade(Box2.6).

BOx 2.6: An AssessmenT OF AusTRALiA’s COmPeTiTiveness

TheWorldEconomicForumprovidesausefulcross-countryassessmentofcompetitivenessbasedonitsratingon12categories(or‘Pillars’)thathavebeenfoundtocorrelatewithacountry’slonger-termproductivityperformance(WorldEconomicForum2015).These12Pillarsincludeacountry’sinstitutions,infrastructureandmarketefficiency,withscoresineachofthe12categoriesaggregatedtoformanoverallglobalcompetitivenessindex(orGCI).

Australia’soverallGCIrankinghasfallenoverthepastdecade,from16thto21st.Whileslippingacrossmostcategories,Australia’sdropintheareasrelatedtomarketefficiency(inbothgoodsandlabourmarkets)hasbeenstarkest(Figure2.17).

Figure 2.17: Australia’s competitiveness ranking

19 16

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1st pillar:Institutions

2nd pillar:Infrastructure

4th pillar:Health andprimary education

6th pillar:Goods marketefficiency

7th pillar:Labor marketefficiency

8th pillar:Financial marketdevelopment

9th pillar:Technologicalreadiness

10th pillar:Market size

11th pillar:Businesssophistication

12th pillar:Innovation

2015–16

2006–07

Note:Pointsfurtherfromtheorigindenoteahigher/betterranking.Source:WorldEconomicForum2015.

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Intheareaofgoodsmarketefficiency,thefallinAustralia’srankingreflectslowerscoresonindicatorsofdomesticcompetition,partlyoffsetbyincreasedscoresrelatingtoforeigncompetition.Thelowerrankingonlabourmarketefficiencyreflectsincreasingcostsassociatedwithredundanciesandhiring,andlittleprogressoverthepastdecadeinstrengtheningthelinkbetweenproductivityandpayoutcomesinemploymentagreements.

Australia’srankingoninfrastructurehasalsofallen,reflectinglowerscoresforroadandairtransportinfrastructure,partlyoffsetbyincreasesinthequalityofelectricityinfrastructureandamorecomprehensivemobilephonenetwork.

WhiletheGCIisonlyonemeasureofcompetitiveness,thesemovementsinAustralia’sGCIperformancehighlightsomeareaswherereformeffortsshouldbefocused,namelyinproductandlabourmarketefficiencyaswellascertaincategoriesofinfrastructure.InthecategoriesinwhichAustralia’sscorehasimprovedmost—healthandprimaryeducation—itisimportantthatincreasedpublicspendingintheseareasisallocatedefficiently,toensurethathigherspendingtranslatestobetteroutcomes.

Tocompeteeffectivelyinemergingexportmarkets,Australiawillthereforeneedtoundertakefurtherreformstodriveproductivityperformance,particularlyintheservicessector.Thiswillrequireexposingthedomesticeconomytoincreasedinternationalcompetition,througheliminatingremainingtradebarriersandaddressingtherelativelyhighregulatoryburdenimposedonbusinessesengagingininternationaltrade,asnotedintheWorldBank’sEaseofDoingBusinessmeasureforAustralia.

Strengtheningandextendingnationalcompetitionpolicythroughoutthedomesticservicessectorwillalsobeneeded,especiallyinAustralia’slargehuman-servicessector,wherecompetitiveforcesandconsumerchoicearegenerallylacking(Box2.7).

BOx 2.7: ReFORm PRiORiTies ACROss AusTRALiA’s seRviCes seCTOR

Withthetermsoftradereturningtowardshistoricalaverages,thefocusofpolicymakersisnowonimprovingtheproductivityofAustralia’sservicessectorasawayofmaintainingeconomicgrowthandprosperity.

ThisfocusreflectsthelargeweightoftheservicessectorintheAustralianeconomy(morethan70percentofoutputand80percentofemployment)anditsunderperformanceinkeyareasrelativetoglobalproductivitybenchmarks.

Forexample,Australia’sProductivityCommissionfoundthatproductivityinAustralia’sretailindustryisalmost40percentbelowtheUnitedStates’,whileresearchersbasedattheRBAhavefoundbelow-parproductivitygrowthinthefinancialservices,educationandwholesaleindustriesoverthepastdecade.

Recognisingthisproductivitychallenge,theHarperReviewofCompetition(2015)highlightedtheneedtocultivatemorecompetitioninproductmarkets,particularlyacrosstheservicessector.TheReviewemphasisedtheneedforpolicysettingstobeflexibleinordertoallownewentrantspossessingdisruptivetechnologiesorlower-costproductsinto

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theAustralianmarket,includinginthe‘sharingeconomy’andthroughonlineprovision.Aspartofthis,theReviewidentifiedintellectualpropertylawasanareawherepolicyframeworksneededtobereassessedtoensurethattheexistingregimeisnotpreventingnewideasandtechnologiesfrombeingefficientlydispersedacrosstheeconomy.

TheReviewalsoemphasisedthepotentialforefficiencyimprovementsinhumanservices,includingthoseprovidedbygovernments,suchashealth,educationandcommunityservices.Whilealreadysignificant,theageingofAustralia’spopulationmeansthathumanservicesareexpectedtobecomeanevenlargerpartoftheeconomy,underliningthebenefitsthatcouldaccrueintheseareasfromincreasedcompetitionandcontestabilityaswellasgreaterconsumerchoice.

CompetitionreformwillnotonlyhelpAustralianbusinessestocompeteinfiercelycontestedserviceexportmarkets,butwillalsobeimportantinachievingproductivitygrowthacrossthenon-tradedsegmentsoftheservicessector.BetterproductivityperformanceinAustralia’snon-tradedsectorwill,inturn,freeupresourcestocopewiththedemandsofanageingpopulationandtofurtherimprovelivingstandardsoverthenextdecade.

AsnotedinBox2.6,thereisalsoroomforAustraliatosignificantlyimproveitsinfrastructure,withfurtherinvestmentneededinareasliketransportnetworkstosupportgrowingurbanpopulations.Additionalpublicspendingintheseareasneedstobeaccompaniedbyamorerigorousapproachforselectingprojects,toavoidwastingpublicresources(InfrastructureAustralia2016).

Asarelativelysmall,capital-importingeconomy,Australiawillalsoneedtoensurethatpolicysettingsremainsupportiveofforeigninvestmentininfrastructureandotherpartsoftheeconomy.China’smovetowardscapitalaccountliberalisationwillfundamentallychangetheavailabilityoffundswithintheinternationalcapitalmarket.China’svastpoolofsavingscouldhelpunderpinAustralia’sinvestmentneedsoverthenextdecade,butonlyiftheforeigninvestmentregimeandbroaderpolicyframeworkscontinuetomakeAustraliaanattractivedestinationforbothdirectandportfoliocapitalinflows.Improvinginfrastructuredeliveryforexistingassetswillbeapriority,includingthroughmoreefficientpricingintheareasoftransportandwaterinfrastructure(InfrastructureAustralia2016).Similarly,witharelativelysmallpopulation,Australianeedstoensurethatthelocalworkforcehasthecapabilitiesandnimblenesstocapitaliseonnewandemergingtechnologies.Inpart,thismeansbuildingupontheemergingcultureofstart-upbusinessesandentrepreneurship,andencouraginggreatercommercialisationofresearchideas,consistentwithAustralia’sNationalInnovationandScienceAgenda(AustralianGovernment2016).

Partners in economic transformation

ForbothChinaandAustralia,thepastdecadesaweconomicprosperityreachnewlevels,aseacheconomysuccessfullynavigatedtheglobalfinancialcrisistoextendalreadylongperiodsofunbrokeneconomicexpansion.

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Butglobaleconomiccircumstanceshavechanged,andthesourcesofgrowththatunderpinnedrisingincomesinthelastdecadewillneedtochangealso.Thechallengeinthenextdecadewillthereforebetounleashnewsourcesofgrowth,especiallyineacheconomy’sservicessectorandinotherareaswherenewtechnologiesarerapidlyemerging.

Toachievethis,bothcountrieswillneedtoextendanddeepenreforminthoseareasoftheeconomythathaveremainedprotectedfromdomesticandinternationalcompetition,whichwillbethemainrecipefordrivingproductivitygrowthandinnovation.

InChina,openingupdomesticcapitalmarketstotherestoftheworldwillbecrucialinsupportingdomesticfinancialmarketreformstoimprovetheallocationofcapitalandtounderpinfurtherincreasesinincomes.ReformstoreducetheroleofSOEs,includingthoseoperatinginthebankingsector,willalsobeneeded,aswillfurthertradeliberalisationofChina’sservicessector.Together,thesepoliciescanassistChinatorebalancetowardsmoreconsumer-orientedgrowth,andsupporttheeconomy’stransformationtowardstheservicesandhigher-technologymanufacturingsectors.

Intheeconomictransition,Chinaalsoneedstobalancetheshort-termgoalofsupportingaslowingeconomywithfiscalandmonetarypolicymeasures,whichmaycontributetotheriseoftotaldebt,andthelong-termobjectiveofachievingmorebalancedandsustainablegrowth,whichwillrequireapropermanagementoffinancialrisks.

AsChina’scapitalaccountbecomesmoreopen,itsinvestmentlinkswiththerestoftheworldarelikelytogrowdramatically,whichhasthepotentialtoprofoundlyaffectAustraliaandtherestoftheworld.

Asacountryreliantonforeigninvestment,AustralianeedstobereadytoembracetheexpansioninChineseoutboundinvestment,includingininfrastructurewhereAustraliawillneedtofinancenewprojectsinareasliketransportationtosupportgrowingurbanpopulationsandlivingstandards.

Morebroadly,Australiawillneedtoincreasecontestabilityacrossmarkets,includinginsignificantpartsoftheservicessectorthatarecurrentlyprotectedfromdomesticandinternationalcompetition.Foreignparticipationwillbeimportanttosuccessinthisendeavour.Amongotherthings,thiswillinvolveextendingreforminareassuchascompetitionpolicyandlabourmarketregulationandbreakingdownremainingbarrierstointernationaltrade.

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CHAPTER3trade in goods and services

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Key messAges

AustraliaandChinaareandwillremaindeeplycomplementarybilateraltradingpartners.ThebedrockofthistradehasbeenChina’sdemandforAustralia’smineralandenergyexports.ThestructuraltransformationofChina’seconomyimpliesastructuralchangeinthecompositionofbilateraltrade.

ModellingundertakenforthisReportindicatesthatwhileAustraliawillcontinuetosupplyChinawithmineralswellintothefuture,therelativeimportanceofhighvalue-addedgoodsandservicesinAustralia’sexportbasketwillincrease.Thistransformationwill,byitself,leadtofastgrowthintradebetweenAustraliaandChinainrealterms,muchofitinservices.Australiancompaniescanbeasourceofthehigh-qualityfoodandhealthproductsthatChineseconsumersincreasinglydemand.Evenmorepromisingistheexpansionoftheservicestradebeyondeducationandtourism,toservicessuchashealthcareandfinance,whereAustralianexperienceandexpertisecanassistwiththedevelopmentofChina’sownservicessector.China,meanwhile,willcontinuetomoveupthevaluechainintohighervalue-addedmanufacturingandservices.

Eveninapessimisticscenario,inwhichaverageChinesegrowthisbelow5percentoverthenext10years,themodellingsuggeststhatAustralianexportstoChinawouldstillgrowinrealtermsby28percentandChineseexportstoAustraliawouldgrowby20percent.A‘baseline’scenariohasAustralianexportsgrowingby72percentandChineseexportsby41percentoverthesameperiod.Buttherewillbemuchstrongeroutcomes—growthof120percentinAustralia’sexportsand44percentinChina’s—ifthetwocountriessucceedintheirambitionsforsupply-sidestructuralreform.

• ThepotentialofAustralia–Chinatradewillnotberealisedautomatically.Australiadoesnotenjoythesamenaturaladvantageinservicesasitdoesinresources.Deeper,broaderengagementatalllevelsofsocietywillbenecessary.DomesticregulatoryreformsinbothChinaandAustraliawillbenecessaryifbothcountriesaretomakethemostoftheopportunities.

• Recognitionofprofessionalqualifications,startingwithtraditionalChinesemedicineandengineering,willaddnewtradepotential.Onereformthatofferslargepotentialgainswouldbetoestablishrecognitionofprofessionalservicesqualificationsfromtheotherjurisdiction.Bytheendof2017,thesidelettertoChAFTAonskillsassessmentandlicensingisdueforreview.Tohelpmakethemostofthisreview,theAustralianandChinesegovernmentsshouldcoordinateengagementbetweenaccreditingregulatorybodies.

• E-commercechannelsarenowprovidingachannelforChineseconsumerstofindnicheproductsandservices.Regulatorsonbothsidesshouldcooperate,particularlyconcerningfoodandhealthcareproducts,toencouragemutualrecognitionofstandardsthatallowthistradetobescaledup.

• Reflectingthenatureofregionalandglobalsupplychains,extendingthetariffreductionscommittedtoinChAFTAthroughtoRCEPnegotiationswillhelpsustainChina’sindustrialup-skilling.

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• InordertocapitaliseondemandfromChinesetourists,Australiacouldconsiderremovingrestrictionsondomesticaviationservicesthatmakeinternationalroutestothecountrylesscommerciallyattractive.ThiswouldnotonlyhavepositivedirectimpactsonthecompetitivenessoftheaviationindustryinAustralia,butwouldencouragemoreflightsfromChinathatwouldboostAustralia’stourismindustry.

• Atthenationallevel,theStrategicEconomicDialogueprovidesamechanismalongsideChAFTAforhigh-levelofficialengagement.TheAustralia–ChinaState/ProvincialLeadersForumandsister-cityrelationshipsprovidemorelocalchannelsforengagement.

• Withinthecommunity,theChinesediasporainAustraliaisavaluableagentforbuildingengagementandtrust,asarecivilsocietyorganisationsandpeakbusinessgroups.

EconomicprosperityinAustraliaandChinadependsoninternationaltrade.Tradeallowscountriestospecialiseinareasofcomparativeadvantage,encouragesthemtoexploiteconomiesofscale,andobligesthemtocompetewiththebesttheworldhastoofferinforeignanddomesticmarkets.Byincreasingcompetition,tradeboostsproductivity,fuelsinnovation,makesconsumersbetteroffthroughimprovedchoiceandlowersinputpricesforproducers.

AustraliaandChinaaredeeplycomplementarytradingpartners.Australiahasalargenaturalresourcebaserelativetoitspopulation.Australiathereforespecialisesintheproductionofprimarygoodsforexport,andusestheproceedstopurchaselabour-intensiveandothermanufacturedgoods.Conversely,Chinahasalargelaboursupply,butrelativetoitspopulationhassmallerendowmentsofnaturalresourcesandaccumulatedcapital.Forthisreason,China’sindustrialdevelopmentwasbuiltonlabour-intensiveproduction,whichitexchangeswithAustraliaforimportsofscarceresources.

In2014,AustraliaandChinaeachimportedanequivalentof21percentoftheirGDP,andexported20and24percentrespectively(OECD2016).ChinaisnowAustralia’slargesttradingpartner.ItbecameAustralia’ssinglelargestsourceofgoodsimportsin2006(replacingtheUnitedStates,Figure3.1A)andthelargestmarketforgoodsexportsin2009(replacingJapan,Figure3.1B).Thetotalvalueofbilateraltrade,includinggoodsandservices,wasin2015A$156billion(ABS2015b).In2009–2010,ChinaovertooktheUnitedStatesasthelargestoverseaspurchaserofAustralianservices.ThevalueofAustralia’sservicesexportstoChinaincreasedfromA$1.1billionin2000–2001toA$8.8billionin2014–2015,asChina’sshareofAustralia’sservicesexportsrosefrom3percentto14percent(ABS2016c).

Therelationshipisnaturallyasymmetricbecauseoftherelativesizeofthetwocountries.AustraliaisonlyChina’sseventh-largestimportsourceand14th-largestexportdestination(DFAT2016c).EventhoughAustraliaisalreadyaneconomicallydevelopedcountry,itsentirepopulationisroughlythesameasthatofShanghai.TheChineseeconomyinevitablydwarfsAustraliainscale,despiteitsmuchlowerlevelsofpercapitaincome.

ThisasymmetrymeansthatevensmallchangesinChina’seconomycanhaveprofoundimpactsonAustralia.Bycontrast,AustralianpolicychoicesoreconomicperformancehavelittleimpactonChina,whichhasnoshortageofothercountriescompetingtosupplyitshugedomesticmarket.Forthisreason,Australianeedstoensurethatitspoliciesenableflexiblemarketsthatcanadaptquickly,allowingdomesticbusinessestoremaincompetitiveinresponsetochangingglobalcircumstances.Waitingforglobalagreements,orholdingoutoneconomicliberalisationasabilateralnegotiatingtactic,wouldmeanmissedopportunitiesforAustralia.

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CHAPtER 3: trade in goods and services

Australia’sroleasalow-cost,high-qualityandreliableproviderofrawmaterialsneededforChina’sgrowthmakesAustraliaamuchmoreimportanttradingpartnerthancouldbeexpectedbasedonscalealone.Beyondthis,AustraliacanassistChinainitsowneconomictransformationtoaservices-basedeconomy.ThisisanareawhereAustralianexperiencemaybehelpful.Australia’sservicessectoraccountsformorethan70percentofitsrealgrossvalueadded(ABS2016e).Outsideofmining,thefastest-growingindustriesinAustraliaoverthelast25yearshavebeeninknowledge-orientedindustriessuchasinformationmedia,telecommunications,financeandprofessionalservices.Therehasalsobeensubstantialgrowthinmajorservicesindustriessuchaseducationandtourism(ABS2016e).

Australia’s merchandise trade by trading partner

Figure 3.1A: export share Figure 3.1B: import share

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USA India Other Export Markets

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Source:CalculatedfromABS5368.02016a.

ChAFTA,whichcameintoforceinDecember2015,willlowerthecostsofbilateraltradeacrossresources,manufacturingandservices.ButChAFTAis,inmanyrespects,likeopeningadoor.Theopportunitiesofthisopendoorwillnotbefullyrealiseduntilfurtherworkisdone.ThetwocountriesthereforeneedtousetheplatformestablishedbyChAFTAtodeveloptheirrespectiveeconomicstrengthsinamutuallybeneficialway.InadditiontoanoverarchingJointCommissionwhichisscheduledtomeetatleastannuallytoreviewoverallimplementation,ChAFTAcreatescommitteesdealingwithinvestment,tradeinservices,financialservices,movementofnaturalpersons,tradeingoods,sanitaryandphytosanitarymeasures,technicalbarrierstotradeandintellectualproperty.

Throughtheseforums,ChAFTAshouldbethoughtofasalivingdocumentthatcanfacilitatemanyofthepolicysuggestionsfromthisReport.Inparticular,AustraliacanhelpmeetthechangingneedsofChinaasitshiftstoamoresustainablemodelforeconomicdevelopment,movingupthevaluechainwithalargerservicessectorandagrowingmiddleclass.ThegoalofthisisnottocreateanyartificialtradepreferencebetweenAustraliaandChina,buttocreateanenvironmentinwhichbothcountriescanmoreeasilydeveloptheirrespectiveadvantagesformutualbenefit.Thatbenefitcanextendbeyondbilateraltrade,andAustraliaandChinacan

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jointlypursuetradestrategiesthatexpandregionalintegrationtospreadthegainsfromtradethroughcountriesinvolvedintheRegionalComprehensiveEconomicPartnership(RCEP),andeventuallyaFreeTradeAreaofAsiaandthePacific(FTAAP)(seeChapter7).

The resources trade

TheunprecedentedscaleandspeedofChina’surbanconstruction,aswellasChina’sdominanceinmanufacturing,havedemandedtremendousmineralandenergyresources,particularlysteel(Garnaut2012).Themaininputstosteelareironoreandmetallurgicalcoal,bothofwhichAustraliahasinabundanceathighqualityandlowcost.Priortothe2000s,Australia’smainexportstoChinahadbeenagricultural,withironoreaccountingforjust15percentofthevalueofAustralianexportstoChinain2001(DFAT2011).

AustralianironorehelpedfuelChina’sinvestmentboomintheearly2000s.Whiletheglobalfinancialcrisiscausedabriefslumpin2008,theresources-intensivenatureofChina’sinvestment-ledgrowthhelpedAustraliaavoidtherecessionthatgrippedotheradvancedeconomies.Asironorepricespeakedin2011,Australia’sironoreexportswereworthA$44billion,or57percentofthetotalvalueofAustralianexportstoChina.Bytheendof2015,theironorepricehadfallentoone-quarterofitspeak,inresponsetoincreasedglobalsupplyandslowingdemandgrowthinChina.However,increasedexportvolumesandthedecliningvalueoftheAustraliandollarmeanthatthetotalAustraliandollarvalueofironoreexportshasremainedwellabovehistoriclevels(Figure3.2)andAustralia’stotalshareofChina’sironoreimportshasbeenincreasing.

Figure 3.2: iron ore price and export value

0

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Monthly Value of Iron Ore Exports (RHS) Iron Ore Price (LHS)

Source:Price,IndexMundi-ChinaimportIronOreFines62%FEspot(CFRTianjinport),USDollarperDryMetricTon,MonthlyExport,andAustralianBureauofStatisticscatno.5368.0Table12B2016a.

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Thepricesofcommoditiesaredeterminedthroughtheinteractionofglobaldemandandsupply,includingtherecenteffectsofChineseinvestmentoverseastoexpandthatsupplywhilereducingtheresource-intensityofgrowthonthedemandsidethroughimprovedefficiency.BecausethepriceofcommoditiesimpactsbothAustraliaandChinagreatly,betterunderstandingpricedeterminantsandtheeffectofsupplyresponsesshouldbeoneoftheprioritiesforjointacademicresearchbetweenChineseandAustralianacademic,governmentandbusinesspartners.

Whateverthefluctuationsinglobalprices,thesheervolumeofChineseresourcedemandwillkeepresourcesasthebedrockofbilateraltradefordecades.Evenatslowerratesofeconomicgrowth,thesizeofthebasetowhichthatgrowthappliesmeansthatoveralldemandwillstillincreasebyasignificantamountinabsoluteterms.TherearestillhundredsofmillionsofChinesewhowillmovetocities.Thismigration,coupledwithhigherlevelsofincomeandconsumptionforurbanresidents,couldsustainChinesedemandforapartments,highways,railways,bridgesandcars(BerkelmansandWang2012;WilinksandZurawaski2014).AlthoughChina’srichestcitiessufferfromtrafficcongestion,overallcarownershipinChinaislow.Acontinuedshiftinmanufacturingfromtextiles,clothingandfootweartohighervalue-addedelectronicsandmachinerywillalsosupportresourcedemand.Chinaproduced603kilogramsofsteelperpersonin2014,butpeaksteeldemandcouldreach700–800kilogramsperpersoninthemid-2020sdependingonthespreadofautomobileownership,theprevalenceofhigh-riseconstructionandthepaceoftechnologicalchange(McKayetal2010).China’ssteelproducersoperateinahighlycompetitivemarket—continuedrelianceonmarketmechanismstodealwithanyshort-termovercapacityinsteelproductionisthebestwaytomakesurethatthesupplywilladjusttomeetdemand(Hubbard2015).

Muchoftheseresourceswillcontinuetobeimported.China’sdependenceonimportedironorerosefrom50percentin2005to81percentin2015.Australia’sshareoftheseimportsrosefrom41percentin2008to64percentin2015(Russell2016).Aspriceshavefallen,AustralianironoreproducersincreasedtheirshareoftheChinesemarket.Infact,evenasChina’ssteelproductiondeclinedby2.3percentin2015,thevolumeofAustralia’sironoreexportstoChinaincreasedby9.8percent(Robertsetal2016).

ChinesedemandforAustralianresourcesextendswellbeyondironore.ThecompositionofChina’sresourceconsumptionislikelytochangeasitsmanufacturersmoveupthevaluechainanditsmiddleclasscontinuestogrow(Box3.1).Forexample,greaterdemandforwhitegoods,consumerelectronicsandlightweightelectricvehicleswillincreasedemandforAustraliancopperandbauxite(themineralfromwhichaluminiumisproduced),andrequiremorethermalcoal,gasanduraniumforpowergeneration.AustraliasupplieshalfofChina’simportsofmetallurgicalcoal,anotherkeyingredientinsteel.ChAFTAisalreadyassistingAustralianresourceexporters,havingeliminatedthetariffonmetallurgicalcoalinDecember2015.ItalsoremovesChinesetariffsonsteamingcoal,copper,aluminium,nickel,zincandtitanium,eitherimmediatelyoroverafour-yearperiod.ThiscouldreducecostsofdeliveringAustralianmineralsandenergytoChinabyA$600millionperyear(MineralsCouncilofAustralia2016).

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BOx 3.1: mORe THAn ORe

China’sconsumptionofcopperandaluminiumhasincreasedby16percentannuallyoverthepastdecade,makingittheworld’slargestconsumerofbothcommodities.In2014,Chinabought46percentofAustralia’scopperexports,worthA$1.8billion,and74percentofAustralia’stotalnickelexports,worthA$0.6billion.China’smachinery,automobileandhomeapplianceindustriesarekeydriversofaluminiumdemand.AustralianexportsofaluminiumoxidetoChinamakeup89percentoftotalworldaluminiumoxideexports.AndAustralianexportsofaluminiummetaltoChinaare19.1percentoftotalworldaluminiumexports(MineralsCouncilofAustralia2016).AsChinaincreasesproductionofmoresophisticatedmanufacturinggoodsitsdemandforaluminiumwillalsoincrease.ThescaleofChina’saluminiumsmeltingcapacitymakesitdifficultforothernationstocompeteforsupplyoftheprimarymetal,butAustraliaremainsamajorsupplierofthebauxiteandaluminarequiredtofeedthosesmelters.

China’simportsofLNGwillgrowasChinaseekscleanerenergysourcesbyreducingdependenceoncoal.Australiaiscurrentlyoneoftheworld’sthreelargesturaniumexporters,andhashadanagreementsince2006toallowuraniumexportstoChina.Whiletradestatisticsonuraniumarenotpubliclyavailable,thevolumeofAustralianuraniumexportstoChina(around500tonsayear)isreportedlylessthanexportstotheUnitedStates,theEU,JapanorSouthKorea(WorldNuclearAssociation2016).

AustraliawasChina’ssecond-largestsupplierofcoalin2015,afterIndonesia.Australiasupplied35percentofChina’stotalimporttonnage(Figure3.3A).AustraliaisChina’slargestsupplierofliquefiednaturalgas(LNG),supplying28percentofChina’srapidlygrowingimportsin2015(Figure3.3B).

Figure 3.3: Chinese imports from Australia and rest of world

Figure 3.3A: Coal (Tons) Figure 3.3B: Lng (Tons)

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Source:ChinaGeneralAdministrationofCustoms2016.

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ProjectionsacrossarangeofcommoditiessuggestthatfoodandLNGarelikelytoriseinimportanceasashareofAustralia’sexportstoChina,whileironoreandbasemetalsarelikelytofallasashareoftotalcommodityexports(Table3.1).

Table 3.1: Actual and projected exports of commodities to China

share of commodity exports to China by value (per cent)

2005 2015 2025 2035

Growthscenario Actual Estimated Projection Projection

Ironore 47.3 57.9 51–51.5 43–47.5

Basemetals 25.1 13.2 13 12–13

Coal 4.3 8.7 9.5–10 11–13

Naturalgas(LNG) 0.0 5.4 10 12–14

Food 5.8 8.6 9 9.5–11

Source:Robertsetal2016.

TheAustralia–ChinaresourcetraderelationshipechoestheevolutionoftheAustralia–Japanrelationshipsincethe1960s.WhileAustralia’sresourcestradeisprivate,since1976therehasbeenanofficialtreaty-levelrecognitionbetweenAustraliaandJapanofeachcountry’s‘mutualinterestineachbeingastableandreliablesupplier’,discussedfurtherinBox3.2(Dee2006).The2014Japan–AustraliaEconomicPartnershipAgreementaffirmedthisprincipleinachapterthatensuresthestablesupplyofenergyandminerals.Thiscommitmentisimportant,becausewhileglobaltradedisciplinesarestrongwithrespecttorestrictingimportbans,multilateralrulesagainstexportrestrictionsarenotasrobust.

BOx 3.2: ResOuRCe seCuRiTy AnD gLOBAL TRADe

Alleconomiesrequireaccesstoenergyandmineralresourcesforindustrialisation,urbanisationandgrowth.Toensurestabilityoftheirowneconomy,somecountriesadoptpoliciestoensureresourcestability,whichmayincludestrategicstockpilesofresourcesor,inextremecases,policiestendingtowardautarky.Butthesepoliciesareofteninsufficienttomeetdemand,andcanonlybedoneatveryhighcost.Theyforgothegainsthatcanbehadfromglobaltradeonopenmarketsconsistentwithcomparativeadvantage.

Butinternationaltradeisnotwithoutitsrisks.Rawmaterialsmaybeabundantin,orneedtotransitthrough,politicallyunstableordangerouspartsoftheworld.

TheresourcepartnershipsbetweenAustraliaandthecountriesofNortheastAsiaoverthelast60yearsisapowerfulexampleofhowresourcesecuritycanbeachievedthroughopenmarkets,inastablegeopoliticalsettingandinthecontextofmaturepoliticalrelationships.TheabilityofdownstreamresourceuserstoinvestdirectlyintoAustralia’sresourcesaddsthereassurancethatresourceswillbeavailable,whileexpandingsupplyforglobalmarkets.

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AspointedoutinChapter1,thegeographicalorientationoftheChineseeconomyhaschangedfundamentally,frombeingcontinentallyself-containedtobeingthelargestmaritimeeconomyintheworld.Importdependencehasgrownascommoditypriceshavefallenandhigh-costdomesticsuppliesbecomelessattractiveindustrialinputs.ThereductionsincostsandgainsinefficiencyfromincreasedrelianceoninternationalmarketshavefreedupcapitalforinvestmentelsewhereintheChineseeconomyandmadebetteruseofstateresources.ThisdevelopmenthasnaturallyandsteadilydrawnChinaintothemaritimeeconomy,includingtheconstructionofhugeseafreightcapacities,interestinmaritimescientificandweatherresearch,andconcernaboutsecuringinternationalsupplies.Asitisoneoftheworld’slargestmaritimeresourcesuppliers,Australiareciprocatestheseinterests.

PolicythinkingabouttheimplicationsofChina’smaritimeeconomyhasfailedtokeeppacewiththischange.ThemajorefforttoredressthisdeficiencythatisnowunderwayinChinawouldbeassistedbycollaborationbetweenAustraliaandChinaontheimplicationsofgrowingresourcedependencyforresourcesecurity,maritimeresourcedevelopmentandprotection,maritimescientificandweatherresearch,andAustralianparticipationinChina’sMaritimeSilkRoadinitiative.Workingtogetherontheseandotherjointinterestsinthemaritimeeconomy,givenbothcountries’deepmutualinterestsinthissubject,shouldbeseenasatoppriorityforbothgovernments.TheinitiativecancommenceundertheestablishedframeworkforcooperationbetweenChina’sNationalDevelopmentandReformCommission(NDRC)andtheAustralianTreasury,andbringinotheragenciesandresearchorganisationsasitdevelops.ThiscouldincludebuildingontheexcellentcooperationbetweenbothcountriesonAntarcticresearch.

ResourcesecurityisimportantforChinainensuringongoinginputsforitseconomicgrowth.Thisdoesnotmeansecurityfrominternationalmarkets.Atreaty-levelcommitmentbetweenAustraliaandChinanottoarbitrarilyrestrictAustralianresourceexportswouldhelpreinforceChina’sconfidenceintheabilityofopenmarketstoprovideresourcesecuritywhilereducingcostsandimprovingefficiencythroughincreasedcompetition.ThiswouldbothbegoodforChinaasarecipientofAustralianrawmaterials,andgoodfortheAustralianresourcesindustry,whichcouldmakelong-termplanswithconfidence.ThiscommitmentwouldbethecoreoftheproposedAustralia–ChinaComprehensiveStrategicPartnershipforChange.

Agricultural trade

EvenbeforeChina’sreformandopeninginthelate1970s,thepostwarAustralia–Chinatraderelationshiphadbeguninagriculture,withlarge-scaleAustralianwheatexportstoChinafrom1960(Wilczynski1965).MineralexportstoChinaovertookagriculturalexportsinthe2000s,butAustraliastillplaysanimportantroleinChina’sagriculturalmarket.ChinahasalsobecomeasignificantexporterofagriculturalproductstoAustralia.Thelocationofthetwocountriesindifferenthemispheresmeansthatcounter-seasonalproductscanbetradedtofilldomesticsupplygaps.Theproximityofthetwocountriesallowsforproductstoreachmarketsquicklyandinqualitycondition.AndAustralia’strackrecordasasafeandreliablesourceofhigh-qualityproduceshowsthatitcanhelpmeetthefoodsafetydemandsofChineseconsumers.

Australia’sexportsofagriculturalprimaryproductstoChinagrewsteadilythroughthe2000sbeforemorethandoublinginvaluebetween2009–2010and2013–2014,whentheyreachedA$9.6billion.In2010–2011,ChinaovertookJapantobecomethemostimportantexportdestinationforAustralianagriculturalprimaryproducts.China’sshareofAustralia’stotalagriculturalexportsgrewfrom6.4percentin2000–2001toover20percentin2014–2015(Austrade2016b).

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AustralianexportsofwoolandgrainstoChinawereeachworthmorethanA$2billionin2014–2015(Figure3.4).AustraliaisChina’slargestsourceofwoolimports.AustralianbeefexportstoChinahavegrown,fromalowbase,atarateofmorethan200percentayearandwereworthmorethanA$736millionin2014–2015.ChinaisAustralia’ssecond-largestmarketfordairyexports,whichgrewanaverageof20percentannuallyoverthepastfiveyears(andwereworthA$295millionin2014–2015)(Australia–ChinaBusinessCouncil2015).AustralianwineexportshavefocusedontheChinesemarketformorethanadecade.China’swineimportindustrywasvaluedatA$2.1billionin2014–2015.AustraliaisChina’ssecond-largestwinesupplierbyvalue,withexportsvaluedatA$269millionin2014–2015(DFAT2014b).Chinahasalsotappedtheexpertiseofforeignwinemakersandhasbeenexpandingitsowndomesticproductionoverthistime,whichiswhygrowthopportunitiesforAustralianwinemakerscomefromfocusingonthepremiummarketratherthanbulkwineexports.

AgriculturaltradehasgrowndespiteChinesetariffbarriersandnon-tariffmeasures.WTOdatashowthatwhileChina’strade-weightedaveragetariffratein2013wasjust4.6percent,itwas13.5percentforagriculturalgoods(WTO2016b).ChAFTAremovedsomeofthesebarriers.Forexample,tariffsonbeefthatpreviouslyrangedfrom12–25percentarebeingeliminated(DFAT2014b).UnderChAFTA,theAustraliandairyindustrywillnowreceiveevenmorefavourabletreatmentthanthatnegotiatedbyNewZealandwithChinaintheir2008freetradeagreement.

OneofthekeydriversforopeningupChina’sagriculturetofurthertradeistoensurelong-termfoodsecuritythroughaccesstoopenmarkets.Chineseagriculturestilltendstoberelativelysmall-scaleandnon-commercial,althoughtherearenowmajoragriculturaloperationsintheprivateandpublicsectorsthatareexpandingtheirinfluenceinChinaandabroad.Asmorearablelandpassesintourbanuse,Australia’shighlyproductivefirmsandextensivelandcanbuttressChina’sfoodsupplies.InthesamewaythatAustraliahasprovedtobeareliablepartnerforChineseenergyandmineralsdemand,sotoocanAustraliabeavaluablepartnerinsupplementingChina’sfoodsecurity.

DevelopingthecapacitynecessarytomeetChina’sdemand,evenatthemargin,willrequiresignificantinvestmentinAustralianagribusiness,someofwhichmaybefinancedbyChineseinvestors,asdiscussedinChapter4(Australia–ChinaBusinessCouncil2014).

Volumegrowthisnottheonlyindicatorofpotential.AustralianagriculturealsoofferspremiumopportunitiestoserveChina’sgrowingmiddle-incomeconsumers.Moreover,accordingtotheBCGChinaConsumerSurvey2016,foodsafetytopsthelistofconsumerconcerns,aheadofhealthcare,educationandtheenvironment.TheresultsareparticularlystarkforyoungerChineseconsumers,with63percentofthoseagedbetween18and25expressingdissatisfactionwithfoodsafety(WaltersandKuo2016).

Since2004,bothcountries’dairyindustrieshavebeeninvolvedinanofficialdialogue(DFAT2012).Butmovingfromformaldialoguetolarge-scaledeliveryofnewsupplywillrequireinvestment,servicesandinfrastructure.A2012jointreportbetweentheAustraliaandChineseministriesresponsiblefortradeandforagricultureidentifiedtheconstructionofbreedingfacilities,aswellasdairyfarms,aspossibleopportunitiesforChineseinvestmentinAustralianagribusiness.

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PartofthepremiumvalueofAustralianfoodproductsinChinaisAustralia’strackrecordinsupply-chainmanagementandfoodsafety.ForChineseinvestors,partneringwithrecognisedAustralianbrandsandbusinessescanhelpthemrealisethefullvalueoftheiroutput.ForAustralianbusinesses,partneringwithChineseinvestorshelpswithdistributionchannelswithinChina,whetherdirectlytoretailconsumersorasinputsforotherpartsoftheChinesefoodindustry.

Despitetheseopportunities,investorsinAustraliafromChinafaceamuchstricterthresholdforinvestmentinagribusiness(A$55million)comparedtoothersectors(wherethethresholdisoverA$1billion)orcomparedtootherFTApartnersfromChile,NewZealandandtheUnitedStates,aswellasotherTPPmembersshouldtheTPPcomeintoforce.Whilethisscreeningthresholddoesnotnecessarilypreventinvestmentgoingahead,itaddsextracostsandriskstoinvestmentsthatwouldexpandtradeanddevelopruralAustralia.BarrierstoChineseinvestmentareconsideredinChapter4.

new opportunities for bilateral trade

TheminingboombenefitedAustraliansdirectlyemployedintheresourcesector,boostedgovernmenttaxreceiptsandincreasedthepurchasingpowerofAustraliansoverseasthroughastrongerAustraliandollar.Australianhouseholdscouldaffordtoimportmore,andmuchofthisimportdemandwasmetbyChina.By2014–2015,almostone-thirdofAustralia’simportsofelaboratelytransformedmanufactures—acategorythatincludesclothing,motorvehicles,machineryandpaint—camefromChina,upfromjust10percentin2000–2001(ABS2002;DFAT2016c).

ButthehighAustraliandollaralsoreducedthecompetitivenessofotherAustralianexports,particularlyinmanufacturing.Indeed,therapidriseofChinesemanufacturing,withhundredsofmillionsoflow-costChineseworkersenteringtheglobaleconomyforthefirsttime,inhibitedwagegrowthinthelowerendofmanufacturingaroundtheworld.

TheboostinAustralia’snationalincomefromtheresourcesboomcushionedAustraliafromsomeofthecoststhatcomewithindustrialrestructuring.However,Australianowfacessignificantpolicychallengesifitistomaintainitslivingstandardswhileadjustingtomuchlowercommodityprices.Inparticular,Australia’sresourceendowmentsandpositioninAsiaprovidelimitedcompetitiveadvantagetoAustralianbusinesswhencomparedtocompetitorsinotherdevelopedmarketsinEuropeandNorthAmerica.

TheflexibilityofAustralia’sfloatingexchangerateregime,whichallowsthedollartofallinvalueascommoditydemandeases,isanimportantchannelformakingnon-resourcesectorsmorecompetitive.Butpolicymakersneedtomakesurethatlabourmarketsareflexibleenoughtoenablecreationofjobsinemergingindustries,thatworkersareabletoacquiretheskillsrequiredtofindnewemploymentinemergingindustries,andthatfaster-growingregionsreceiveadequateinfrastructureinvestment.TheremovalofobstaclestoChinesecapitaltodevelopAustralia’sproductivecapacityinareasofgrowingChinesedemandwouldbeofbenefittobothcountriesandstrengthentheiroverallrelationship(seeChapter4).

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Figure 3.4: Australian agricultural exports to China (A$ million, 2014–2015)

0

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1,000

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estoc

kBee

fDair

yWine

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ttle

Mutton

Hortic

ulture

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Other cr

ops

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imal

Five year average annual growth (RHS)

Note:Freeonboardvalue,Grainsincludesoilseedsandpulses.Source:ABARES2016.

AsChAFTAcomesintoeffect,over86percentofAustralia’sgoodsexportstoChina(by2014value)willenterdutyfree.Thiswillincreaseto94percentby2019and96percentby2029(DFAT2016d).ThisisanimportantopportunitytodiversifyAustralia’sexportstoChina.In2014,morethan85percentofAustralia’sgoodsexportstoChinawereinunprocessedprimaryproductsandgold.

ComparingthisfigurewithAustralianexportstohigh-incomeNortheastAsianeconomiesshowsthatwhileprimaryexportscompriseanimportantshareofexportstotheseothercountries,thereisalsoalargeroleforprocessedprimaryproducts,especiallyfoods(Figure3.5).ThissuggeststhatthereisasignificantopportunityforAustralianagribusinesstotransformrawunprocessedfoodandlivestockintosafeandrespectedbrandsofhigh-qualityfood,wineanddairyproductstoexporttoChinainthefuture.AustraliaisalsoalargepotentialsourceofingredientsusedinTraditionalChineseMedicine(TCM).

ThevalueofChineseonlineretailsalesofgoodsandservicesin2015wasRMB3.9trillion(US$592billion),anincreaseof33.3percentcomparedwith2014.Thisgrowthisdueprimarilytolowerprices,greaterproductvariety,betterproductinformation,morereliablesellerreputationsandfasterdeliverytimescomparedtotraditionalretailshopping.Thepent-updemandforqualityAustraliangoodsinChinaisevidentinthegrowingvolumeofAustraliangoodsretaileddirectlyandindirectlyinChinathroughe-commercechannels.

Chineseconsumersdemandforeigngoodsfortheirquality.AccordingtoNielsonresearch,ChineseonlineshoppersimportedUS$16.3billionofforeignproductsin2014(Burbank2014).In2014,AustraliaPostandtheChinesee-commercegiantAlibabaagreedtoadealthatallowsAustralianbrandstoselldirectlytoChineseconsumersthroughleadingChineseonlineretailerTMall(ABCNews2014)(Box3.3).PopularpurchasesfromAustraliaincludehealthfoodproducts,infantformula,cosmetics,organicfoodsandsheepskinboots.AnadvantageofthisarrangementisthatitguaranteestotheChineseconsumertheauthenticityofthegoodandprovidesaguaranteedsupplychainforsellers.

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Figure 3.5: Australian goods exports to northeast Asian economies

0

10

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40

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100

%

China South Korea Japan

Processed Primary Products

Manufactures

Other goods

Gold

Unprocessed Primary Products

Note:Theexportof‘othergoods’includesconfidentialuraniumexports.Source:DFAT2015c

Theopportunitiespresentedbytheinternetande-commerceneedtobecloselystudied.Governmentagenciesresponsibleforinnovationpoliciesonbothsidesshouldpartnerwithindustrytoidentifyandremovebarrierstothefulladoptionofthisnewtechnology.Moreover,thepoliciesthataffectcross-bordere-commerceneedtobecarefullycommunicatedoneachside.Forexample,suddenrecentchangestotheenforcementofChina’sCustomsandDutiesLawweremistakenlybutavoidablyperceivedbysomeasacrackdownonforeigncompetition,ratherthantheclosingofataxloophole(Manuel2016).

AlthoughchangestoChina’se-commercemarketwerewidelyanticipated,therolloutofthesechangeswasconductedwithoutadequateconsultationwithkeystakeholders.Thisresultedinconfusioninthemarket,andledtoadverseimpactsonsuppliers.Thishasbeenalearningexperience.Theseguidelineshavesincebeenrevisedandagraceperiodallowedinordertominimiseunintendedconsequencesandallowforsellersandsupplierstoadjusttothesechanges.ClosercooperationbetweenAustralianandChinesecustomsauthoritiescouldhelpensurethatthesekindsofactionsarebettercommunicatedandunderstood.Itcouldalsoensurethatregulationsarecommonlyunderstoodandconsistentlyappliedbetweenallstakeholders.

Evenoutsidee-commercechannels,thereisastrongflowofhealthfoodproductsthatareboughtatretailoutletsinAustraliaandpostedtoChina(BattersbyandZhou2015).Small-scaleretailcanbeattractivepartlybecauseofthehighnumberofChinesewithfriendsandrelativesinAustralia,andbecausetheselow-valuepersonalimportsintoChinaavoidtheneedtoundergotheoften-onerousproductandfood-safetytestingthatwouldberequiredforcommercialimports.WhileformaltariffbarriersarereducedunderChAFTA,theneedforproducttestingandcertificationwithinChinaincreasesthecostsoflarger-scaletradeinagricultureandprocessedfoodproducts.Therefore,Australiancompaniescanalsobesuccessfulincomplementinge-commercedeliverychannelswithatraditional‘bricksandmortar’presence(seeBox3.4).

Removingbarriersto,andloweringthecostof,commercial-scaleimports,aswellasguaranteeingtheintegrityofbilateralsupplychainsandproductquality,shouldbeapriorityforAustralia–Chinatradecooperation.Whentheenforcementofdomesticstandardson

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importedgoodsismorerigorousthanitisforlocallyproducedgoods,thisconstitutesadefactotradebarrier.Thereareopportunitiestoreducethesediscrepancies,basedonanoverarchingprinciplethatthepurposeofsuchregulationsistoprotectdomesticconsumers,notdomesticproducers.Indeed,onereasonforthepopularityofe-commerceinAustralia–ChinatradeisAustralianproducersoffoodandnutritionalproductsnotbeingabletoaccessChineseconsumersthroughtraditionalchannelsbecauseofhightariffsandprotractedproductregistrationandaccreditationprocesses.

BOx 3.3: ALiBABA gROuP OPens neW mARKeTs FOR AusTRALiAn exPORTeRs

AlibabaGrouphasprovidedanelectronicbridgeforAustralianexportersintonewChinesemarkets.

ThevalueofChina’se-commercemarketexceededUS$600billionin2015.Ofthis,AlibabaaccountedforaroundUS$485billionine-commercesales,orover80percentofthetotal.ThisfiguremakesAlibabaGroupthelargestretaile-commercecompanyintheworld.Bythe2020fiscalyear,AlibabaaimstobethefirstcompanytohavearetailmarketscaleofoverUS$1trillion.

AustralianexportershaveachievedsuccessbytappingintoAlibabaGroup’se-commerceplatformsincludingTmall,TmallGlobal,1688.com,TaobaoandAlibaba.com.

AustralianproductsareincreasinglypopularonChinesee-commercechannels.Alibabaseesstrongandgrowingdemandforarangeofproductssuchasdairy,premiumfoods,healthcare,skincare,andmotherandbabyproducts.

Eachyear,Alibabarunsthelargestshoppingfestivalintheworld,theDouble11ShoppingFestival,on11November.In2015,Australiarankedfifthamong41countriesgloballyonTmallGlobal,withoneAustralianvendor,ChemistWarehouse,recordingsalesworthRMB10million(overA$2million)injustthefirst46minutesoftheFestival.

AlibabaGrouphasalsoforgedastrategicpartnershipwithAustraliaPost.AustraliaPost’sTmallstoreprovidesasolutionforexporters,particularlysmallandmediumenterprises,toaccesssomeofthe420millionactiveChineseconsumersacrossAlibabaGroup’splatforms.

AlibabaGroupplanstoopenanofficeinAustraliaattheendofthe2016tobettersupportitsAustralianclientsandassistmoreAustraliancompaniesinaccessingtheChinesemarket.

Toleveltheplayingfieldfurther,ChinacouldunilaterallyrecogniseAustralia’shighfoodsafetyandqualitystandards,andexpeditetheapprovalsofAustralianfoodexportstoChina.Thiswouldbeawin–winpolicy:itwouldbenefitChineseconsumersthroughlowerpricesandbenefitAustralianproducersthroughlowertransactioncosts.BothcountriesshouldaimtoensurethatChineseconsumerscanaccesssafeproductsatlowcostfromaroundtheworld.TherelevantchapterofChAFTAonsanitaryandphytosanitarymeasurescanhelpensurethatquarantinerulesdonotposeanunnecessaryobstacletotrade.However,thereareopportunitiestogofurtherinbuildingtrustandunderstandingonbothsides,includingthroughdirectexchangesofofficials.

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BOx 3.4: BLACKmORes’ CHinA enTRy sTRATegy

Blackmoresisamarketleaderinthenaturalvitamin,herbalandmineralsupplementsmarketinAustralia,withstrongmarketpositionsthroughoutAsia.

BlackmoreslaunchedinChinain2012andhasestablisheditselfasapremiumnaturalhealthbrandwithChineseconsumers.BeforelaunchinginChina,Blackmoresspentmorethantwoyearsresearchingthemarket.ThisinvolvedextensiveuseoftheservicesofAustradeandDFATtounderstandtheregulatoryenvironment,tomeetrelevantChinesegovernmentagencies,toconnectwithindustryorganisationsandtoassesspotentialpartnersandmarket-entrymodels.

UnlikemanyforeignfirmswhosawrapidgrowthinChina’svitaminsanddietarysupplementsmarketasashort-termtradingopportunity,Blackmores’relationshipwithChinahasbeenpositionedfortheverylongterm.ThecompanyestablishedaWhollyOwnedForeignEnterprise(WOFE)inBeijingandsubsequentlyestablishedbranchofficesinShanghaiandwithintheShanghaiFreeTradeZone.

BlackmoreshasabsorbedfromitslonghistoryandexperienceinotherAsianmarkets—thecompanyhasbeeninThailandandMalaysiafor40years—thatsuccessintheregionrequirestherecruitmentofstronglocallyengagedteamsineachmarketwhoareresponsibleforitsbrand.Since2012,Blackmoreshasbuiltateamof30staffinChinawithofficesinBeijing,ShanghaiandGuangzhou,withanothersoontoopeninChengdu.

Blackmoresdistributesthroughthetraditional‘bricksandmortar’retailtrade,hasanextensiveonlinepresenceandover3200offlinedistributionpointscoveringfirst-tierandsecond-tiercities.Thecompanyhasawide-rangingpresenceonallmajorChinesee-commerceplatforms(domesticandcross-border),includingTmallandJD.comaswellasstrategicpartnershipswithVIP.comandNetease.Thecompanyservesmorethan20keye-retailersandthousandsofTaobaoandWeChatstoresthroughFreeTradeZonedistributors.Blackmoreshasalsoundertakenbroadchannelexpansiontocoverchainpharmacy,independentpharmacy,healthandbeautystores,supermarkets,hypermarkets,medical,TVshopping,dutyfreeoutlets,departmentstoresandcorporatesales.

BlackmoresstronglysupportedtheentryintoforceofChAFTA,whichstrengthensthelong-termcommercialtiesbetweenAustraliaandChina.ChAFTAnotonlydeliveredtheeliminationoftariffsonAustralia’spharmaceutical,vitaminandhealthsupplementproductsbutalsocontainsabuilt-inagendatoaddressnon-tariffbarrierstotradebetweenAustraliaandChina.

ThissituationcouldbeimprovedbytheincreasedsharingoftechnicalexpertisebetweenregulatorsinAustraliaandChina,includingstaffexchanges.Suchexchangeswouldhelpbuildcapacity,familiarityandtrustwitheachother’sregulatorysystems.

The next stage for bilateral trade

TheopportunitiesforbothChinaandAustraliaarelarge,ifpolicymakersareproactiveinpursuingthereformsnecessarytoachievethem.

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ChAFTAoffersaframeworkthroughwhichAustralia–Chinainitiativesinreformandliberalisationacrossallareas—merchandisetrade,servicestradeandinvestment—canbeadvanced.Thebilateralliberalisationofcommoditymarketaccessdeliverssomeimmediatebenefits.Thesebenefitsareimportanttothegrowthofagriculturaltrade,forexample,buttheywillalsobedependentonimprovingthebilateralinvestmentregimeandachievingtheliberalisationofcomplementaryservices.GiventhebigshiftinthestructureoftheAustralia–ChinarelationshipthatthisReporthighlights,manyofthepotentialgainsfromChAFTAwillonlyberealisedthroughsecuringreformandopeningoftradeinservicesaswellasreformofinvestmentpolicies.Itisdifficult,inanycase,forliberalisationoftradeinservicestobenarrowlybilateralandonlyprovidingspecialiflimitedbenefittoeitherAustraliaorChinaineachother’smarket.Reformthatincreasestheproductivityofservicesmarketsrequirescomprehensivedomesticinstitutionalreform.ButChAFTAopensthedoortotriallingservicesreformwithAustraliainChinaandhasthepotentialtobeattheleadingedgeofChina’seconomicreformprogram.ThereispotentialforChAFTAtodeliverbenefitsbeyondtheborderfordomesticreforminbothcountries.

ModellingundertakenforthisReportbolstersthiscase.First,thegainsareestimatedfromthefullpreferentialmerchandisetradeliberalisationthatispotentiallyavailableundertheChAFTAframework,usingstandardGTAPtechniques(Gretton2016).(InChapter4,thiswillbeextendedtoconsiderthegainstobehadfromliberalisationthatismorecomprehensive,includingservicesandinvestment).ThepresentsimulationshowsthattheremovalofalltariffspreferentiallybetweenChinaandAustraliayieldsmodestbutimportantoutputgainstoeachcountry.Inthelongrun,itcouldincreaseAustralia’sGDPby0.22percentandliftChina’sGDPby0.11percent(Table3.2).ThissimulationmeasuresthemaximumpossiblegainunderafullycomprehensiveChAFTAagreement,notthegainsfromtheagreementthatiscurrentlyinplace.Itpresumesthatthetwocountrieswillmoveto100percentbilateraltariffremovalintheirmerchandisetrade,andthattherearenonegativeeffectsimposedbyrulesoforiginorotherregulationstoenforcepreferences.TheChAFTAagreementcurrentlyinplaceisinfactstillsubjecttocarve-outsandproduct-specificrulesoforiginandwillnotyieldthesegainsfully,butthismeasurecanberegardedastheouterlimittopotentialgainsfromChAFTA-focusedmerchandisetradeliberalisation.

Table 3.2: simulated effects of reducing remaining tariffs to zero

Australia China

gDP gain as proportion of

full world mFn liberalisation

gDP gain as proportion of

full world mFn liberalisation

simulation per cent change

per cent of full gain

per cent change

per cent of full gain

Australia–china bilateral 0.22 23 0.11 4

Australia unilateral 0.56 60 0.03 1

china unilateral 0.12 13 2.28 78

RcEP open liberalisation 0.88 94 2.37 81

World mFn liberalisation 0.94 100 2.94 100

Source:Gretton2016.

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Bywayofcomparison,andtodefinetheparametersofgainsfromusingChAFTAasaleverforbroaderregionalandmultilateralliberalisation,modellingisdonetosimulateliberalisationthroughacomprehensiveAsianfreetradeagreement—RCEP.And,asabenchmark,anestimateismadeofthebenefitstoAustraliaandChinafrommultilateralmerchandisetradeliberalisation.

IfRCEPbringscomprehensivemerchandisetradeliberalisationbasedonopenregionalism,Australia’sGDPcouldincreaseby0.88percentandChina’sby2.37percent.Ifalltariffswereremovedglobally,Australia’sGDPcouldincreaseby0.94percentandChina’sby2.94percent.Australiacanachieve60percentofthatglobalmerchandisetradeliberalisationscenariobyunilaterallyremovingtariffs.Chinacanachieve78percentoftheglobalscenariobyremovingitstariffs.Thesescenariosaresimplysimulatedtoestimatethedifferentmagnitudesofpotentialgainsunderalternativetradepolicystrategies.

The structure of bilateral trade

NotonlyisthevolumeoftradebetweenChinaandAustraliasettoincrease,itsstructurewillchangeaswell,dependingonthewaysinwhichtheChineseeconomyitselfistransformed.

ThegrowthtrajectoryofChina’seconomywillbeoneofthebiggeststoriesintheglobaleconomyoverthenextdecade.NotonlywillitmatterforthelivingstandardsforChinesepeople,itwillalsoimpactonChina’stradewithAustraliaandtherestoftheworld.

Takingintoaccountpossibledevelopmentsinbotheconomiesaswellasintherestoftheworld,whatisthestructureandscaleofAustralia–Chinatradelikelytolooklikeinthenext10years?Toanswerthisquestion,growthanditsstructureoverthisperiodismodelledunderthreedifferentsetsofassumptionsusingGTAP(Sheng2016).

Intheperioduntil2020,InternationalMonetaryFund(IMF)growthprojectionsareused,afterwhichthreegrowthscenariosforChinaareprojectedusingUnitedNationspopulationprojectionsandtheglobalcompetitivenessindexasaproxyforqualityofinstitutions.Inthefirst‘businessasusual’case,China’sGDPgrowsatanaverageannualrateof5.0percentayearfrom2021to2025withannualaveragelabourproductivitygrowthof5.2percentoffsettinganannualaveragedeclineintheworking-agepopulationof0.2percent(Table3.3).

Anoptimistic,orreform-based,scenariowouldseeChineseinstitutionsconvergeupwardstothequalityofSouthKoreaninstitutions,withgrowththenaveraging6.1percentto2025.Afinal,stagnationcasewouldseegrowthfallto3.1percentperyearasChineseinstitutionsconvergedownwardstowardsthequalityofTurkishinstitutions.Thegrowthrateto2020isfromtheIMFandisthesameforallthreeprojections,at6percentfrom2016–2020.

ThestructureofbilateralAustralia–Chinatradeisprojectedto2025underthethreegrowthscenarios.Theworldissplitinto12regionsand16sectors,whicharecomprisedof10manufacturing,twoagriculturalandfourservicesectors.TheresultsareshowngraphicallyinFigure3.6.

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Table 3.3: Decomposition of Chinese gDP growth under three growth scenarios

Historic 2011-2015

imF Outlook 2016-2020

Projection 2021-2025

Business as usual

Growth 7.5 6.0 5.0

Productivity 7.3 6.3 5.2

Workingpopulation 0.2 –0.3 –0.2

Reform scenario

Growth 7.5 6.7 6.1



stagnation

Growth 7.5 5.0 3.1



Source:HubbardandSharma2016.

Underthebusinessasusualscenarioofanaverageof5.73percentgrowthperyearfrom2016–2025,AustralianexportstoChinagrowfromUS$84.0billionin2014toUS$145billionin2025,or72percentinconstantvaluetermsoverthedecade.ChineseexportstoAustraliaincreasefromUS$41.0billiontoUS$58.0billion,or17percent.TotalAustralianexportsincreasefromUS$295billiontoUS$535billionwhiletotalChineseexportsincreasetoUS$4.04trillionfromUS$2.58trillion.China’sshareinAustralianexportsfallsslightlyto27.1percent(from28.5percent)whileAustralia’sshareinChina’sexportsfallsfrom1.6percentto1.43percent.

Figure 3.6: Real growth in exports from China and Australia under three Chinese growth scenarios

0

%

20

40

60

80

100

120

140

Australia to China China to Australia Australia to the world China to the world

Stagnation Business as usual Reform Source:Sheng2016

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Theextractionsector,whichincludesmetals,mineralsandvariousothernaturalresources,isthelargestsectorforAustraliacomprisingof70.6percentofexportstoChinaand46.6percentoftotalexportsin2014(Table3.4).Therelativeimportanceofthissectorfallsin2025to58.7percentofAustralia’sexportstoChinaand36.0percentoftotalexports.

ThegrowthinAustralia’sexportstoChinaisdrivenmainlybyservices,whichmorethandoubleasaproportionoftotaltrade,ledbytransport,telecommunications,computerandinformationservices.CurrentlytheAustralianservicesexportsectorislargelyeducationandtourism,witheducationaccountingfor4.9percentofAustralianexportstoChina(ofthe8.0percentthatthetransport,travelandtourismsectoraccountsfor).Underthebusinessasusualscenario,educationandtourismgrowto11.9percentofAustralianexportstoChina,ofthe19.6percentthatthebroadertransport,travelandtourismsectoraccountsfor.Agriculturalexportsalsorisesubstantially.

Table 3.4: Actual and projected shares of exports by sector

2014 2025 Business as usual

AustoChina

AusTotal

ChinatoAus

ChinaTotal

AustoChina

AusTotal

ChinatoAus

ChinaTotal

GrainsandCrops 2.5 4.5 0.4 1.4 3.0 4.8 0.3 0.9

LivestockandMeatProducts

4.8 6.0 0.5 0.7 6.4 6.9 0.5 0.6

MiningandExtraction 70.6 46.6 2.3 2.1 58.7 36.0 1.5 0.9

ProcessedFood 0.6 1.9 1.2 0.9 0.8 2.5 1.1 0.7

TextilesandClothing 0.0 0.2 21.7 16.3 0.0 0.2 20.0 15.0

Leather,WoodandPaperproducts

0.6 0.9 4.5 3.1 0.5 0.7 4.7 3.4

PetroleumandChemicalproducts

8.2 8.7 14.1 12.1 6.3 8.5 10.7 8.6

Metalproducts 2.9 4.4 9.0 7.2 2.2 3.2 7.8 6.1

Motorvehiclesandtransportequipment

0.1 1.6 4.8 4.1 0.1 1.8 5.3 4.5

Electronicequipment 0.2 0.9 14.1 22.2 0.1 0.2 15.1 26.0

Othermachineryandequipment

0.7 2.9 19.6 18.4 0.5 3.3 27.9 25.7

Othermanufacturing 0.0 2.9 3.0 2.5 0.0 3.8 2.1 1.8

Utilitiesandconstructionservices

0.1 0.4 0.1 0.6 0.1 0.5 0.1 0.6

Transport,travelandtourism

8.0 12.9 3.7 3.7 19.6 19.7 2.2 2.0

Financial,insuranceandbusiness

0.5 1.8 0.4 1.1 1.1 2.5 0.2 0.7

Otherservices 0.3 3.3 0.6 3.6 0.6 5.2 0.5 2.6

Bilateral trade share (% of trade with world) 28.5 1.6 27.1 1.4

Source:Sheng2016.

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Table 3.5: Actual and projected share of exports by sector in alternative scenarios

2025 Reform 2025 stagnation

AustoChina

AusTotal

ChinatoAus

ChinaTotal

AustoChina

AusTotal

ChinatoAus

ChinaTotal

GrainsandCrops 3.4 4.8 0.1 0.3 2.8 4.6 0.3 0.9

LivestockandMeatProducts

10.3 8.0 0.0 0.0 6.2 6.5 0.5 0.5

MiningandExtraction 62.2 41.5 0.4 0.2 59.1 39.1 1.2 0.6

ProcessedFood 0.7 2.3 0.8 0.5 0.8 2.4 1.1 0.8

TextilesandClothing 0.0 0.2 16.5 10.7 0.0 0.2 21.1 15.5

Leather,WoodandPaperproducts

0.5 0.9 2.5 1.7 0.5 0.8 4.7 3.4

PetroleumandChemicalproducts

3.2 7.3 12.9 9.5 6.6 8.1 10.2 8.2

Metalproducts 1.5 2.7 8.3 5.9 2.5 3.3 7.4 5.8

Motorvehiclesandtransportequipment

0.1 1.7 2.1 1.7 0.1 1.7 5.0 4.3

Electronicequipment 0.1 0.3 14.2 21.6 0.1 0.3 16.5 27.4

Othermachineryandequipment

0.2 2.4 34.8 28.9 0.7 3.4 27.1 25.1

Othermanufacturing 0.1 4.0 0.8 0.6 0.1 3.8 1.9 1.6

Utilitiesandconstructionservices

0.1 0.4 0.1 0.6 0.1 0.4 0.1 0.6

Transport,travelandtourism

16.8 17.3 3.1 2.5 18.8 18.3 2.1 2.0

Financial,insuranceandbusiness

0.9 2.2 0.3 0.8 1.1 2.3 0.2 0.7

Otherservices 0.1 4.0 3.1 14.5 0.6 4.8 0.5 2.6

Bilateral trade share (% of trade with world) 31.1 1.3 24.1 1.4

Source:Sheng2016.

UndertheChinareformscenario,totalAustraliantradeandChinesetradearelargerthanthebusiness-as-usualscenario.ChineseexportsincreasetoUS$4.48trillion,comparedtotheUS$4.04trillioncaseunderthebusiness-as-usualscenario.ChineseexportstoAustraliaareroughlythesameunderbothscenarios,atUS$59.1billionin2025.TotalAustralianexportsareprojectedtobeUS$595billionin2025,largerthanthebusiness-as-usualcaseanddrivenmostlybytheincreaseinexportstoChina.AustralianexportstoChinaincreasefromUS$84billiontoUS$185billion,orjustover120percent,inconstantvalueterms.

Australia’sexportstoChinaareprojectedtobeUS$185billionin2025underthereformscenariocomparedtoUS$145billionayeargivenbusinessasusual.UnderthestagnationscenariowithChinesegrowthsignificantlycontractingafter2020,AustralianexportstoChinaareprojectedtobeUS$107billion,stilla28percentincreaseinconstantvalueterms.YettotalChineseexportswillbeoverUS$1trillionlessin2025underthisscenario.

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ThestructureofAustralianexportstoChinadoesnotchangesignificantlyundereachscenariobecauseunderallscenariostheimpactofstructuralchangeintheChineseeconomyispowerful.Theminingandextractionsectorwillbelessimportant,whileservicesandagriculturewillgrowinimportanceinallcircumstances(Table3.5).Thetotalshareofeachcountryintheother’stradewillnotchangegreatlyinanyscenario:theshareofChinainAustralia’sexportswilldeclineslightlyfrom28.5percentin2014to27.1percentinthebaselinecaseandincreaseto31.1percentinthereformcase;andtheshareofAustraliainChina’sexportswillfallfrom1.6percentin2014to1.4percentintheformercaseand1.3percentinthelatter.

TheshareoftextilesandapparelinChina’sexportstoAustraliawas22percentin2014.Thatisprojectedtofallto20percentunderthebusiness-as-usualscenarioand17percentunderthereformscenario.IfgrowthinChinastagnates,theshareisprojectedtobe21.1percent.Electronicequipment,withashareof14.2percentin2014,exhibitsasimilarpattern.TheshareoftextilesandapparelinChina’stotaltradetellsasimilarstory:highergrowthscenariosindicatesuccessfulindustrialtransformationandupgrading,withlow-skilledmanufacturingbecominglessimportant.AfailuretotransformthestructureoftheChineseeconomyresultsinthegrowthstagnationscenario.

EducationserviceswillbeamajorAustralianexporttoChinaunderallthreegrowthscenarios,accountingforbetween10percentoftotalexportsinthestagnationscenarioandcloseto12percentinthereformscenario.EvenifgrowthstagnatesinChina,educationexportswilltripletoUS$12billionin2025.Underthereformscenario,educationexportswillbeashighasUS$18.6billion.

The transformation of China’s trade with Australia

China’sindustrialup-skillingisalreadyunderway,asshownbytheshiftingcompositionofChineseexportstoAustralia.Twenty-fiveyearsago,ChineseexportstoAustraliawerepredominantlylowervalue-addedgoodssuchashouseholdequipment,textiles,clothingandfootwear.Overthattime,China’sexporteconomyhasprogressedfrombeingalow-endproduceroftextilesandassemblerofsimplegoods,tobeingahigh-endproduceroffarmoresophisticatedelectricalandmachineryproducts.

Muchofthelowest-skilledfactoryworkthatboomedinChina’scoastalprovincesandspecialeconomiczoneshasnoweithermovedtoless-developedinlandregionsortootherlower-wagecountries.WhiletheabsolutevalueofallcategoriesofChinesemanufacturingtoAustraliahasgrown,thesharecontributedbysophisticatedengineeringproducts,suchasmachinery,hasrisenfromlessthan10percenttoalmosthalfofallimportssince1990(Table3.6).

Australia’sfallingbarrierstomanufacturingimportshaveassistedthisevolution.In1991,theweightedaverageofeffectivelyappliedtariffsonmanufacturedimportsintoAustraliawas10.5percent;by2002ithadmorethanhalvedto4.3percent,andin2014stoodat2.5percent(WorldBank2016).ChAFTAwilleliminatealmostalltariffsonimportsofChinesemanufacturesafter1January2019.

TheeffectivemanufacturingtariffsappliedtoChinesegoodsaroundtheworldalsofelloverthisperiod,loweringthecostofChina’sentryintoregionalandglobalproductionnetworks.Weightedaveragetariffsonimportsofmanufactureswere36percentin1992,

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fallingto13percentin2001and4percentin2014(WorldBank2016).Loweringthecostofmanufacturedimportsprovidescheaperpartsandcomponentsforsubsequentexportsofmoreelaborategoods.

Table 3.6: The changing nature of Chinese manufacturing exports to Australia

1990 2000 2010 2014

A$ Percentagesharein

total


total


total


total

Simplytransformedmanufactures

77,509 6.5 461,961 5.4 1,942,412 5.2 2,879,711 5.8

Engineeringproducts

100,168 8.4 1,907,341 22.1 17,255,046 45.8 23,279,101 47.0

Otherelaboratelytransformedmanufactures

1,014,804 85.1 6,245,133 72.5 18,494,832 49.1 23,335,877 47.1

Source:DFAT2015c.

upgrading chinese manufacturing through regional supply chains

Chinesemanufacturedgoodsarenotstrictly‘madeinChina’butrather‘madeinAsia’,or‘madeintheworld’onceglobalsupplychainsinvolvingparts,componentsandintellectualpropertyareconsidered.YetwhileacontractorinChinaassemblesApple’siPhoneandiPadproducts,thecontributionofChineselabourtotheseproducts’finalretailvaluewaslessthan2percentin2011(Kraemeretal2011).EvenforatinycomponentsuchasaLightEmittingDiode(LED)manufacturedinChina,28percentofthevalue-addedisestimatedtocomefromoutsideChina(UNCTAD2015).ForaproductassimpleasarubbertyremadeinChina,theChineseshareofvalueaddedisjustunder77percent.

Theemergenceofregionalandglobalsupplychainsrevealsthelimitsofbilateraltradearrangementsthatfocusonlyonremovingformaltariffbarriersamongpotentialexportmarkets(ProductivityCommission2010).Whentariffsonintermediateandunfinishedgoodscascadethroughmanydifferentcountriesbeforeproducingafinishedproduct,theunilateralreductionorremovalofimporttariffshelpsaneconomyremainacompetitivebaseforglobalproductionnetworks.

Tradeagreementsthatseektoentrenchpreferentialtreatmentforparticularbilateraltradeflowsfurthercompoundtheseinefficiencies,andencourageothernationstocompeteonthebasisofpolicydistortionsratherthaneconomicfundamentals.Inaddition,thecostsofdelaysatcustomsanddisruptionstologisticsmakeitdifficulttoreapthefullefficienciesfromtrulyintegratedtrade.

Broadertradeagreementsprovidethegreatestwelfaregains,andsomultilateraltradeliberalisationthroughtheWTOwouldprovidethegreatestgaintoglobalwelfare.TheconsolidationofexistingbilateralpreferentialtradeagreementsintoRCEPisapracticalintermediatestep.RCEPcouldformthefoundationfordefiningthepathwaytowardsaFTAAPthatisnotjustregionallybutgloballyliberalising.

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OnepromisingprospectforimprovingbilateraltradelogisticsisChina’sOBORinitiative,whichaimstoimproveinfrastructureconnectivityintheregion.Thisshouldhelpboosttradebyloweringtransactionandtransportcosts.AustralianandChinesecooperationintheAIIBisalsoawelcomeandpracticalsteptowardreducingtransportcosts.TheAIIBwasfoundedtohelpfinanceinfrastructureinvestmentintheregion,whichcouldincludefinanceforinfrastructuredevelopmentinNorthernAustraliaunderOBORarrangements.MoredetaileddiscussionofareasinwhichAustraliaandChinacancooperatetoadvanceregionalandglobaleconomicdiplomacyissetoutinChapters7and8ofthisReport.

Delivering services to chinese consumers

China’sdomesticreformagendaprovidesastrongcaseforallowingAustraliancompaniestocompetedirectlyinChina’sservicesmarkets.TheDecisionofthecurrentCentralPartyCommittee’sThirdPlenumin2013—ameetingthatintroducesafive-yeareconomicreformagenda—focusedonthedevelopmentoftheservicessector,includingfinanceandhealthcareservices.Thishasbeenencapsulatedinthefiveprioritiesforthe13thFiveYearPlanofinnovation,coordination,greendevelopment,opening-upandsharing.

ThegrowthofChina’smiddleclassisdrivinggrowthinthebilateralservicestrade(ProductivityCommission2015).Accordingtoonelong-termestimate,theproportionofChina’spopulationinthemiddleclasscouldrisefromaround10percentin2009toover40percentin2020,andmorethan70percentin2030.Thisequatestoover850millionChinesepeopleenteringthemiddleclasswithinthenexttwodecades(KharasandGertz2010).ThismeansthatChineseconsumerswillspendmoreoftheirdiscretionaryincomeonservices.Someoftheseservices,suchastourismandeducation,maybeprovidedtoChineseoverseas.ButAustraliacanalsoassistChinaindevelopingitsdomesticservicessector(seealsoChapter5).

ThepotentialforincreasedservicesimportsinChinatakesonaddedsignificanceforAustraliagiventheparticularlyhighcontributionofvalue-addedservicestotheAustralianeconomy.WhilealargeproportionoftheprofitsoftheAustralianresourcesboomaccruedtooverseasinvestorsinminingcompanies,moreservicesexportstranslatedirectlyintomoreAustralianjobs.From2002–2011,fromthestarttonearthepeakoftheresourcesboom,thevalue-addedinAustralia’sservicesexportsactuallyexceededthatofmineralsexports(KellyandLaCava2014).

tourism and education services in Australia

ChinesedemandforAustralianserviceshassofarbeenconcentratedintravelservicesforeducationandtourism(Box3.5).

In2015,education-relatedtravelfromChinatoAustraliawasworthA$4.8billion(ABS2016a).Therearemorethan136,000ChinesestudentsinAustralia,morethanone-quarteroftheinternationalstudentpopulation(DFAT2016b).Thelong-runsignificanceofthissectorisevenhigherthanthesestatisticssuggestgiventheAustralianbrandawareness,familytourismexpenditure,professionalrelationshipsandmigrationopportunitiesthataccompanyinternationaleducationalexchange.ThisstoryistoldingreaterdetailinChapter4.

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BOx 3.5: CHinese TOuRism in AusTRALiA

In2015,annualChinesetouristarrivalstoAustraliaexceededonemillionforthefirsttime,accountingfor13.8percentoftotalinternationalarrivals.AccordingtoTourismResearchAustralia,intheperiodthroughto2025,Chinawillaccountfor60percentofgrowthininboundtourismexpenditureinAustralia.By2017–2018,ChinaisexpectedtobecomeAustralia’slargesttourismmarketintermsofinboundtouristnumbersandtouristexpenditure,overtakingNewZealand(TourismResearchAustralia2016).

ChinesevisitorshavebeenthedrivingforcebehindrecentincreasesintouristarrivalsandspendingtrendsinAustralia,withChinanowAustralia’sprimarysourceofinboundtourismexpenditure(TourismResearchAustralia2014).In2000,travelfromChinaaccountedforjust3.5percentofinternationaltravelexpenditureinAustralia;in2015,itaccountedfor22percent(ABS2015b,2016a).In2014–2015,totalexpenditurebyChinesevisitorsincreasedby29.8percentinrealtermsandthenumberofvisitornightsrose18.8percentto39million(TourismResearchAustralia2016).

Thesetrendsareencouraging,butcomealongsidepotentialchallengesaswellasopportunitiesforfurthergrowth.Sincetheglobalfinancialcrisis,theAustraliandollarhasweakenedmoresharplyagainsttheNewZealanddollar,theSingaporedollarandtheChineserenminbi,thanithasagainsttheUSdollarortheBritishpound.ThishasmadeAustraliarelativelymoreattractivefortourismthanothercountriesintheregioninrecentyears(Terlato2015).Buttheshort-termnatureofsuchadvantageshighlightstheimportanceofdevelopingatourismindustrythatisrobusttoglobaleconomicuncertainty.

DespiteChineseconsumersrankingAustraliafirstoutofallcountriesin‘aspiration’,‘awareness’and‘intention’tovisit,Australiaranksonly10thinactualvisitation,behindmore-establishedcompetitorssuchastheUnitedStatesandFrance(TourismAustralia2015b).Theexpansionofairconnections,widermarketingoperationsinChinaandtheaccessibilityoftailor-madetravelexperiencestoChinesevisitorswillbeessentialinnarrowingthisgap(TourismAustralia2011).Australia’stourismsectormustseizetheopportunitiesofferedbyrecenttouristactivityandthefavourableopinionofChinesevisitorstocementAustraliaasapremierdestinationinthelongerterm.

TourismResearchAustraliaforecaststheshareofChineseleisurearrivalsinAustraliatogrowfrom13percentin2014–2015to17.9percentin2017–2018and27.2percentin2024–2025.ThiswouldseethenumberofannualChineseleisuretouristarrivalsmorethantreblefrom684,000in2014–2015to2.6millionin2024–2025(TourismResearchAustralia2016).

In2011,theChinaNationalTourismAdministrationandtheAustralianGovernmentsignedaMemorandumofUnderstanding(MoU),continuingAustralia’sApprovedDestinationStatus(ADS)andcommittingtosupportcooperationintourismthroughanannualdialogue.AustraliaandNewZealandwerethefirstWesterncountriestobegrantedADSin1999andAustralia’sdeliveryoftheschemeishighlyregardedinChina.Theofficial-levelAustralia–ChinatourismpartnershipwasreaffirmedinApril2016,withanewMoUonStrengtheningTourismCooperationbeingsignedaspartofAustraliaWeekinChina.The2016MoUbuildsonthe2011agreementandcoversindustrycooperation,labourandskillsdevelopment,investment,researchandinfrastructure.

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Duringthe2016AustraliaWeekinChina,nationalleadersannouncedthebilateralYearofTourismfor2017.Designating2017a‘TourismYear’isanexcellentopportunitytoincreasepeople-to-peoplelinksthroughtourism.ItwillfocustheChinesegovernment(andmedia)onAustraliaandstrengthentheAustralia–Chinatourismrelationship.Anumberofeventsareplannedfor2017,includingAustralianparticipationintheBeijingInternationalFilmFestivalandChineseparticipationintheVirginAustraliaMelbourneFashionFestivalandAustralia’sChineseNewYearcelebrations.

InordertoensurethecurrentrapidgrowthintheinboundChinesetourismmarketremainssustainable,andthebenefitsofthisgrowtharedistributedbeyondAustralia’sgatewaycitiesofSydneyandMelbourne,theAustraliangovernmentisstrivingtoincreasethegeographicdispersionofChinesevisitors.Dispersalspreadstheopportunity,prosperityanddemandfromChinesetourism,andisbeingachievedthroughmeasuressuchasimprovingtourisminfrastructureinruralandregionalareasandtheintroductionofaWorkandHolidayArrangementthatallows5000Chineseparticipantseachyear.ThisprogramenablesChinesewithtertiaryeducationandEnglishskillstoexperienceaworkingholidayinAustralia.ItwillboostdemandfortourismservicesandhelpaddressshortagesofbilingualworkersavailabletothetourismindustryastheindustryseekstoservicegrowingnumbersofChinesevisitors.

WhileAustraliaisattractivetotouristsbecauseofitsnaturalenvironment,tourismaroundtheworldisfiercelycompetitive.Thescopeofpeople-to-peoplelinksbetweenChinaandAustraliaareahugeassetforAustralia.ChinesevisitingtheirfriendsorrelativesinAustralianotonlystrengthenedthesepeople-to-peopleties,butspentanaverageofalmostA$4000pervisitin2015(Figure3.7).Bycontrast,ChineseholidaymakerscomingtoAustraliajustfortourismspentA$2389pervisit,closetotheaveragespendofallholidaymakersinAustralia.

Figure 3.7: Total average spend of foreigners visiting friends and relatives in Australia, 2015

0 $

500 1000 1500 2000 2500 3000 3500 4000 4500

China Other Countries

Indonesia Switzerland Hong Kong

Scandinavia Singapore

United Kingdom Other Europe Netherlands

Canada Total

Malaysia France Taiwan

Italy Germany

Korea United States of America

Thailand Other Asia

Japan India

New Zealand

Source:TourismResearchAustralia2016.

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WhenChinesevisitorsarenotcomingtovisitfriendsandfamily,thenAustraliawillhavetocompeteforChinesetouristswithestablisheddestinationsinSoutheastAsia,EuropeandNorthAmerica.ThismeansthatAustraliantourismprovidersneedtofocusonensuringaqualityexperiencethatisadaptedtotheChinesemarket.ButthepayoffsfromattractingnewvisitorscanbelargeoncetheconnectionbetweenChinaandAustraliaisestablished.Ina2016surveyof514recentChinesevisitorstoAustralia,nearlyhalfwererepeatvisitors.Three-quartersofsurveyedvisitorsintendedtovisitagainorcomebackfortertiaryeducation,48percentwereinterestedinrealestateinvestment,while41percentand24percent,respectively,wereinterestedinthefurtherpurchaseofAustraliangoodsandservicesinChina(LEKConsulting2016).

Thesurveyfoundthattourismisafirststeptomuchdeepereconomicengagement.Chinesevisitors’averageannualspendonAustralianproductsroseby40percentaftervisitingAustralia.ThereportrecommendedthatAustraliangovernmentandbusinessesneedtoacttoharnessthefullpotentialofChinesetourismandthatAustralianeedstoensurethat:itremainsanattractivetraveldestinationsothatvisitornumberscontinuetogrow;visa-applicationprocesses,whereappropriate,aresmoothandeasytonavigate;Australia’sairportsandtransportfacilitiesareamongtheworld’sbest;andtheAustralianworkforcegrowsitsChinese-languagecapability.

AustraliaisinanAsiantimezone,butBerlinandParisarebothclosertoBeijingthanBrisbane.Thishighlightstheimportanceofdirectairconnectionsthatrespondtotravellerdemands.ManyflightsfromChinatoAustraliastillrequiretime-consumingconnectingflights,bothdomesticallyandviaAsia.AuthoritiesinAustraliaandChinasignedamilestoneairservicesagreementinJanuary2015,triplingandinsomecasesabolishingcapsonthenumberofseatsforpassengersfromsomeofChina’sbiggestcities(MinisterforTradeandInvestment2015).TourismagreementsbetweenSouthAustraliaandChinaSouthernAirlinesareanotherwaytofacilitatethis(Williams2016).ButAustraliacoulddomoretoensurethatprofitableroutesareavailabletoChinesecarriers.Thiswouldincluderemovingrestrictionsthatpreventforeigncarriersfromflyingdomesticpassengersorcargoondomesticlegsofinternationalflights—effectivelytriplingaviationcapacitybetweenChineseandAustralianmajorgatewaylocations.TheairservicesagreementalsoprovidesforunrestrictedaccessbetweenChinaandAustralianregionalairports.Whilethisarrangementhasmadesignificantaviationcapacityavailable,ChinaisoneofAustralia’sfastestgrowingvisitorsourcesandmorecanbedonetoensureaviationcapacitywillfosterfuturegrowthinvisitationfromChina.

RemovingtheserestrictionswouldmakeiteasierforChinesetouriststoseemoreofAustralia,andexpandcapacityinAustralia’sdomesticaviationmarketswithoutrequiringadditionalcapitalinvestmentfromAustralianairlines.GiventhatthisreformisdirectlybeneficialtoAustralia,itshouldnotbecontingentonreciprocationinthedevelopingChineseaviationmarket.BetterconnectivitywouldalsofurtheropenuptheChinesetourismmarkettoAustralianswantingtoexperienceChinesefood,cultureandhistory,aswellaseconomicandsocialprogress(Box3.6).

ToprovidebetterservicestoChinesevisitors,Australiahasimprovedvisaarrangementsbyreducingdocumentaryrequirementsandwaivinginterviewrequirements.Australiahasintroducedathree-yearmultipleentryvisaasstandardforeligibleChinesebusinessvisitors,andeligibleChinesetouristsapplyingthroughanagentviaanonlinetrial.Additionally,Australiaisnowtriallingtheonlinelodgementofvisitorvisaapplications;thisserviceisexpectedtoberolledoutfullybytheendof2016.Atrialof10-yearvisitorvisasforeligibleapplicantsinChinaisalsoexpectedtobeginbytheendof2016,alongwiththeimplementationofaChineselanguagelodgementoption.UndertheDevelopingNorthernAustraliaWhitePapervisainitiatives,Australiabeganapriority48-hourprocessingtrialforvisitorvisaapplicationsfromChinesepassportholdersinMarch2016.

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BOx 3.6: AusTRALiAn TOuRisTs in CHinA

Australianoutboundtourismisrelativelylargerbyvolumethanitsinboundtourism(TourismResearchAustralia2016).In2015,Australianresidentsmade9.5millionoverseastrips,spendingatotalofA$32billionabroad.In2015,Australiaranked10thininternationalinboundtourismexpenditure,valuedatUS$23.5billion(behindItalybutbeforeHongKong).

In2015Australianresidentsmade422,800tripstoChina,meaningChinaisAustralia’ssixth-largestdestinationmarket.ThosedestinedforChinacomprised4.5percentofAustralia’stotalresidentdepartures,behinddestinationssuchasThailand(5.8percent),theUnitedKingdom(6.3percent),theUnitedStates(10.7percent),Indonesia(11.7percent)andNewZealand(13.4percent).TourismResearchAustraliaforecaststhatAustralianoutboundtourismwillgrowatanaverageof3.7percentperannumfrom2014–2015to2024–2025,reaching13.3millionoverseastripsin2024–2025.

From2000to2015,visitstoChinahaveincreasedfrom2.7percenttotheircurrent4.5percentofAustralianinternationaltravel(ABS2016c).ThevalueofgoodsandservicesacquiredthroughAustralians’traveltoChinaforpersonalreasonsincreasedby392percentbetween2000and2015.Overthesameyears,businessandeducationtravelgrewsignificantly,butatslowerrates—203percentand115percentrespectively(ABS2015,2016a).

AsofDecember2015,Australiaisthe16thmostcommonsourcecountryofChina’sinboundtourism.Percapita,itranksseventh,aheadofJapan,Canada,theUnitedStatesandtheUnitedKingdom(CNTA2016).

AirconnectivityimprovementsareamajorfactorbehindthegrowingnumbersofAustraliantouristsinChina,asisthesizeofAustralia’sChinesediasporaandtheextentofpeople-to-peoplelinks.WendyWu,ownerofAustralia’slargesttouroperatortoChina,took10,000passengersin2013(upfromjust16in1994).‘Themajorityofourcustomers,’saidMsWu,‘saytheywanttogotoChinabecausetheirChineseneighbours,friends,relativesandcolleagueshavetalkedaboutitandsaidtheyhadawonderfultimethere’(Karnikowski2013).

Againstthisbackdrop,thereshouldbegreatpotentialforChinatocompeteforalargershareofAustraliantourismexpenditure.LikeAustralia,Chinacouldimproveitscompetivenessthroughmeasuresfacilitatingtouristmobility,includingmoreflexibleandpreferentialvisaarrangements(seeChapter4).ManysucharrangementswouldrepresentreciprocationofexistingAustralianinitiatives.ThebilateralYearofTourismin2017alsoprovidesanexcellentopportunityforChinatopromoteitstourismattractionstoAustraliantourists.However,thesepromotionscouldgobeyondtraditionalrealmslikefood,culture,historyandnaturalscenery,toshowcasenewattractionsincludingChina’sstate-of-the-artinfrastructureinhigh-speedrailandmetropolitansubwaysystems.ThesenewtouristattractionswouldnotonlyincreaseconvenienceforAustraliantravellers,butalsoprovideopportunitiesformoreAustralianstoexperienceChina’seconomicdevelopmentandsocialprogress.Deepercommunityunderstandingiscriticaltothebuildingofmutualtrustandpartnershipsandfacilitatingflowsofcommercialopportunitiesbetweenthetwoeconomies.

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Developing China’s services sector

ThenextstepinimplementingChAFTA,whichhasthepotentialtohelpdrivethetransformationofChina’sdomesticservicesindustry,istofurtheropenuptheChineseservicesmarkettocompetitionfromAustraliancompanies.TheChineseservicesmarketisnotasopentoforeigncompetitionasChinesegoodsmarkets,andevenabsentformalbarrierstotrade,serviceprovidersoftenfacestiff‘behindtheborder’barriersintheformoflocalrestrictionsonlicensingandprofessionalaccreditation.Thedomesticprovisionofservicesoftendependsoncomplementaryarrangementsallowingforeigndirectinvestment,aswellasrulesfacilitatingthemovementofpeople.

MuchofthehardworkinenhancingthesesectorsrequiresmajordomesticpolicyreformsthatarealreadyunderwayinChina.Thesereformsrecognisethatthebiggestgainsfromtradeliberalisationoccurnotfrommarketaccessoverseasbutfromallowingothercountriestoparticipateindomesticmarkets.AustralianservicesprovidersarenotbigenoughglobalplayersthattheywillbeabletoswampChineseincumbents.Nevertheless,theiragilityandexperienceindevelopedmarketscanhelpbringcompetitivepressureandknow-howtoChinesedomesticmarkets,andhelpprepareChinesecompaniesforfuturecompetition.Australiasuccessfullyexecutedasimilarstrategyinliberalisingitsfinancialmarkets30yearsago.

WhileAustralianfinancialinstitutionsmaybeabletoplayaroleindeliveringfinancialservicesdirectlytoChineseconsumers,theyhavemoreofaroletoplayinloweringthecostsoftradebetweenAustralianandChinesecompanies.ThisincludesbysupportingsettlementortradedirectlybetweentheChineserenminbiandtheAustraliandollar,providingproductstohedgecurrencyrisk(particularlyasChina’sforeignexchangeregimebecomesmoreflexible),andfosteringintegrationwithChinesepaymentsystemssuchasUnionPayandAlipay.ChAFTAalsocreatedaCommitteeonFinancialServices.OpportunitiesforcooperationinfinancialservicesarefurtherexploredinChapter5.

ChAFTAremovesmany‘attheborder’constraintsonbothestablishedandemergingaspectsofthetraderelationship.Thechallengenowistoaddressresidual‘behindtheborder’barriers—thesizeabletradeconstraintsthatgobeyondthescopeoftraditionalbilateraltradenegotiations.ThekeywaytodothiswillbethroughChAFTA’sTradeinServicesCommittee,whichwillreviewthestateoftheservicestradewithintwoyearsandproposemeasurestoincreasetradeinservices.AnexampleofbilateralopportunitiesisdeliveringhealthcareservicestoChina’sageingpopulation(Box3.7).

PartofitsroleistoensurethatthecommitmentsthatAustraliaorChinamightmaketothirdpartiesinothernegotiationsareautomaticallyextendedthroughChAFTA.Australia’sMostFavouredNationcommitmentextendstoallservicesectors.China’sislimitedtoeducation,tourismandtravel-relatedservices,construction,engineering,securities,environmentalservices,servicesrelatingtoforestry,computerandrelatedservices,andcertainscientificandconsultingservices.ThismeansthatifAustraliaorChinaextendsmorefavourableaccessconditionstoothertradepartners,thensuppliersintheothercountrywillautomaticallyreceivethisbettertreatment.

Onereformthatofferslargepotentialgainswouldbetoestablishrecognitionofprofessionalservicesqualificationsfromtheotherjurisdiction.Bytheendof2017,thesidelettertoChAFTAonskillsassessmentandlicensingisdueforreview.Tohelpmakethemostofthis

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review,theAustralianandChinesegovernmentsshouldcoordinateengagementbetweenaccreditingregulatorybodies,suchasCertifiedPublicAccountantsAustraliaandtheChinaInstituteforCertifiedPractisingAccountantsinthefieldofaccounting,andAustralianStateBarAssociationsandtheAll-ChinaLawyersAssociationinthelegalprofession.TwootherfieldsthatcouldprovideearlygainsareengineeringandTCM(ProductivityCommission2015).

BOx 3.7: HeALTHCARe seRviCes

China’sdevelopinghealthcaresectorisstrugglingtokeepupwiththedemandplaceduponitbyChina’shugeandageingpopulation(Austrade2016a).Thereareover202millionChinesewhoareover60,representing15.5percentofthepopulation.Andthisshareisprojectedtoincreaseto24percentby2050(Xu2016).

Australia’shealthcarefacilitiesareamongthebestintheworld(BrownandvanNieuwenhuizen2016),andChAFTAwillgivethemanadvantageagainsttheirmaincompetitorsinthemarket:JapanandtheUnitedStates.AustralianexportershavetheopportunitytoservicetheChinesemarketbyproviding:

• trainingandeducationprogramsforhumanresources;

• homecareservices;

• operationandmanagementofseniorsliving/retirementvillages/resorts;

• conceptualdesignandplanningofinstitutionalagedcare,seniorsliving,retirementvillagesandresorts;

• qualityhealthcareproducts(thatis,functionalfood,additivesandnutrition,healthyfood,assistedlivingande-healthproductsfortheelderly);and

• infrastructureinvestmentandoperation(Austrade2016a).

traditional chinese medicine

ChinaisalsocontributingtothedevelopmentofnewsectorsinAustralia.TCMinAustraliaisstillanascentindustry,yetithassucceededinattractingsignificantattentionfromgovernmentbodiesandbusiness.Therangeofrecentadvancementsinregulation,collaborationandexchangewillonlyleadtogreateropportunitiesforAustralianTCMresearch,developmentandexportinyearstocome.

InNovember2014,theUniversityofWesternSydney(UWS)andtheBeijingUniversityofChineseMedicinesignedaMoUtodevelopAustralia’sfirstTCMintegrativeclinicalservice.TheAustralianprimeministerandtheChinesepresidentattendedthesigningceremony.

TheUWSNationalInstituteforComplementaryMedicine(NICM),whichwilloperatethenewservice,hopesitsresearchwillleadtonewtreatmentsforoutstandingmedicalneedsandnewmedicinesforglobalexport.TheNICMwillalsopartnerwithChineseresearcherstorunclinicaltrialsonTCM(CRI2015).Theinstitution’scapabilitiesshouldalsobeofinteresttointernationalcomplementarymedicinecompanieswishingtoprepareregulatoryfilingsforothermarkets,suchasintheUnitedStatesandEurope(ATC2014;Austrade2014).

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ThisMoUisoneofarangeofinitiativesinrecentyearsthathavemadeAustraliawellplacedtoadvancetheproduction,regulationandmarketaccessofTCMinthefuture.InJuly2012,AustraliabecamethefirstWesterncountrytoinstitutemandatorynationalregistrationofTCMpractitioners,amajorinstitutionalstepforTCMdevelopmentandqualitycontrol(CMBA2012).

ChAFTAincludesanumberofprovisionsencouragingbilateralTCMcollaborationandexchangebetweenregulators,professionalbodiesandrelevantgovernmentdepartments.TheagreementencouragesthedevelopmentofmutuallyacceptablestandardsforTCMlicensingandcertification,aswellasprovidingsupportforpersonnelmovement,grantingentryandtemporarystayforfouryearstoaquotaofTCMpractitioners.

Inadditiontotheexportofservicessuchasclinicaltrials,someagriculturalandmedicalbodiesareexploringprospectsfortheAustralianexportofTCMgoods.TheWesternAustralianDepartmentofAgricultureandFoodhasencouragedthegrowingofjujubesorChinesedates,acommonfoodandmedicinalproduct,whichcanbegrowninAustraliacounter-seasonallytoChina(DAF2016).UniversityofQueenslandpharmaceuticalresearchershavepointedtothepossibilityoftheexportofcanetoadproductsforTCMuse(Milman2015).

Building trust to achieve potential trade

Abusiness-as-usualapproachtothebilateralrelationshipwillnotbesufficienttocapitaliseonitsfullpotential.TheresourcestradeispredominantlyconductedthroughlargeminingcompaniesontheonesideandChineseSOEsontheotherside.Butthistradegoesbeyondthesupplyofbulkcommoditiestoincludetargetedmarketing,integratedsupplychainsandcross-culturalhumanresourcemanagement.Thistradeisbuiltonafoundationofstrategictrusttoensurethatgovernmentsdonotarbitrarilyinterferewithcommercialrelationships.Goingbeyondthis,intheservicestradesforexample,willrequiredeeperunderstandingandinstitutionalrelationsbetweenAustralianandChineseorganisationsandpeople.

High-level official engagement

TheAustralianandChinesegovernmentshavearoletoplayinremovingbarrierstotrade,catalysingthecommercialandsocialrelationshipsfromwhichbeneficialexchangescanemerge,andestablishingtheinstitutionsandtrustrequiredtolowerbarrierstotrade.Thisisahardtaskgiventheexpandingpoolofbilateralstakeholders.Alargernumberofsmaller-valuedtradetransactionsmeanthatindustryplayerswillbelessorganisedandfindithardertoattractattentionattheofficiallevel,meaningthatgovernmentsonbothsideswillneedtotakegreaterefforttoconsultwithbusiness.

Atthehighestlevel,ajointcommitmenttotradeliberalisationshouldbeproactiveandextendbeyondtheimplementationofChAFTA.ThisworkcanbedevelopedaspartoftheagendafortheStrategicEconomicDialogue(SED)betweenthetwocountries(Box3.8).ThisdialoguebringstogethertheAustralianTreasurerandMinisterforTradeandInvestmentforannualtalkswiththeChairmanofChina’sNationalDevelopmentandReformCommission(NDRC).

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BOx 3.8: THe AusTRALiA-CHinA sTRATegiC eCOnOmiC PARTneRsHiP

WhenthenChineseexecutivevicepremierLiKeqiangvisitedtheAustralianprimeministerKevinRuddinOctober2009,hestressedtheroleof‘dialogue,coordinationandcooperation’inbuildingAustralia–Chinarelations(ChineseEmbassyAustralia2009).TheAustralia–ChinaStrategicEconomicDialogue(SED),whichprovidessuchanopportunityforAustralia,wasannouncedin2013.ThefirstmeetinginJune2014wasattendedbytheAustralianTreasurerandTradeMinister,andtheChairmanofChina’sNDRC.

AtthisinauguralSEDinBeijing,thetwocountriesestablishedanInvestmentCooperationFramework.TheFrameworkgoesbeyondChAFTAandcreatesnewpathwaysforpromotingtheexportoffinancialservices,two-wayinvestmentinnewsectorsandidentifyingroadblocksforinvestorsfrombothcountries.Thereistremendousopportunitytodeepentherelationshipatanumberoflevels,includingbyexpandingservicesexportsfromAustraliatoChinaandimprovinginvestmentopportunities.

ThesecondSED,heldinCanberrainAugust2015,sawthetwogovernmentsagreetofurther‘two-wayinvestmenttodiversifyourtraderelationshipandcreateopportunitiesintheservicessector’(TreasurerofAustralia2015a).

Thishigh-levelpoliticalcooperationispracticallysupportedbyaMoUforcooperationbetweentheNDRCandtheAustralianTreasury,whichwasfirstsignedin2008(AustralianTreasury2008).Chapter6discusseshowtoenergisetheseinstitutions.

Whilemuchhasbeendonebothintermsofinternationaltradelawandbilateralnegotiationstoremoveformalbarrierstotrade,manyofthebarriersthatremainoccuratstate/provincial,municipalandmorelocallevelsofgovernment.Itisoftenattheselevelswherenationallawshavetobeimplemented,andwherelocallicensingpracticesandenforcementcanhavetheeffectofproducingmajor,ifsometimesunintended,barrierstointernationaltrade.

Thepremierforumforbilateralengagementatthestate/provinciallevelistheAustralia–ChinaState/ProvincialLeadersForum.TheAustralianprimeministerandtheChinesePresidentopenedtheForum.Thisinstitutionshouldmeetregularly,andpossiblyestablishastandingsecretariatthatisabletosupportitswork,shareknowledgeandcoordinatetheimplementationofitscommitmentsandinitiativesbetweendifferentlevelsofgovernment.

Theenvironmentformanagingandwelcomingforeigninvestmentprojectsissignificantlyinfluencedbyhowtheyaremanagedatthelocallevel.Astrongpartnershipbetweenprovincialandstategovernments,anddialoguewithlowerlevelsofgovernmentsandcommunitystakeholdersassistsfirmstodiscovertradeopportunitiesandfacilitatetheinvestmentthatsupportstrade.Australianstateshavelonghadsisterstate–provincerelationshipswithChina’smostoutward-orientedprovinces(Table3.7),andtherearemorethan70sister-cityrelationships.TradedelegationsledbythepoliticalleadersofAustralianstatesandterritoriestoChinacanhelpcementcommercialties(Box3.9).

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Thiscanbetakenfurther—althoughChinaonlyestablisheddiplomaticrelationswithSouthKoreain1992,thetwocountriesalreadyhave154sister-cityrelationships(Ren2014).TherelationshipbetweenWeihai,atownof600,000people,inShandongProvince,andIncheon,acityof3millioninSouthKorea,isanexemplarofasister-cityrelationship.Morethan800SouthKoreancompaniesoperateinWeihai,whichisalsohometo40,000SouthKoreans(Zhao2015).

Stateandprovinciallevelgovernmentscanfurtherbilaterallinksthroughmoreexchangeprogramsforstudents,businesspeopleandgovernmentofficials.Victoriaiscurrentlytakingtheleadinestablishinga‘PartnershipsforProsperity’strategywithChina(GovernmentofVictoria2016).Thisinvolvesstrengtheningcooperationoninnovationwithitsexistingsister-province,Jiangsu,aswellasformalisinganewsister-provincerelationshipwithSichuan.Thestrategyincludestargetedcapacitybuildingwithinbusiness,governmentandeducation,aswellasculturalengagement.Victoriawantstobethedestinationfor20percentofChineseinvestmentinAustraliaby2026.Overthesametimeframe,theVictoriangovernmentexpectsexportstoexpand,revenuefromChinesetouristsinthestatetoincrease,andpost-graduatetertiaryenrolmentsfromChinatogrowbyaquarter.

Table 3.7: sister state–province relationships between Australia and China

Australian state or Territory Chinese Province or municipality Relationship established

NewSouthWales Guangdong 1979

Victoria Jiangsu 1979

Tasmania Fujian 1981

SouthAustralia Shandong 1986

WesternAustralia Zhejiang 1987

Queensland ShanghaiMunicipality 1989

NorthernTerritory Anhui 2000

AustralianCapitalTerritory Beijing 2000

Queensland* Guangdong 2004

Source:ACCCI2001;AHFAO2015;GFAO*referstoaFriendlyCooperativeProvinceratherthana‘sister’relationship.

TheAmericanChamberofCommerceinChina(AmCham)conductsannualsurveysofChina’sbusinessenvironment,andreleasesanannualwhitepaperforAmericanbusiness(AmCham2015).ManyofthedetailedconcernsraisedbythisorganisationarelikelytoreflecttheexperienceofAustralianbusinessinChina.AmChamfindsthatforeigncompaniestradinginChinareportthatlocalregulatoryenvironmentsandconditionsmatter.CentralpoliciesarenotalwaysuniformlyenforcedacrossChina,andtheinstitutionsandinfrastructureneededtogetproductstomarket,andthefinancialservicesrequiredtofacilitatetrade,arenotalwayswelldevelopedbeyondChina’sfirst-tiercities.Inparticular,foreigncompaniesoftencomplainthatregardlessoftarifflevels,theirexportoperationsbecomecomplicatedbyinconsistentandinefficientcustomsproceduresandregulationsatthelocallevel.AmChamreportsthatthereisaperceptionamongforeignbusinessesthatlocalgovernmentsfavourlocaldeveloperswithregardstoaccesstolandandrealestate.

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Beyondthefirst-tiercities,anabsenceofinternationalschools,multilingualhealthcentresandinternationalfinancialinstitutionscanmakeitdifficultfornon-Chinesespeakingforeignershopingtodobusiness(AmCham2015).Someareasimposeregulationsandfeesforimportinginternationaleducationalresources,includingtextbooks.Furtheropeningupofthemarketforhealthcareandeducationserviceswouldmakeiteasierforinternationalproviderstooffertheseservicestoforeignvisitors,thereforefacilitatingmorebusinessandinvestmentconnections.Atapracticallevel,evendifferentregionalbureauxoftheExit-EntryAdministrationofChina’sPublicServiceBureauinterpretandapplyregulationsdifferently.Thiscancausevisaproblemsforstudentsandprofessionals.

Statesandprovincescanplayaleadingroleindrivingpracticalcooperation(Box3.9).Australianstategovernmentsalreadyhaveanon-the-groundpresenceinChina—NewSouthWales,SouthAustralia,QueenslandandWesternAustraliainShanghai;NewSouthWalesinGuangzhou;VictoriainNanjing,BeijingandChengdu;SouthAustraliainShandong—whichcanhelpdeliverthisengagement.Victoria’sChinastrategyincludesincreasingresourcesforitsnetworkofgovernmentbusinessofficesbyA$66million,includingtheappointmentofanewdeputycommissionerresponsibleforWesternChina(PremierofVictoria2016).TasmaniaalsorecentlycapitalisedonavisitbytheChinesePresidentbylaunching‘Tasinvest’,apromotionthatattractedover100representativesofChinesecompanies.TasmaniaalsosignedaMoUonplanningandcooperationwiththeChinaDevelopmentBank,inordertofacilitateChineseinvestmentinTasmanianmining,agriculture,tourismandinfrastructure(PremierofTasmania2014).

State–provincialandsister-cityrelationshipsshouldbeforumsinwhichtonegotiateandresolvetheseissues,aswellastorecogniseprofessionalaccreditations(suchasrealestatebrokerlicenses),andensuretransparencyandconsistencyingrantinglocallicensesandgovernmentapprovals,includinginbankingandfinance.AustraliancompaniesoperatinginChinadonotneedanykindofpreferentialtreatment,buttheydoneedanassurancethattheinterpretationoflawsandregulationsatthelocallevelisnotbeingusedtorestrictcompetition.Opportunitiesforofficialvisitsandexchangesofstateandprovincialgovernmentofficials,includingwithjudicialandprosecutorialorgans,cancontributetothetrustandunderstandingneededtoidentifyandresolvelocalregulatorydiscrepancies.

BOx 3.9: sTATe AnD PROvinCiAL Ties

Thefirstsisterstate–provincerelationshipwasestablishedin1979betweenNewSouthWalesandGuangdongprovince,andtheannualNSW–GuangdongJointEconomicMeetinghasbeenakeycomponentoftherelationship.InJuly2008,theNSWgovernmentalsosignedaformalMoUwiththeFinancialServicesOfficeoftheShanghaimunicipalgovernmenttostrengthentheirrelationship.Sincethen,thetwocitieshaveheldanannualfinancialservicessymposiumtogrowtheirpositionsasfinancialhubsintheAsiaPacific.InJune2012,Guangdong’sformerpartysecretaryvisitedSydney,andin2015,theNSWPremierMikeBairdhostedthecurrentGuangdongPartySecretaryHuChunhua,whowasthenreceivedbytheAustralianprimeministerasaguestoftheAustraliangovernmentinCanberra.PriortotheNSWpremier’sfirstofficialvisittoChinain2014,NSWreleaseditsownChinaEngagementStrategy.ThepremierledadelegationtoGuangzhouinNovember2015inordertodiscussopportunitiesunderChAFTA.InApril

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2016,theNSWhealthministertravelledtoChinatopromotenewopportunitiesforhealthcareprovidersandmedicaldevicemanufacturersunderChAFTA.Duringthisvisit,theministeralsoattendedAustrade’sAustraliaWeekinChina2016.

TheVictoria–JiangsuJointEconomicCommitteefirstmetin1987.AnumberofVictorianprojectsinChinahaveprogressedthroughthisCommittee,particularlysomerelatingtosustainableurbandevelopment.Tocelebratetherelationship’s35thanniversary,aMoUwassignedbetweenRegionalDevelopmentVictoriaandtheJiangsuForeignAffairsOfficeinJuly2014,launchingtheVictoria–JiangsuRegionalCityAlliance.Theallianceaimstostrengthenmultiplecity-to-citytradeandinvestmenttiesbetweenthetwostates.Over60governmentandbusinessleaders,includingJiangsu’svicegovernor,attendedthelaunch.FollowinghisvisittoChinain2015,VictorianPremierDanielAndrewsproposedtosendeverymemberofhisministrytoChinabeforethenextstateelectioninNovember2018.ThepremierintendstovisitChinaeveryyearinordertoboosttradeandexplorefurtherinvestmentopportunities.

Ontopofthis,JiangsuandVictoriahaveaformalpartnershipbetweentheVictorianDepartmentofEducationandTrainingandtheJiangsuProvincialDepartmentofEducation,andtheHamerScholarshipprogramforyoungVictorianstostudyChineselanguageandcultureinJiangsu.Moreover,MonashUniversitywasthefirstAustralianuniversitylicensedtoopenacampusinChina,inpartnershipwithSoutheastUniversityinSuzhou.AspartofVictoria’snewChinaStrategy,Victoriawillalsoformaliseitsnewsister-provincerelationshipwithSichuanbytheendof2016.

TasmaniaandFujianprovincehavehadanactiverelationshipsince1981.Afterthe2014AustraliaG20Summit,ChinesePresidentXiJinping(aformergovernorofFujian)visitedTasmaniaaccompaniedbytheFujianpartysecretary.TheTasmanianpremierandtheFujianpartysecretarysignedtheAgreementonEstablishingtheJointCommitteeforCooperationandDevelopment,anorganisationalbodyoverseeingbilateralexchange,andcommittedtoholdbiannualmeetingstodiscusstrade.ThedelegationwasaccompaniedbyrepresentativesfromeightFujiancompanies,includingXiamenAirlines,theZijinMiningGroupandXiamenConstructionandDevelopmentGroup.TheinauguralmeetingoftheJointCommitteewasheldinMarch2015inFujianandattendedbytheTasmanianpremier.TasmaniaalsosignedaMoUwithFujianwhenChinesePresidentXiJinpingvisitedTasmaniainNovember2014,establishingaJointCommitteeforCooperationandDevelopment.

In2013,theSouthAustraliaShandongCooperationandDevelopmentForumwasestablished,withtheinauguralForumheldinJinanthatApril.TheForumischairedbytheSouthAustralianpremierandthevicegovernorofShandong.Thedelegationincludedbusinessleadersfromthemineral,energy,agribusiness,wineandeducationsectors.MoUsadvancingeconomicrelationsweresignedwiththeShandongCommerceBureauandtheQingdaoBureauofCommerce.InMay2015,theGovernorofShandong,GuoShuqing,welcomedSouthAustralia’slargestevertradedelegationledbytheSouthAustralianPremierJayWeatherill.Thepremierreleasedthestate’supdatedChinaEngagementStrategyinMay2016(PremierofSouthAustralia2016).

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WesternAustraliahashadasisterstate–provincerelationshipwithZhejiangprovincesince1987.In1995,theWesternAustralia–ZhejiangSister-StateEconomicExchangeCommitteewasestablishedtooverseetheeconomicaspectsofthepartnership.InSeptember2012,adelegationledbytheZhejianggovernorvisitedPerthtocelebratethe25thanniversaryoftherelationship.InApril2014,aMoUwassignedbetweenthetwopartiesonlivecattleexports.TheWAministerforregionaldevelopmentledadelegationinAugust2015toChinatomeetwithZhejiangprovincialgovernmentofficials.

QueenslandandShanghaihavemaintainedasisterstate-cityrelationshipsince1989.Tomarkthe25thanniversaryofthisrelationshipin2014,theirtwogovernmentsagreedtoworktogetheronurbandevelopmentissues,strengtheninformationsharinginrelationtotheShanghaiFreeTradeZone,andexpandcooperationandexchange.

TheAustralianCapitalTerritory(ACT)hashadaformalsister-staterelationshipwithBeijingsince2000.ThescopeoftheACT’sengagementwithChinawasexpandedin2014withaneconomiccooperationagreementsignedbytheACTchiefministerandthemayorofShenzhen.

grassroots engagement

Thenextroundoftradeopportunitiesinservicesrequiresmuchmoresophisticatedengagementbytensofthousandsofenterprisesandentrepreneursoneachside(seeChapter6).TheAustralia–ChinaCEORoundtableisthepremierforumforthisatthepeakbusinesslevel.

Opportunitiesexisttoimprovebilateralcapacityinmanyservicesindustries,includingtourismandeducation,andprofessionalservices,wherethedeliveryofhigh-valueproductsdependsontailoringservicestomeetthedemandsofspecificconsumers.Adeepunderstandingofconsumerpreferencesisessentialtoprovidingnicheservices,andmembersofAustralia’sChinesediasporacommunityareideallyplacedtoplayaleadingrole(Box3.10)Thiscommunityisgrowing—thenumberofChinese-bornAustralianresidentsmorethandoubledfrom2004to2014(ABS2015b).TheestimatedChineseresidentpopulationiscurrentlyaroundhalfamillion(ABS2015b).OngoingmigrationfromChinatoAustralia(discussedinChapter4)helpsmeetAustraliandemandforhumancapitalinfast-growingareas.Chineseaccountants,advertisingandmarketingprofessionals,ITspecialistsandeducatorsdonotjustbringtechnicalskills,butalsopossessup-to-dateknowledgeofconsumerpreferences,businesspracticesandmarketopportunitiesinChina.

WhetherChinese-born,orraisedinAustraliawithanawarenessofChinesecultureandsensibilities,theChinesediasporacommunitybringswithitnewandvaluableopportunitiestotailorlocalproductsandservicestosuitChineseconsumerdemands.WhenChinese-Australianbusinessleadersmakeuseoftheirlinguistic,networkingandentrepreneurialadvantages,theircolleaguesandcollaboratorsgainfirsthandexperienceoftheimportanceofdevelopingculturallyspecifichumancapital,andtheopportunitiespresentedbyChina’scontinuedtransformationandgrowth.

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Forexample,thepresenceofChineseworkersintheSouthAustralianwineindustryhasalreadybeguntotransformit.WineproducersthroughoutAustralia,especiallysmall-andmedium-sizedbusinesses,arekeentocaptureashareofthegrowingChinesemarket,buttheyhavelimitedabilitytoidentifymarketopportunitiesandadapttoChinesetastes.Chineseworkerscanprovidethelinguisticability,multiculturalbusinessperspectiveandnetworkingadvantagesneededtomatchproducerstointernationalconsumers.SomerecentChinesegraduateshaveevenstartedtheirownexport-focusedwinebusinesses.

TheAustralia–ChinaYouthAssociation(ACYA)andtheAustraliaChinaYoungProfessionalsInitiative(ACYPI)areexemplarnon-governmentorganisations.ACYAissupportedbytheAustraliangovernmentthroughtheAustralia–ChinaCouncilandhasmanyinstitutionalpartners,particularlyinAustralianandChineseuniversities.ACYAisdedicatedtoimprovingpeople-to-peopletiesthroughcareerandeducationservices.Itoperatesacross22chapters,17inAustralianuniversitiesandfiveinChinesecities,andin2010launchedtheannualhigh-levelAustralia-ChinaYouthDialogue(ACYD).

InOctober2015,theACYPIsurveyedmorethanonehundredofitsownmembersaswellasparticipantsinthe2015SouthAustralia–GreaterChinaFutureLeadersDialogue.MoreimportantthanthebusinessenvironmentineitherAustraliaorChina,participantscitedthe‘lackoftrustinandunderstandingoftheothercountry’asthemostimportantissueinthebilateraleconomicrelationship.Australia’srelationshipswithJapanandtheUnitedStateswereregardedastheleastimportantissueintheAustralia–Chinarelationship(Eganetal2015).

InitssubmissiontothisReport,ACYPIrecommendedinvestingineducation(particularlysecondary,tertiaryandongoingprofessionaldevelopment),encouragingdevelopmentofpeople-to-people-tiesandmaintaininganongoingbilateraldialogue(oneconomicsandothermatters)asthekeymeansofbuildingthistrust,anddevelopingtherelationship-specifichumancapitalthatiscrucialtoprovidingtailoredgoodsandnicheservicestoeachother’smarkets.

BOx 3.10: CuLTuRAL COnneCTiOns AnD Business OPPORTuniTies FROm THe CHinese DiAsPORA

ChinesegraduatescanhavetransformativeeffectsonAustralianbusinesses.Atonemedium-sizedwineproducerintheAdelaideHills,aChinese-speakingemployeebeganaddressingoccasionalenquiriesfromChinaandtranslatingtastingnotes.Theemployee,awinebusinesspostgraduate,soontookonapermanentpositiondevelopingthebusiness’‘strategyforChina’—apositionshehad,accordingtothegeneralmanager,effectivelycreated‘forherself’.Now,36percentofthatbusiness’totalrevenue(approximatelyA$2million)isaccountedforbyChina.

Chinese-Australianbusinessleaderscanplayacentralroleinstrengtheningandconsolidatingsupplychains.OneChinese-Australianbusinessownerdescribedsourcingcardboardpackagingforaclient:‘They’resoexpensivehere,butinChinait’ssocheap…[What’s]reallyimportantforbusinessisyouhavetohearthepeople.Youhavetoknowwhatthey’rethinking.Andyouhavetoknowwheretheneedis’(Rizvietal2016).

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Theseformsofstate–provincial,sister-cityandcivilsocietycooperationareanunderutilisedresourceforimprovingtheoverallbilateralrelationship—asarepeakbusinessgroups.TheroleofthesebodiescouldbeexpandedandformalisedintoanewAustralia–ChinaLeadersForum,whichwouldbetaskedwithidentifyingpracticalareasforcooperation,andcontinuebuildingtheunderstandingandtrustthatisthebasisofatruepartnership.

Programsofcooperationamongdifferentlayersofsocietywillalsobecrucialinthedevelopmentandmaturationofeachnation’s‘brand’intheothercountry(Box3.11).

BOx 3.11: BRAnD AusTRALiA AnD BRAnD CHinA

Acountry’s‘brand’representsthepromise,inherentvalueandreputation,realorperceived,thatitsnamepossessesintheeyesofoverseasconsumers,tourists,businesspeopleandotherforeignentities.WhatisChina’sideaof‘brandAustralia’,and,conversely,howdoAustraliansperceive‘brandChina’,ineconomic,cultural,politicalandothersenses?

AustraliaenjoysapositivebrandimageinChina.ManyChinesebelievethatAustraliaisa‘friendly’placewithpleasantweatherandmanyopenspaces.Inrecentyears,Australianconsumerproducts,includingfood,agriculturalgoodsandhealthsupplements,havebecomeverypopularwithChineseconsumersastheyareconsideredtobehighquality,healthyandmostimportantlychemical-free,whereastheequivalentChineseproductsarenot.Australiaisperceivedasnon-threatening,andtherearefewnegativeperceptionsofthecountryinmostChinesepeople’sview.Butthatcanchange.IncidentssuchastheproblemssurroundingChinalcoinvestmentsinAustraliahaveanadverseimpactonChineseperceptionsofAustralia’s‘brand’,aswouldproblemswithAustraliangoods.

InAustralia,thereisawiderrangeofperceptionsofChina.AustraliansrespectChina’sachievementsinmoderndevelopment.Arecentpollacrossseveralcountriessuggeststhat80percentofAustralianrespondentsacknowledgedChinaasarisingpower.ElementsofChineseculturelikeChinesefood,kungfuandthehard-workingethicoftheChinesearealsowidelyadmiredandwelcomedinAustralia’smulticulturalsociety.China’spoliticalsystemevokesanxietiesandthereareoftennegativereactionstoChineseinvestmentinAustralia,particularlyinrealestate.Howeverunfairly,China’sconsumerbrandsareoftenperceivedascheapandofinferiorquality,eventhoughChinanowmanufactures—andAustralianowbuysfromChina—avastrangeofworld-classproducts,suchastheiPhone.EventhoughthesearesometimesdesignedintheUnitedStatesorJapan,theyare‘madeinChina’.QualitywhitegoodslikeHaierandMidea,aswellasotherforeignbrandsmadeinChina,provethatChinaiscapableofmakingworld-classconsumerproducts.ThiscouldhelpChinaenhanceitsownnationalbrandintheprocess.

Governmentscanplayaroleinbuildinganationalbrand.OrganisationslikeAustradeandTourismAustraliaworktoenhancethetradeopportunitiesinChinaofproductsandservicesthatplayontheAustralianbrand:milkpowder,educationandtourism,forexample.ForChinesecompanies,theChinaCouncilforthePromotionofInternationalTradeorganisesChinesetradedelegationstovisitothercountries.ItalsomanagesoverseastradeshowsforChineseorganisationsandassistsChinesecompaniestoattendoverseaseconomicconferences,exhibitionsandforums.

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Developinganationalbrandisonewayofdevelopingsoftpower.Thiscansometimestaketheformofculturaldiplomacyinitiatives,suchastheConfuciusInstitutessetuparoundtheworldtopromoteChineseculture.

OntworecentglobalsoftpowerrankingsAustraliawaslistedasthesixthmosteffectivecountryatdeployingitssoftpower,behindmuchmorepowerfulcountriessuchasUnitedStates,theUnitedKingdom,France,GermanyandJapan(Monocle2016;PortlandCommunications2016).Chinalagsbehindontheserankings,withthecountry’ssoftpowerrankedat21stand30thintheMonocleandPortlandCommunicationsranking,respectively.ThisimpliesthatChina’ssoftpowerscoreisoutofsyncwithitsoveralleconomicandpoliticalaccomplishments.

WhiletheserankingsarebothconductedbyWesternorganisationsandmaynotportraysentimenttowardsAustraliaorChinaacrosstheentirespectrumofcultures,itdoesringtruethat,comparedtothesizeofitspopulationandeconomy,Australiacarriessignificantweightintermsofsoftpower.

Nationalbrandchanges,ascountriesdevelopandchange.BoththeAustralianandChinesegovernmentshavearoletoplayinfosteringthisfamiliaritythroughmorepeople-to-peopleandculturalexchangesthatwillreconfigureperceptionsandplayanimportantroleintheevolutionofeachcountries’nationalbrandintheothercountry.ThenuancedmutualunderstandingthatemergesfromthiswillallowbothChineseandAustraliancitizenstogainthemostinworkingtogetherontherelationship.

Thescopeforamaturinganddeepeningofthebilateraltraderelationshipisclear.Australiawillexpanditsexportsinhighvalue-addedgoodsandservices,thoughitsresourceabundancewillcontinuetomakeitanimportantsupplierofenergyandmineralstoChina.However,realisingthefullpotentialofthisrelationshipdependsonactiveengagementonthepartofpublicandprivatesectorsinbothcountries,andonthevigorousprosecutionofrespectiveagendafordomesticreform.

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CHAPTER4investment, human capital and labour movement

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Key messAges

Two-wayflowsofinvestment,peopleandideasareessentialtoadvancingeconomic,politicalandsocialtiesbetweenAustraliaandChina,andtorealisethefullpotentialforexpandingtradeinhighervalue-addedgoodsandmoresophisticatedservices.Chinahasbecomeamajorsupplierofinternationalcapital.Australia’sresourceendowmentsmadeitanaturaldestinationforChineseinvestmentduringtheminingboom.Australianowfacesglobalcompetitiontoattracttheforeigncapitalitneedstoservicegrowthinagriculture,tourismandinfrastructure.

China’sdomesticeconomictransformationisprioritisingdevelopmentoftheservicessector.InthesamewaythatforeigninvestmentintoChina’smanufacturingsectormadeChinaahighlycompetitivegoodsproducer,foreigninvestmentintoservicesindustrieswillimprovequality,reducecostsandfurthertheChinesereformagenda.Thefreerexchangeofpeopleandideaswillbecrucialtostrengtheningbilateralinvestmentandtrade.MorecanbedonetoleveragediasporacommunitiesinfacilitatingeconomicexchangeandinensuringthatChineseandAustralianstudents,touristsandbusinesspeopleenjoygreaterfreedomofmovement.

Theargumentinthechapterconcludesthat:

• TheChAFTAframeworkopenstheopportunitytoupgradetheexistingAustralia–ChinaBilateralInvestmentTreaty(BIT)byadoptingtheprinciplesofnationaltreatmentandanegativelistoninvestmentaccess.TheearlynegotiationsofanewAustralia–ChinainvestmentagreementinthisframeworkwillalsoassisttheprogresswithRCEPinvestmentprotocolsandChina’sBITnegotiationswiththeUnitedStatesandtheEU.

• Australia’scurrentforeigninvestmentreviewregimerisksdeterringbeneficialChinesecapitalbyincreasingthecostsandtheuncertaintyofdoingbusinessinAustralia—especiallyascapitallookingtoinvestinmanufacturing,agriculture,tourismandservicesisfarmoremobilecomparedtothatseekingresourcesinvestment.Australiashouldinstituteamorepredictableandtransparentinvestmentreviewprocessthatfocusesonongoingriskmanagementratherthanapre-approvalprocess,andmovetoa‘notificationandcompliance’systemforcommerciallycertifiedstate-ownedenterprises.ForeigninvestmentpolicyinChinaisintheearlystagesofliberalisation.Chinashouldapproachforeigninvestmentfromtheperspectiveofnegative-listingandnationaltreatment,andshouldreconsidersector-specificinvestmentrestrictionsthatapplytobothdomesticandforeigninvestors.

• Bothsideswouldbenefitfromclearframeworksforcooperationonthebilateralmovementofpeopleandideas.Abilateralworkingpartyconsistingofofficial,business,tourismandeducationrepresentativesshouldbeconvenedtoreviewtheadequacyofvisaarrangementsonbothsides.Existinginitiatives,suchasAustralia’sSignificantInvestorVisaprogram,couldbemorewidelyadvertisedtopromoteuptake.Bothcountriesshouldconsidermakingiteasierforoneanother’scitizenstoliveandworkineithercountry.

• Forexample:AustraliashouldconsiderrelaxingthecaponChineseworkingholidayvisas;AustralianstudentsshouldbeextendedmoreopportunitytoaccessAustralianincomecontingentloansfordegreestudyattop-rankingChineseuniversities;andAustraliashouldexpanditsnetworkofbilingualEnglish–Chineseschools.

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Fullyrealisingthepotentialfortradeinhighervalue-addedgoodsandmoresophisticatedservicesrequiresChinaandAustraliatogobeyondatransactionalrelationshipbasedonresourcesandmanufacturedgoods,towardapartnershipthatsupportslong-termtwo-wayinvestmentandtheexchangeofideasandtalentinbuildinginnovativeandmoreproductiveeconomies.Whiletheresourcestraderemainscentral,thefuturerelationshipcannotbefocusedonlyonresourcesorcontainedtoprescribedsectors.Rather,itisarelationshipthatinfuturemustencompassconnectionsbetweenalldimensionsofthebroadereconomicrelationship—tradeingoodsandservices,investmentandpeople-to-peopleconnections.

Thischapterconsidersthebenefitsfromdirectinvestmentandfrompeople-to-peopleconnectionsbetweenthetwocountries(Box4.1).Chapter5discussestheevolvingframeworkwithinwhichportfolioinvestmentandotherfinancialflowswillgrowandcapitalmarketswillintegratemorefully.

BOx 4.1: THe BeneFiTs OF FOReign DiReCT invesTmenT

Foreigninvestmenthelpsmeetthegapbetweenwhatdomesticresidentsareabletosave,andtheproductiveinvestmentopportunitiesintheeconomy.Itimprovestheglobalallocationofresourcesbyincreasinginvestmentinthecountriesthathavelowerdomesticsavingsandincreasingreturnsincountrieswithexcesssavings.

Investorsprimarilyseekareturnonthecapitaltheyinvest.Butinvestmentisalsogoodforworkers,asitequipsthemwithmorecapitalandthereforemakesthemmoreproductive.Thisincreaseswagesandlivingstandards.Localasset-holdersbenefitfrombeingabletoselltothehighestbidderontheworldmarket,makingitmoreprofitabletodevelopnewassets.

Theextentofthis‘capitaldeepening’effectappliestoallforeigninvestment,andwillbeinfluenced,amongotherthings,bytheratesoftaxationoncapital,thegeneralbusinessenvironmentandtheperceivedpoliticalriskofinvestingoffshore.

Thebenefitsofdirectinvestmentgobeyondsimplyprovidingloansorbuyingsharesinaforeigncompany,toestablishingorbuyingacontrollinginterestinthecompany,injectingnotonlycapital,butalsocruciallinkagestoforeignmarketsandtechnologies,whichfurtherexpandsexportopportunitiesforproducersandopensupawiderrangeofcheapergoodsforconsumers.

Unlikeportfolioinvestment,whichcanbeeasilyliquidatedandtransferredinresponsetofinancialmarketfluctuations,directinvestmenttendstobuildlonger-livedassetsthatprovidereturnsoveryearsorevendecades,includinglong-terminvestmentininfrastructure.Foreigndirectinvestment(FDI)createspowerfullong-termcommercialinterestsinmaintaininggoodrelationsbetweencountries.

Directinvestmentabroaddeliversbenefitsthatcanspillovertothewholeeconomy—includingfamiliarisinglocalswithnewproductiontechniquesandbringinginternationalstandardsintodomesticproduction.

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CHAPtER 4: Investment, human capital and labour movement

Australia’spopulationislowrelativetoitslandareaandnaturalresources.Foreigninvestmentinmines,ports,transportinfrastructure,technology,landandfactoriesisessentialtotransformresourceendowmentsintorealwealth.ForeigncapitalinAustraliacamefirstfromtheUnitedKingdom,butmorerecentwaveshavecomefromtheUnitedStates,JapanandnowChina.Australiahashistoricallyrunasmall,butpersistent,currentaccountdeficit.ThatmeansthatAustraliansinvestmorethantheysave,withthedifferencemadeupbyborrowingfromabroad.ReducingforeigninvestmentwouldmeanthatmanyproductiveinvestmentsinAustraliacouldsimplynolongerbefunded.Thatwouldlowerproductivity,andreducethestandardoflivingandtheeconomicstrengthofthecountry.

DespitebeingafoundationofAustralia’seconomicprosperity,theroleofforeigninvestmentisnotalwaysfullyorwidelyunderstoodinthecommunity.ConcernsinAustraliaabout‘sellingoffthefarm’andshiftingprofitsoverseasmissthepointthatforeigninvestmentenhancestheproductivityoflocallabour,liftswagesandincreasesthevalueofdomesticassets.InvestmentininfrastructureandbetterlinkagestoforeignmarketsfurtherexpandexportopportunitiesforAustralianproducers,andopenupawiderrangeofcheapergoodsforAustralianconsumers.Australianasset-holdersbenefitfrombeingabletoselltothehighestbidderontheworldmarket,makingitmoreprofitabletodevelopnewassets.

ForeigninvestmenthasalsoplayedacrucialroleinChina’sreformandopeningsince1978.InvestorsfromHongKongandTaiwanwerethefirsttodevelopChina’semergingcoastaltradinghubs.FDIhelpedtransplanttherulesandinstitutionsofamodernmarketeconomyintoChina.Forexample,whenaspecialeconomiczonewasestablishedinShenzhenin1980,thatcitywasasmallfishingtown.ItisnowoneofChina’slargestandwealthiestmetropolises.

Despitephenomenallyhighratesofinvestmentoverthepasttwodecades,Chinahasrunacurrentaccountsurpluseveryyearsince1994.Thismeansthat,unlikeAustralia,Chinadoesnotdependonglobalsavingstomeetitsinvestmentneedsbecauseitsownsavingsareveryhigh.ButChina’seconomicgrowth,particularlyinitsexport-orientedmanufacturingsector,hasreliedheavilyonthetechnologytransferandadvancedlabourskillsthatcomewithFDI.

OnewayofdealingwithpersistentcurrentaccountsurpluseswasfortheChinesegovernmenttoallowChinesecompaniestoinvestabroad.This‘goingout’policywaslaunchedin1999andformallyincludedinChina’ssubsequentFiveYearPlans.AswellasprovidingahigherreturnonChinesesavingsthanthatavailableonUSgovernmentdebt,thestatedgoalsofthispolicyaretoensurethatChinacanaccessthenaturalresourcesitneedsforeconomicdevelopment,accessexportmarketsandacquireforeigntechnologyneededtoimproveeconomiccapacityinChina(GovernmentofChina2006).

Morerecently,China’sOBORinitiative,anditsleadershipinestablishingthemultilateralAIIB,seeknotjusttoconnectChinatoforeignmarkets,butalsotobuildconnectivity—andthereforeprosperity—acrosstheregion.ThiswillprovideinvestmentopportunitiestoexpandinfrastructureinvestmentsinAustralia,includingreapingthebenefitsofagriculturalinvestmentinNorthernAustralia.

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The benefits of opening up to foreign investment and services

Tocapturethegainsfromthesepolicyinitiatives,therewillneedtobefurtherpolicyengagementofthekindrecommendedintheargumentofthisReport.

TheeconomicbenefitsofChina’sopeninguptoforeigncapitalandtocompetitionintheservicessectorareverysubstantial.

Inordertogivearoughquantificationofthesebenefits,modellingcanbeusedtosimulatetheeffectofservicessectorandfinancialmarketreformthatmightbesetintrainbyastrongpolicycommitmenttoopeningup,utilisingtheGTAPmodelintroducedinChapter3(Gretton2016).

Domesticreformsacrosstheservicessectorswouldimprovetheproductivityofvalue-addinglabourandcapitalinproductionandwouldbetradeliberalising.Themodellingsuggests,forexample,thatforevery1percentimprovementintheproductivityofserviceprovisioninChina,ChineseGDPcouldbeincreasedby0.68percent,withasmallbutpositiveflow-oneffecttoAustralia.ThesameproportionalincreaseintheproductivityofserviceprovisioninAustraliacouldgenerateanincreaseinAustralianGDPof1.13percent.

Barrierstotheefficientfunctioningofthefinancialsystemariseforavarietyofreasons,includingownershiprestrictions,governmentdirectivesontheuseoffinance,domesticmarketpracticesandregulationsfavouringdesignatedactivities,aswellasdiscriminationbetweenforeignanddomesticinvestors.Higherinvestmentcostsraisethepriceofaneffectiveunitofcapitalusedinproductionandreducethecompetitivenessofcapital-usingactivitiesandpotentialoutput.AreductionintheriskpremiumofinvestmentinChinaachievedthroughdomesticfinancialsystemreformswouldlowertherateofreturnrequiredbydomesticandforeigninvestorstoundertakenewinvestment.

Themodellingestimatessuggestthata10percentreductioninthecostofcapitalthroughfinancialmarketreformcouldincreaseChina’sGDPby5.7percentabovelevelsthatwouldotherwisebeachievedinthelongerterm.Thisprojectiondoesnotnecessarilyrepresenttheeffectsofasinglepolicy,butratheraconcertedefforttoimprovetheoperationofthefinancialsystem.Thetimehorizonoverwhichthebenefitscouldbeachievedwould,inturn,dependonthepaceofreform,therateatwhichbusinessestookupnewopportunitiesandthetransitionoflabourtothesenewactivities.

WhiletheseprojectionsprovideanindicationofthepotentialeconomicbenefitsoftradeliberalisationandeconomicreformtowardsbetterfunctioningmarketsforgoodsandservicesandamoreefficientfinancialsysteminChinaandinAustralia,theydonotdirectlycapturealleffects.Beyondreducingtherisksassociatedwithinvestment,forexample,awell-functioningandefficientfinancialsectorinChinashouldalsoallocatecapitaltothemostprofitablefirmsandexertpressureonthosefirmstomaintainhighstandardsofcorporategovernance,affordingadditionalpotentialproductivitybenefits.DistributionaleffectswithintheChineseeconomycouldalsofollow,suchasbetweengovernment-ownedorcontrolledsectorsandothersectorswithintheeconomy,andbetweentheChineseeconomyandothereconomies.Overall,aloweringofinvestmentriskinChinawouldbeexpectedtoraiseglobaleconomicactivityandincomes.

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Thesesimulationsoftheeffectsofalternativepolicydirectionsillustratetheimportanceofleveragingbroaderregionalandglobaltradeliberalisationagendastothebilateralagenda,andpressingaheadwithatradeliberalisationagendathatgoesbeyondmerchandisetradetoincludetheservicessector,thefinancialsectorandinvestmentreform.CapturingthesegainswillbecentraltorealisingthepotentialofthenextphaseofAustralia–Chinaeconomicengagement.Therestofthischapterconsidersinmoredetailthechallengesthatpolicymakersmustnavigateandthespecificreformsthatwillbenecessaryforsecuringthebenefitsfromliberalisation.

Adapting to Chinese FDi in Australia

Inthe1980s,China’stwolargestinvestmentsoutsideofHongKongwerebothinAustralia—ChinaInternationalTrustandInvestmentCorporation(CITIC)investedinthePortlandaluminiumsmelter,andtheChineseMinistryofMetallurgicalIndustrytooka40percentstakeinanewironminewithRioTintoatMtChannarinWesternAustralia.ThesetwoinvestmentsoperationalisedimportantaspectsofChina’sreformandopeningtradeandeconomicstrategy.Today,investmentfromChinaintotheAustralianmarkethasdiversifiedintoothersectors.Lastyear,China’soutboundinvestmentreachedUS$118billion,anincreaseof15percenton2014.AustraliaisamajorinvestmentmarketforChina.In2015,ChineseinvestmentinAustraliaamountedtoUS$11billion—a33percentincreaseontheyearbefore(Figure4.1).

TheKPMG–UniversityofSydneydatabaseonChinesedirectinvestmentinAustraliadetailsthechangingtrends.Withtheresourceboomover,Australiahasfallenbacktobeonlythesecond-largestdestinationforChinesedirectinvestmentaftertheUnitedStates.Butrelativetoeconomicsize,AustraliaisChina’smostimportantultimatedestinationforforeigninvestment.WithareductioninChineseinvestmentinresourcesastheresourcesboomends,45percentoftherecordedinboundinvestmentin2015wasinrealestate.TheshiftawayfromresourcessawprivateChineseinvestorsexceedingChineseSOEinvestmentforthefirsttimein2014(KPMG2016).The2015sharewas49percentSOE,48percentprivate,3percentSOE–privatejointventure.

MOFCOMandMFAidentifyopportunitiesforChineseinvestmentinAustralianagriculture,aquaculture,dairy,ironore,naturalgas,coal,bauxiteminingandaluminiumsmelting,shaleoil,pharmaceuticalproduction,trade,retail,transport,research,finance,telecommunicationsandtourism(MFA2014).Thepromotionofbilateralinvestmentgivesmomentumtothedevelopmentofbilateraltrade.

ThelegacyoftheplannedeconomyhasmeantthatallmajorChineseinvestments—whetherprivateorstate-owned,domesticorforeign—historicallyrequiredgovernmentapprovals.Ontopofproject-levelapprovals,restrictionsontheChinesecapitalaccounthavelimitedtheabilityofChinesefirmstoinvestoffshore.However,therequirementsforproject-levelinvestmentapprovalshavebeenrelaxedovertime,andasrestrictionsonthecapitalaccountareremoved,theflowofChineseinvestmentislikelytoexpanddramatically.AccordingtoABSdataforforeigninvestmentstocksin2015,Chinaisonlythefifth-largestdirectinvestorinAustraliabehindtheUnitedStates,Japan,theUnitedKingdomandtheNetherlands.However,ChinesedirectinvestmentinAustraliahasbeenincreasingrapidlyfromalowbase,growingfromA$3.6billionin2008toA$35billionin2015(ABS2016f).

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Figure 4.1: stock of foreign direct investment in Australia by source (2014 A$ billion)

0 20 $

40 60 80 100 120 140 160 180 200

United States

Japan

United Kingdom

Netherlands

China

Singapore

Canada

Other

Unspecified

Source:ABSCat.No.5352.0,table2,2016f.

ThespeedwithwhichChinahasexpandeditsglobalinvestmenthasraisedsomeconcernsintheAustraliancommunity.Theseconcernsarenotnew,andnotuniquetoChineseinvestment(Box4.2).TheForeignInvestmentReviewBoard(FIRB)processhashelpedallaypopularconcernsaboutnewwavesofforeigninvestmentinAustraliasince1976.ButthediscretionaccordedtotheAustralianTreasurertoblockcertainproposalson‘nationalinterest’groundsmeansthatindividualcasescanbecomehighlypoliticised.Whileinpractice,theformalpowerisrarelyused,itneverthelessaddstotheuncertainty,andthereforetherisks,forforeigncompaniesseekingtoinvestinAustralia.

AslongasAustraliawascompetingforinvestmenttodevelopitsrichnaturalresourceendowments,thisriskmayhavebeentrivialcomparedtothesovereignrisksinvolvedinmanyotherresource-richnations.Internationalcapitallookingtoinvestinmanufacturing,agriculture,tourismandservicesismuchmoremobile.Inthesesectors,Australia’scompetitorsareadvancedeconomiesinEurope,AsiaandNorthAmerica.AmongstitsOECDpeers,Australia’sregimeranksasthesixth-mostrestrictivebasedontheOECD’sindexofforeignequityrestrictions,screeningandotherpriorapprovalrequirements,rulesforkeypersonnelandotherrestrictionsontheoperationofforeignenterprises(Figure4.2).Itisonlyslightlymoreliberalthantheaverageofnon-OECDmembersthatareassessed.TheChineseinwardinvestmentregime,whichisdiscussedlaterinthischapter,isthemostrestrictiveofallcountriessurveyedonthismeasure.

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BOx 4.2: POPuLAR ATTiTuDes TOWARD FOReign invesTmenT

SuccessivewavesofforeigninvestmentinAustraliafromtheUnitedKingdom,theUnitedStates,JapanandnowChinahaveallcausedcommunityanxieties(Groot1990).AGalluppollinJune1972,whichreferencedBritishandAmericaninvestors,reportedthatalmost90percentofAustralianswouldlimitthesharesthattheseforeignerscouldpurchaseinAustraliancompanies.AsurveyconductedbytheJapaneseembassyin1988foundthat36percentofAustraliansbelievedthattheirgovernmentshouldactivelydiscourageJapaneseinvestment.A1996Newspollrecorded56percentofAustraliansagreeingthatforeigninvestmentlevelswerealready‘toohigh’.

AnnualsurveysconductedbytheLowyInstituteforInternationalPolicyfrom2009to2014,afterChineseinvestmenthadbecomeprominentinAustralia,consistentlyfoundthatmorethanhalfofrespondentsagreedwiththepropositionthattheAustraliangovernmentallows‘toomuch’investmentfromChina(LowyInstitute2015).AnEssentialReportfromAugust2012suggeststhatmostAustraliansarewaryaboutinvestmentfromanyforeigngovernment-relatedentities—Chineseorotherwise(LewisandWoods2012).

AforeigninvestmentstudybyUTSresearchersin2015suggeststhattheAustralianpublicismoreconcernedabouthowlargetheshareofanAustraliancompanybeingboughtbyaforeigninvestorisratherthanwhetherthatinvestorisastate-ownedentityorwhethertheforeigninvestorisfromaparticularcountry—althoughChinaispreferredsignificantlylessthantheUnitedStatesorJapan(Laurencesonetal2015).

CommunityapprehensiontowardsFDIisequallypresentinChina—aPewGlobalAttitudessurveyfoundthat50percentofChinesebelievethatforeigncompaniesbuyinglocalcompaniesis‘bad’(PewResearchCentre2014).However,ACRI-Zogbypollingin2015foundthatChinesebusinesselitesviewAustraliaasamoreattractiveplacetoinvestthanGermany,theUnitedStates,Singapore,Canada,NewZealand,SouthKoreaandRussia(ZogbyResearchServices2015).

Potentialinvestors,andgovernments,haveanimportantroletoplayinensuringthatthedirectandindirectbenefitsofforeigninvestmentprojectsareunderstoodthroughoutwidercommunities.

SinceChAFTAcameintoforce,privateinvestmentsfromChinainmostsectorsonlyrequirescreeningwhenthetotalprojectvalueisaboveanA$1094millionthreshold.ThiseffectivelyremovesmuchofChineseprivateinvestmentfromscreening.Nevertheless,thereareexceptionsonasectoralbasis,includingmedia,airports,telecommunications,transport,defenceanduraniummining,whicharesubjecttomorerestrictivethresholds.Allapplicationstoinvestinresidentialorvacantcommerciallandarereviewed,andinvestmentsinAustralianagribusinessandpurchasesofagriculturallandalsohavestricterthresholds.

Mandatoryscreeningalsoappliestoinvestorswhichareatleast20percentownedbyaforeigngovernment.ThisprovisionhasbeenalongstandingfeatureoftheFIRBprocess,andisnotformallydirectedatChineseSOEs.GiventhatChina’sresourcessectorsandpublicutilitiesarelargelystate-owned,theseprovisionsaremorelikelytoaffectinvestorsinthesesectorswhocomefromChina.

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Figure 4.2: OeCD foreign direct investment regulatory restrictiveness index

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

Average excludingAustralia

Australia Average for selectednon-OECD

China

OECD Selected non-OECD

Note:Averagesareunweighted.Othernon-OECDcountriesratedbyOECDare:Argentina,Brazil,Colombia,CostaRica,Egypt,India,Indonesia,Jordan,Kazakhstan,Kyrgyzstan,Latvia,Lithuania,Malaysia,Mongolia,Morocco,Myanmar,Peru,Romania,Russia,SaudiArabia,SouthAfrica,TunisiaandUkraine.Source:OECDFDIRegulatoryRestrictivenessIndex2014b.

Forprojectssubjecttoscreening,theTreasurermayapproveaprojectsubjecttoconditions.Inthepast,thishasincludedconditionsthatproscribeparticularcorporatestructuresonforeigninvestors.Investorswhocontravenetheseorderscanfacecivilpenaltiesandpossiblecriminalprosecution,althoughinvestorscanlaterapplytochangetheconditions.

Afterreceivingapproval,andsubjecttoanyconditions,Chineseinvestmentreceivesthesametreatmentasadomesticinvestorwithrespecttodomesticlaws(‘nationaltreatment’).Chinesecompaniesfacethesamecompetition,taxation,labour,environmental,andworkplacehealthandsafetyregulationsasAustraliancompanies.Investmentsinpubliclylistedcompaniesdemandevenhigherstandardsofcorporategovernanceandtransparency.Nationaltreatmentinthiswayissubjecttorobustprotectionunderanimpartiallegalframework.

Veryfewforeigninvestmentapplicationshavebeenexplicitlyrejected(AustralianTreasury2015).Between1July2008and30June2014,theAustraliangovernmentapproved67,582suchapplications(themajoritybeingapplicationstobuyrealestate)andrejectedonly65applications,mostlyrelatingtorealestate.Thevalueofrejectedproposalsisverylowrelativetothevalueofapprovals,althoughin2010–2011thegovernmentrejectedA$8.8billion(5percent)worthofproposalscomparedtotheA$176.7billionitapproved.In2013–2014,Chinabecamethelargestsourcecountryintermsofvolumeofinvestmentapprovals(14,716),aswellastotalvalueofproposedinvestment(A$27.7billion).

Whiletheformalrejectionrateislow,itisnotclearhowmanyinvestmentproposalsarewithdrawnbeforeaformalrejectionisdelivered,ormoreimportantly,howmanypotentiallysuccessfulinvestmentprojectsaredeterredbytheuncertaintiesofthescreeningregime.SuchuncertaintyisrootedinthediscretionoftheTreasurertorejectprojectsorapplyconditionsbasedonthe‘nationalinterest’.

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TheAustralianGovernment’sDecember2015foreigninvestmentpolicyprovidessomeguidanceastothefactorsthatthegovernmentwouldtypicallyconsider.Theseincludenationalsecurity,competition,tax,theeffectontheeconomyandthecommunity,competitionandthecharacteroftheinvestor,alongwithspecificconsiderationsforagriculturalinvestment,investmentinresidentiallandandnon-governmentinvestors(FIRB2015).However,thispolicyisnotbindingontheTreasurer,andadditionalconsiderationscanbeincluded,asthepolicyisinterpretedonacase-by-casebasis.WhilethismaybereassuringfortheAustraliancommunity,itdoessoatthecostofuncertaintyforpotentialinvestors.Specifically,itcreatesanapplicationriskthatdoesnotapplytodomesticinvestors.Inparticular,asaseniormemberofgovernmentoftheday,theTreasurermayonlyconsiderthenationalinterestinresponsetoshort-termpoliticalissuesorpopularpressure.

AsAustraliaincreasinglycompeteswithotheradvancedeconomiesonthebasisofitsbusinessenvironmentratherthanitsnaturalresourceendowments,thereisnobenefitfromthegovernmentcreatingregulatoryuncertainty.Forthemostpart,Australiancompetitionlaw,labourstandards,corporategovernanceandenvironmentalregulationsshouldbeenoughtoensurethatforeigninvestorsfollowthesame‘rulesoftheroad’asdomesticinvestorsintheAustralianeconomy.

Therecenthigh-profiledecisiontorejectanapplicationforaChinesecompanytoacquirean80percentstakeinAustralia’slargestprivateland-holding,ownedbyS.Kidman&CoLtdonaccountofits‘sizeandsignificance’createsuncertaintyforChineseandotherforeigninvestors(TreasurerofAustralia2016).ThepropertyportfolioisAustralia’slargestintermsoftotallandarea,including10cattlestationsacrossfourAustralianstatesandterritories,coveringover100,000squarekilometresandsocollectivelyaccountsformorethan1percentofAustralia’stotallandarea,and2percentofitsagriculturalland(TreasurerofAustralia2015).ThepublicexplanationgivenbytheTreasurernotesthatforeignacquisitionsoflandthislargewouldnotbepermittedinmanyothercountries.ThiswouldincludeChina.

ThisReportdoesnottakeaviewonthemeritsoftheargumentinlimitingthesizeoflandparcelsavailableforforeigninvestments.However,thiscaseillustrateswelltheproblemthatthecurrentFDIregimedoesnotspecifysuchlimitsclearlyinadvance,whichwouldhaveallowedallpartiestoproceedwithmorecertaintyandavoidtheadditionalcosts,delayanduncertaintyofthereviewprocess.Italsosuggeststhatconsiderationofthebenefitsofforeigninvestoracquisitionsshouldbeproperlyjudgedindependentlyofthechoicesmadebyothercountriesonsimilarinvestmentacquisitions:itmakesnosensetoreplicatedecisionsthataredamagingwherevertheyaremade.Amarketenvironmentthatallowsthefreeentryandexitofcompanies,togetherwithsoundmarketregulationandnon-discriminatoryenforcementofAustralianlaws,islikelyabetterguaranteeofnationaleconomicwellbeingthanone-timeapprovalsofbusinesstransactionsbyFIRBinanadhocscreeningprocess.

Dealing with sensitive sectors

WhilenationaltreatmentforforeigninvestorslookingtocometoAustraliaisasoundprinciple,therewillbesomesectorswheretheAustraliangovernmentmightstillreservetherighttoimposesector-specificrestrictionstoguaranteenationalsecurityorprotectotherlegitimatepublicpolicyconcerns.Australiaalreadyidentifiesthesectorsinwhichadditionalrestrictionstoforeigninvestmentapply(a‘negativelist’),buttherearenobindingprinciplesthattheTreasurermustconsiderwhendecidingthesematters.

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Theforeigninvestmentregimeshouldprovideaclearlinebetweensectorsinwhichforeigninvestmentiswelcome(thereforeremovingapplicationrisk),andthoseinwhichthegovernmentretainsdiscretion.Insectorswherediscretionisretained,thenatureofthenationalinterestconsiderationsbeingappliedshouldbewellspecifiedanddefinedastightlyaspossible.Sector-specificregulatorsratherthantheTreasurermightimposetheseconsiderations.Prioritydevelopmentareasmightstillbedesignatedinwhichforeigninvestmentinlandandagribusinessisaccordedlessrestrictivetreatment.

ClearlydefiningboundariesandprovidingguidanceforpotentialinvestorsinAustralianinfrastructureisalsoimportant.Giventhelong-termnatureandverylargecapitalrequirementsofinfrastructureinvestment,thisisanidealcandidateforforeigndirectinvestment(Box4.3).ChineseinvestmentinAustralianinfrastructureassetshasbeenthecauseofpublicdebateinAustraliaonthegroundsthatsomeinfrastructureassetsmaybecriticaltoAustralia’snationaleconomicandstrategicsecurity.

BOx 4.3: inFRAsTRuCTuRe invesTmenT in AusTRALiA

Priorto1945,neithertheprivatesectornorthefederalgovernmentwereinvolvedintheprovisionofinfrastructureinAustralia:stategovernmentsprovidedthevastproportionofinfrastructure.Inthepostwaryears,federalinfrastructureinvestmentunderpinnedAustralia’srapidindustrialexpansionandurbanisation.Sincethe1950s,thepublicinvestmentshareofAustralia’stotalinfrastructureinvestmenthasremainedfairlystableatjustunder6percentofGDP.

Sincethemid-1990s,therehasbeenadeclineinpublicsectorinfrastructureinvestment.Thishasbeenmorethanoffsetbyprivatesectorinvestmentininfrastructure.

Australia’spopulationisexpectedtoreachover30millionpeopleby2031—withthree-quartersofthisgrowthoccurringinSydney,Melbourne,BrisbaneandPerth—whichwillputpressureonurbaninfrastructurethatisalreadyinhighdemand.Inordertoaddresssomeoftheseconcerns,InfrastructureAustraliareleasedanAustralianInfrastructurePlaninFebruary2016,whichoutlinesreformsforimprovinginvestment,deliveranceandusageofAustralia’sinfrastructure.

TheAustralianInfrastructurePlanhighlightsthetelecommunications,transportationandenergysectorsaswellasurbancongestionandinter-urbanconnectivityaskeyareasforinfrastructureinvestment(InfrastructureAustralia2016).ThequestionforAustralia,however,iswherewillthemoneycomefrom?

Giventhefederalgovernment’sdebtpositionisexpectedtoworsen,theavailabilityofpublicinfrastructurefundingwillbeincreasinglylimited.Fundingforinfrastructureinvestmentfromforeigninvestmentshouldthereforebemobilisedtoplayamuchlargerrole.

Thisriskmanagementisbestapproachedasamatterofbroadpolicythatensuresongoingmonitoringandmitigationofrisks,regardlessoftheidentityoftheassetowner.Foreignoperatorsinthisareacanbelegitimatelyrequiredtonotifygovernmentoftheirinvolvement,andabidebyallrelevantlawsandregulations,includinglicensingconditionsfortheoperationofkeyinfrastructure.Wherethebehaviourofaforeigninvestorbreaksthelaworthreatensnationalsecurity,thentheAustraliangovernmentshouldreservetherighttoforcedivestmentoftheasset.

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Suchanongoing,risk-managementapproachtomanagingAustraliancriticalinfrastructurewouldbemoreeffectivethanone-offscreeningatthepre-establishmentphase.ReformsalongtheselineswouldthereforeenhancethesecurityofAustralianinfrastructureassets,whilereducingtheuncertaintythatotherwisedetersforeigncapital.

AsmoreChineseconstructionandpublicutilitieslooktoexpandabroad,thereisalargeopportunitytoattractmoreChinesecapitalininfrastructure.ThepolicydirectionsuggestedinthisReportshouldnot,ofcourse,berestrictedtoChineseinvestors,orbepreferentialtothem.Wherestategovernmentschoosetopartnerwithinternationalinvestorstobuildorupgradestateinfrastructureassets,thiscanusuallybepresumedtobeinthenationalinterest.Oneoptiontoexplorewouldbetoallowthestategovernmenttoissuesomeformof‘conclusivecertificate’thataninvestmentisinthestate’sinterestandthereforedoesnotrequirethesameforeigninvestmentapprovalsthatcurrentlyapplytoforthesaleofstategovernment-ownedinfrastructureassets.

TheUnitedKingdommightprovideausefulmodelforAustralia.ThereisnolegislativeframeworkdistinguishingforeignfromdomesticinvestorsintheUK.However,certainsectorshavetheirownregulatorybodies,throughwhichforeigninvestorsmayhavetoapplyforauthorisation.Thesesectorsincludewater,gas,financialservices,mediaanddefence,allofwhichrequirepermitstosetuporacquirecompanies.ThesebodiesdonotrestrictFDIinparticular,butenforceanumberofobligations,suchastheneedtonotifysubstantialchangesinshareholdings(Box4.4).

BOx 4.4: FOReign invesTmenT in THe uniTeD KingDOm

Inthelastthreedecades,theUKhasconsistentlybeenoneofthemostsuccessfuldevelopedcountriesinattractingFDI(Driffieldetal2013).Ratherthanpre-screeninginvestors,itreliesonstrongdomesticlegalandregulatoryframeworkstoprotecttheUK’snationalinterests.IntermsofitsstockofFDI,theUKrankedthirdintheworldin2014,behindChinaandtheUnitedStates.Thatyear,whileglobaldirectinvestmentflowsfellby11percent,theUKachieveda50percentincreaseinitsinflows.TheUKledEuropeintermsofthestock,flowandprojectvolumeofFDI(UKTI2015).

InOctober2015,UKPrimeMinisterandChinesePresidentannounceda‘flagship’GBP6billionChineseinvestmentintheHinkleyPointCnuclearplantinSomerset.AChineseSOE,theChinaGeneralNuclearPowerCorporation,wouldbailouttheplant’smaindeveloper,France’sEDF.Inthesameweek,furtherinvestmentprojectswerestruckinareasasdiverseastheautomobileindustry(AstonMartin),creativeindustries(BBCWorld)andproperty(theAdvancedBusinessPark).

TheUK’sattractivenessforforeigninvestorscanbepartlyexplainedbyitslowcorporatetaxrates,aswellasadditionaltaxincentivessuchasresearchanddevelopmentandpatentcredits.TheUK’scorporatetaxrateisunder20percentandisthelowestintheG20andsignificantlylowerthanAustralia’scurrent30percentcompanytaxandtheAustraliangovernment’sannouncedtargetof25percentby2026–2027.Additionally,theUKdoesnotimposeexchangecontrolsthataffectFDIandtherearenogeographicalrestrictionsontheestablishmentofforeignbusinessesintheUK(Smith2012).

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investment from Chinese sOes

WhilenotexplicitlytargetedatSOEsfromChina,theeffectofAustralia’sforeigninvestmentregimetoscreenallforeigngovernmentinvestmentproposalshasadisproportionateimpactonChina.ThisisbecauseofthestillsignificantlegacyofSOEsinallsectorsoftheChineseeconomy,andtheircontinuedleadingroleinresources,financeandpublicutilities(Box4.5).InadditiontoSOEs,Chinacontrolslargesovereignwealthfundsthatseekfinancialreturnsaspartofadiversified,globalportfolio.Thesefundsprovideanadditionalandimportantpoolofnewinternationalinvestmentcapital,whethertheycomewithownershipcontrolthroughdirectinvestmentorwithoutownershipcontrolthroughequityinvestment.

BOx 4.5: unDeRsTAnDing CHinese sOes

DespitetheemergenceofadynamicprivatesectorinChinathatdominatesitsmanufacturingeconomy,SOEsplayanimportantroleinkeyareasoftheChineseeconomy,includingresources,energy,telecommunications,mediaandfinance.DoingbusinesswithChinainoneofthesesectorsmostlymeanshavingtodealwithSOEs.

SOEsarenolongermereinstrumentsofthegovernment,astheywerewhenChinabeganinvestingoverseasinthe1980s(forexample,intheMtChannarproject).SOEreformsinthe1990sand2000stransformedSOEsfromministriesandindustrialbureauxintomarket-orientedoperationswithcorporategovernance,commercialgoalsandassessmentsbasedonfinancialperformance.ManysubsidiariesofSOEsarepubliclylistedonsecuritiesmarketsinChina,HongKongorNewYork.ReformsannouncedinSeptember2014requireindividualSOEstobeclassifiedaccordingtowhethertheyarepursuingstrictlycommercialorbroaderpublicpolicyfunctions.

ThelargestSOEsinindustriesthatareconsideredmostvitaltothenationaleconomy,includingoilandelectricity,aresupervisedbythecentralState-ownedAssetsSupervisionandAdministrationCommission(SASAC).These106centralSOEsaremoderncorporatestructureswithhundredsofsubsidiaries.SASACoverseestheirinvestmentbehaviour,andplaysaroleinpreventing‘destructivecompetition’betweencentralSOEsintheiroverseasinvestments.InpracticethismeansdampeningwhatcansometimesbefiercecompetitionbetweentwoormoreSOEscompetinginthesamemarket.China’sprovinceseachhavetheirownprovincial-levelSOEsthatalsooperateinhighlycompetitivesectorsoftheChineseeconomy.TherearethousandsofSOEsthatcompetebothamongthemselvesandwiththeprivatesector.

OnereasontopaycloserattentiontoSOEinvestmentmightbethepotentialharmtothemarketenvironmentinthehostcountry.TheabilityofSOEstoborrowfromstate-ownedbanksandthepotentialforstatebailoutsleadstofearsthatSOEsmightacceptheavyinitiallossestodriveoutprivatecompetitorsinthehostcountry.Inreality,thecommercialconstraintsonoverseasinvestmentsbyChineseSOEshavebecomemorestringentandtheChinesestateislesswillingtobankrollandsubsidiseunprofitableprojects.

Inaddition,someSOEshaveverylargeassetholdingsand—insomesectors,includingelectricity,oilandtobacco—monopolisetheirsegmentoftheChinesedomesticmarket.Thiscanimprovethecreditworthinessofthesecompaniesevenonpurelyprivateinternational

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lendingcriteria.However,thisdomesticpositiondoesnotautomaticallyflowthroughtotheirbehaviourinoverseasmarkets.Forexample,evidencefromSOEinvestmentbehaviourintheresourcesmarketindicatesthattheyhavetendedtoincreasecompetitionandexpandsupply(Box4.6).Thegeneralapplicationofdomesticanti-monopolyprovisionsregardlessofownershiptypeisthemostappropriateresponse.

ButwhileSOEsdodominatesomeimportantsectorsoftheChineseeconomy,stateownershipisnotsynonymouswithmonopoly.SteelisoneofChina’slargestindustrialsectorsanditispredominantlystate-owned.Butthemostprominentplayersarelocal-levelSOEs,whichcompetefiercelyamongeachother.UsingthesamemeasureofindustrialconcentrationastheUnitedStatesappliestoanti-trustprovisions(theHerfindahl-Hirschmanindex),steelisnotaconcentratedmarketinChina.Moreover,onaccountofthehistoriclegacyoftheplannedeconomyinwhichalmostallindustrialproductionwasdonebySOEs,theystillcontinuetooperateinallkindsofindustrysectors.AroundhalfoftheassetsownedbylocalSOEs(whichaccountforaroundhalfoftotalstateassets)areinun-concentratedmanufacturingsectors,inwhichSOEscompetewithprivatecompanies(Hubbard2016).

BOx 4.6: CHinese gLOBAL invesTmenTs in iROn ORe

China’sglobalinvestmentsinironoreprovidevaluableinformationabouthowcompetitiveneutralityworksinpractice.From2002to2015,Chinamade30overseasdirectinvestmentsinironore,with25madebySOEs.Chinesestatebankinginstitutionsprovidedcreditbasedoninternationalbenchmarks,plusamargin,generallymakingthiscreditcheaperthaninternationalcommercialfinance.

Butdidthisdeparturefromcompetitiveneutralityharmthemarket?

TheseChineseironoreinvestorsincreasedratherthandecreasedpartnershipopportunitiesfornon-Chineseironoreinvestment.Ofthese30investments,21weremadebyfirmswithanoperatingcompetencyinmining.Onlyoneoftheinvestmentswasmadebyaspecialisedironoreminer.ChineseSOEsmostoftentookminorityequitypositionsinpartnershipwithspecialisednon-Chineseironoreminers.Jointventuresandminorityacquisitionsmadeup22ofthe30investments.

ArelatedconcernisthatChineseironoreminersmightattemptto‘lockup’suppliesofironoreusinglong-termcontractswithChinesebuyers,inanattempttoreducethesupplytoothersteelproducersinJapan,TaiwanandSouthKorea.

Butananalysisof50Chineseironoreprocurementarrangementsshowsthatonly63.8percentofprojectedironoreoutputfromChineseprojectswasreservedthroughlong-termcontractsforChinesebuyers.TheeffectofChina’soverseasironoreinvestmentswasthereforetoincreasesupplytotheglobalmarket(Hurst2015).

AccordingtoFIRB’spolicyguidance,theAustralianTreasurerconsiderswhetheraforeigngovernmentinvestmentproposalis‘commercialinnatureoriftheinvestormaybepursuingbroaderpoliticalorstrategicobjectives’(FIRB2015).TheAustraliangovernmenthasalreadyreceivedandapprovedlarge-scaleinvestmentsfromsomeofthemoststrategicallyimportantcentralSOEs,includingfromtheStateGridCorporationofChina,ChinaPowerInvestmentCorporation,MinmetalsandChina’sthreenationaloilcompanies.

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ThedifferencesbetweentheAustralianandChinesesystemsofpoliticsandgovernance(seeChapter6)cangeneratecommunityconcernsinAustraliaaboutSOEs.Anupfrontandtransparentaccountofownershipstructuresandcorporategovernancearrangementsisimportanttoshowingthataninvestorhasnothingtohide.Overtime,goodcorporatebehaviouronthepartofSOEs,andfamiliarityonthepartoflocalcommunities,shouldmakeChineseinvestmentinAustralia’sdevelopmenteasier,asithasinthecaseofotherforeigninvestmentfromdifferentsources.

Thisextendsbeyondcompaniesthatareformallystate-owned.PrivateChinesecompaniessometimeshaveclosepersonneltiesorcontractualrelationshipswithstate,politicalormilitaryinstitutions.Thisisnotinanywaysurprising.TheCommunistPartyofChinahad87.8millionmembersattheendof2014(ChinaDaily2015),includingprivateentrepreneurs,whohavebeenallowedtojointhePartysince2002.AllSOEshavePartyCommittees,asdotheChineseoperationsofmanyprivateandforeigncompanies,includingglobalmarketleadersfromtheUnitedStatessuchasWal-Mart(ChinaDaily2016).

Ratherthanapplydifferentrulesonthebasisofformalownershiprequirements,foreigninvestorsinAustraliashouldbejudgedaccordingtotheiractualbehaviour.ForeigngovernmententerprisesinvestinginAustraliacouldstillbeexpectedtonotifyFIRBoftheirinvolvement.ButSOEsshouldhavetheopportunitytoprovetheircommercialcredentials,possiblybasedonanhistoricalaccreditationmodel(BCA2014),inwhichcasetherewouldbenoneedtotreatthemdifferentlyfromprivatelyownedChinesecompanies.Alternatively,investmentproposalsfromSOEsbelowthegeneralreviewthresholdcouldbegrantedanautomaticapproval,withautomaticconditionsimposedinrelationtolegalorcorporategovernancestandards.

ThisapproachwouldnotprovideChineseSOEswithpreferentialaccess;ratheritwouldremovediscriminationcurrentlyinplacethatdisproportionatelydetersanimportantclassofpotentialChineseinvestors.

investment to transform Chinese services

Inthe1970s,China’seconomywasclosedtoforeigninvestment.Theregimeisnowsignificantlymoreopen,andChinahasbecometheworld’slargestrecipientofforeigndirectinvestmentaftertheUnitedStates.ForeigninvestmentflowsintoChinain2014totalledUS$128.5billion(UNCTAD2015).Butinvestmentrulesandtreatmentvarybetweenindustries,andtheplayingfieldbetweendomesticcompaniesandforeignenterprisesseekingtoenterChinesemarketsisnotyeteven.

ForeigncapitalinChinahasbeenmostwelcomeinthemanufacturingsectorsthatfuelledChina’sexport-ledgrowththroughthe1990sand2000s.Almostthree-quartersofforeigninvestmentinChinagoesintothemanufacturing,wholesaleandretailsectors.ThelargestinvestorsinChinaareitsAsianneighbours,suchasJapan,whichhaveparticularexpertiseinsupply-chainmanufacturing.ThereisalsoalargeinflowofforeigncapitalintoChina’srealestatesector.

Four-fifthsoftheinvestmentfromcompaniesregisteredinChinaasforeign-fundedfirmsorjointventuresareincoastalprovinces.Halfoftheinvestmentisinthreeprovinces—Jiangsu,GuangdongandShanghai.Thisreflectshistoricalpatternsintheopeninganddevelopmentof

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China’sexportindustriesandindustrialproduction.Theseareallimportant‘sisterprovinces’forAustralianstates(seeChapter3),highlightingthehugeopportunityforstategovernmentstoleveragetheserelationshipsfurther.

ForeigndirectinvestmentinChinesecompaniesisalsoimportantforChina’sindustrialandregionaldevelopmentpriorities.TheNDRCandMOFCOMprovidesector-basedforeigninvestmentguidance.Asof2015,thereare349industriesinwhichforeigninvestmentis‘encouraged’,38industriesinwhichforeigninvestmentis‘restricted’,and36industriesinwhichforeigninvestmentis‘prohibited’,withforeigninvestmentinallotherindustriesdeemed‘permitted’.Thestatusofnewsectorsisundefined.RestrictedindustriesincludekeysectorsofinterestforAustralia,suchasfinance,healthandeducation.ForeigninvestmentinChinesemediaisprohibited.

In24oftherestrictedsectors,additionalconditionsareimposedthatpreventwhollyforeign-ownedinvestorsfromenteringtheindustry.ThisisusuallyintheformofarequirementthataChinesepartnermustbethemajorityshareholder.Dependingonthescaleofinvestment,inboundinvestmentscanbeapprovedornotedatthenationalandlocallevels.Afterthis,ordinarybusinesslicencesmustbeapprovedbeforeregisteringfortaxation,customsandforeignexchange.

BusinessesseekingtoinvestinChinafaceacomplicatedregulatoryenvironment.Therearethreeseparatelawsthatgovernthecreationofforeignenterprises—theChinaForeignEquityJointVentureEnterpriseLaw,theForeignCooperativeJointVentureEnterpriseLaw,andtheForeign-InvestedEnterpriseLaw.Therearealsohundredsofsubsidiaryandlocalrulesandregulationsthataffectforeigninvestors.

Sector-andregion-specificbarrierstoinvestment,including‘behindtheborder’regulatoryrestrictionsaretreatedcomprehensivelyintheAmericanChamberofCommerce’s2015(AmCham)WhitePaper,‘AmericanBusinessinChina’.ThisReportdoesnotendorsespecificrecommendationsmadebyAmCham,butinsteadencouragesAustralianinvestorsinChinatobevocaltobothMOFCOMandDFATtoensurethattheseprovisionsareontheradarforongoingconsultationsunderChAFTA.

Whileinvestmentinsophisticatedservicessectors,suchasinsurance,financeandlaw,issignificantlymorerestricted,AustralianbankshavebeeninChinaforalongtime(seeChapter5).ButdespiteChina’sWTOcommitmentstoopenupitsbankingsystemtocompetition,thelargestAustralianbankinChina,ANZ,hasjustfourChinesebranches,twosub-branchesandoneruralbank(AustCham2012).Eachofthebanks,exceptWestpac,holdsstakesinlocalbanksbutcannotincreasetheirequityshareabove20percent.Theserestrictionsinhibitthecross-borderfinancialinfrastructureneededtounderwritemoretradeandinvestment.

Despitethis,AustraliandirectinvestmentinChinahasalsogrownsignificantlyoverthepastdecade.SuccessfulAustralianinvestmentsofarhasbeeninnicheareasincludingbanking,medicaldevices,biopharmaceuticalsandwatermanagement,andthereiscurrentlyactiveinvestmentintherenewableenergysector(Au-Yeungetal2012).AccordingtotheABS,therewaslessthanA$500millionofAustraliandirectinvestmentinChinain2004.By2015,thisstockhadgrowntooverA$14billion(ABS2016f).ThisiswellbehindAustralia’sdirectinvestmentintheUnitedStates,theUnitedKingdom,NewZealandandevenSingapore(Figure4.3).

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Figure 4.3: Recipients of Australian direct investment, 2014 (A$billion)

0 20 40

(A$ billion)

60 80 100 120

United States

United Kingdom

New Zealand

Singapore

China

Canada

Other

Note:Aninvestmentisdeemedtobea‘directinvestment’wheretheinvestorholdsatleast10percentofequityintheinvestedentity.Source:CalculationsbasedonABSCat.No.5352.02016f.

investment in Chinese services sectors

InthesamewaythatforeigninvestmentinmanufacturingmadeChinaanindustrialpowerhouse,Chinanowwantstouseforeigninvestmenttohelpdrivethetransformationofitsdomesticservicessector.Fosteringforeignparticipationandgivingfullplaytothemarketwillhelpallocatecapitalmoreefficiently.ThisbenefitsChina’seconomicdevelopment,andprovidesanopportunityforexperiencedAustralianservicesfirmstoexpandtheirmarketinChinawhilecontributingtoitstransformation.

China’soverallpolicydirectioninrelationtoinboundinvestmentisclearlyarticulatedintheNovember2013DecisionoftheThirdPlenumoftheCentralCommitteeoftheCommunistPartyofChinaonSomeMajorIssuesConcerningComprehensivelyDeepingReform(‘theDecision’).TheDecisioncommitsChinato‘stimulatetheorderlyandfreeflowofinternationalanddomesticfactorsofproduction,highlyefficientallocationofresourcesandin-depthmarketintegration,andfosternewadvantagesinparticipatinginandleadinginternationaleconomiccooperationandcompetitionatafasterpace,inordertopromotereformthroughopeningup’.

TheDecisionacknowledgestheimportantrolethatFDIcanplayinChineseeconomicreform.Specifically,theCentralCommitteecommittedtoapply‘thesamelawsandregulationsonChineseandforeigninvestment’(nationaltreatmentforforeigninvestors),aswellas‘keepforeigninvestmentpoliciesstable,transparentandpredictable’.ConsistentwithChina’stransitiontoahigher-incomeservices-basedeconomy,theDecisionemphasisedopeningarangeofservicessectors,particularly‘finance,education,cultureandhealthcare’.

Chineseauthoritieshavelongtrialledpolicyreformsinparticulargeographicareasasawayoftestingthembeforenationwideimplementation.ThecreationofaPilotFreeTradeZoneinShanghai,followedbysimilarzonesinTianjin,GuangdongandFujian,hasprovidedanadditionalplatformfromwhichtotrialtheThirdPlenumreforms.Ifthesepoliciesarejudgedtobesuccessful,theyshouldbeexpandedtoanationalscale.

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TheDecisionalsocommittedChineseauthoritiesto‘exploreamanagementmodelforforeigninvestorswithpre-entrynationaltreatmentplusthenegativelist’.Ifrealised,thiswouldeffectivelygiveforeigninvestorsthesamerightstoinvestinChinaasdomesticinvestors,subjecttospecifiedexemptions(‘thenegativelist’).TobringthegreatestgainstoChina’seconomy,thelistofexemptionsshouldbeasnarrowlyspecifiedaspossibletocoreareasofnationalsecurityandotherconcerns.InJanuary2015,MOFCOMreleasedadraftlawonforeigninvestmentthatwouldconsolidateandreplacetheexistinglaws.

Thisdraftlawwouldenshrinethe‘negativelist’principleandwouldmoveChineseinvestmentapprovalsawayfromlistsofinvestmentsthatare‘prohibited’,‘restricted’and‘encouraged’towardapresumptionthatforeigninvestmentispermitted,subjecttoawell-defined‘negativelist’ofindustrieswhererestrictionsaremaintained,andahighmonetarythresholdabovewhichscreeningisstillrequired.This‘negativelist’hasalsobecomethebasisofChina’sBITnegotiationswiththeUnitedStatesandtheEU.AfterabusinessisestablishedinChina,theyaretobeaccordednationaltreatment.

Theinvestmentlawwouldalsointroduceanexplicitnationalsecuritytest,whichwouldgivetheStateCounciltheauthoritytoapprove,approvewithconditions,orrejectapplicationsthattouchonnationaldefence,keyinfrastructure(includingtelecommunications),keycommodityresources,investmentscontrolledbyforeigngovernments,orapplicationsthatthreateneconomicstability,publicstabilityor‘anyotherfactor’whichthegovernmentconsidersnecessarytoaddress.

Whiletheseproposedscreeningarrangementsimposerestrictions,thelawwouldforthefirsttimeallowfreeinvestmentinandoutofsectorsthatarenotlistedandthatdonottouchonbroadernationalsecurityquestions.Inthecontinuingrevisionofthedraftlaw,andwhenitisimplemented,itisrecommendedthatthresholdsforreviewareasliberalaspossibleandthatthelistofrestrictedandprohibitedinvestmentsisasshortaspossible.ThiswillmaximiseitspositiveeffectontransformingChina’sservicessectors.

ButanewinvestmentlawwillnotremovealltheobstaclestodevelopingChina’sserviceindustry.Investmentsinagriculture,energy,transportation,civilaviation,telecommunications,automobiles,tobacco,aerospace,urbaninfrastructureandlarge-scaletourismdevelopmentsarestillsubjecttovariousadditionalapprovalshurdlesthatapplytobothdomesticandforeigninvestments.Nevertheless,itwouldbeasignificantmilestoneforChina’seconomicdevelopment.

Opportunity for an enhanced investment agreement

BothAustraliaandChinahavetheirowndomesticpolicyinterestsinreformingtheirtreatmentofinvestmentflows.Thesecouldbepursuedunilaterally.CooperationinthespiritoftheComprehensiveStrategicPartnershipforChangegiveseachpartnertheopportunitytoleveragereformthroughcloserpolicycoordination.

DespitetheprogressChAFTAhasmade,theagreementretainstradebarriersinsectorsofboththeAustralianandChineseeconomies.Theserestrictionsgenerallyrequirefirmswishingtoenterthesesectors(Table4.1)tobeownedormanagedresidentsofthatcountry,orrunasajointpartnership.Liberalisingthesesectorscanprovidecommercialopportunitiesinbothcountries.

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AustraliaandChinahavehadaBITsince1988.Thishasprovidedthebasiclegalframeworkthatgovernsbilateralinvestmenttodate.ItwasadaptedtoanearlierstageofChinesedevelopmentwhenChinawasstillestablishingitsbasicmarketsystemtosupportthedevelopmentofitsownexportmanufacturingsectors.

Table 4.1: Remaining barriers to investment

in Australia: in China:

• Real-estateservices

• Telecommunications

• Fishing

• Professionalservices(patentattorney,trusteecompanies,auditororliquidator,architect(NT),migrationagentandcustomsbroker)

• Shipping/freightservices

• Aviation

• Banking

• Securityservices(NSW)

• Publictransport(NT,ACTandWA)

• Biologicalresearch(QLD)

• Wineproduction(QLD)

• Tourism(QLD)

• Alcoholandtobaccoretail(NT)

• Legalservices

• Medicalanddentalservices

• Advertising/marketresearchservices

• Technicaltestingandanalysisservices

• Agriculture,forestry,huntingandfishingservices

• Mining/oilextraction

• Photographyservices

• Conventionservices

• Telecommunications

• Audiovisual/cinematheatreservices

• Retail

• Natureandlandscape/environmentalprotectionservices

• Insurance/banking/securitiesservices

• Hospitalservices(notincludingBeijing,Tianjin,Shanghai,Jiangsu,Fujian,GuangdongandHainanprovince)

• Maritimeroadandaviationtransportservices

• Constructionandrelatedengineeringservices

Source:China–AustraliaFreeTradeAgreement,Annex3Part1:ScheduleofNon-ConformingMeasures2015.

ChAFTAnowprovidesanappropriatevehicletofosterChina’sservicestransformation,andtomaintainAustralia’sstatusasapreferreddestinationformobileinvestmentcapital.Italsoprovidesopportunitytodevelopcloserlinkagesbetweenthetwocountries’agriculturalsectors.ItincludesanagreementtoreviewtheBITwithinthreeyears,andconsiderthe‘negativelist’principlethatisthebasisofChina’sBITnegotiationswithotherpartners.

Anenhancedinvestmentagreement,whichmightproceedwithintheprocesssetupbyChAFTA(thoughmoreexpeditiouslythanforeshadowed),wouldprovidecommercialcertaintytobothsides,byremovingsomeoftheapplicationsrisksandtheuncertaintyaroundestablishmentofnewenterprisesthatcurrentlyplaguebiginvestmentdecisions.Bothpartieswouldmakecommitmentstoundertakethereformssuggestedearlier.Andbothpartieswouldcontinuetobeabletoapplydomesticlawstoprotectlegitimateinterestsinsovereignty,publichealthandsecurityonanon-discriminatorybasis.

Theconclusionofanenhancedinvestmentagreementcouldbeanappropriatemilestonetomarkthe30thanniversaryoftheoriginal1988BIT.

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Therearetwomajorbenefitsfromadoptingsuchanexpeditedtimeline.

First,Australiaisanadvancedmarketeconomywithahighlydevelopedservicessector,althoughitissmallrelativetotheEUandtheUnitedStates.ThismakesAustraliaanideal‘piloteconomy’forChina’s‘negativelist’and‘nationaltreatment’approachbeforeitconcludesdealswithmuchlargermarkets.AsuccessfulAustralia–ChinainvestmentagreementcouldthereforehelpbreakthelogjaminChina’snegotiationswiththeEUandtheUnitedStates.

Second,anenhancedAustralia–Chinainvestmentagreement,basedonthemutualapplicationofthe‘negativelist’principle,wouldsetthepaceforthedevelopmentnormsrelatingtoforeigninvestment.Unliketradeingoodsandservices,whichisgovernedbyWTOdisciplines,therearenowell-developeddisciplinesandnormsforFDIflowsexceptthoseappliedatanationallevel.TheprinciplesderivingfromanewAustralian–Chineseinvestmentagreementcouldnotonlyserveasamodelforfurtherbilateralnegotiationswiththirdparties,butalsoactasthepilotandthetemplatefornewmultilateralinvestmentliberalisationruleswithinRCEP.Amultilateralarrangementgoverninginvestmentflowswouldbesuperiortobilateralagreementsbecausetheyestablishconsistentrulesacrossmultiplejurisdictions.

ThiscouldhelpcreateopportunitiesforChinaandAustraliatocooperateinIndiaandIndonesia,forexample,andtoassistregionalgrowthbyensuringthatinvestmentflowsaccordingtoeconomicproductivityratherthanpoliticalpreference.ThisisaconcreteexampleofthetypeofengagementenvisagedbytheComprehensiveStrategicPartnershipforChangenotjustinthebilateralrelationship,butalsointheregionandbeyond.

movement of people

Fromtheearliestdaysofglobaltrade,themovementofpeoplehasbeenessentialtothemovementofgoods,servicesandfinance.Inthefuture,increasedbilateralFDIandtheprovisionofservicesrequireopportunitiesforthetwo-wayexchangeofskilledlabour.Therearecurrentlyaround15,000Australiansliving,workingandstudyingintheChinesemainland,manyofwhomareAustralian-Chinese(AustralianCentreonChinaintheWorld2015).ThereisafargreaternumberofChinesecitizensliving,workingandstudyinginAustralia(seebelow).Therearemanybenefitsfromexpandingthistwo-wayflow,bothdirectlyinsupportoftradeandinvestment,andindirectlytobuildthesocialtrustandculturalunderstandingthatwillbecrucialtothedeeperlevelofcooperationenvisagedbythisReport.Thisdoesnotentailapolicyofopenbordersormassmigration,asbothAustraliaandChinaunderstandeachother’ssovereignrighttocontroltheirbordersandensuresocialstability.Butthereareopportunitiestomakethebilateralflowsofpeoplemoreconducivetomutualprosperity.

ThisReportdoesnotattempttoprovideanexhaustivetreatmentofbilateralquestionsinrelationtotheissuingofvisasandthegrantingofvisa-freestatusforAustralianandChinesecitizensineachother’scountry.Itseeksonlytonoteafewkeyareasthatneedtobeconsideredinordertobuilduptheharmoniousandfriendlysocialrelationsthatwillunderpinthenextstageintherelationship.Thereisalreadyanofficialbilateralworkinggroupthatconsiderstourismissues.Abilateralworkinggroup,ledbygovernmentandinvolvingrepresentativesfrombusiness,education,tourismandcommunitygroups,shouldbecommissionedtoreviewvisaissuesmorebroadlyandtocomeupwithaspecifictimetablefortheimplementationofneededreforms.Thiswouldincludeconsideringthecostofvisas,particularlytouristvisas,toensurethatthepricechargedforvisaapplicationsdoesnotexceedtheexpectedadministrativecostsassociatedwithprocessingtheapplication.

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Permanent migration and citizenship

ChinesehavecometoAustraliasincethegoldrushesofthemid-19thcenturyandhavehadacontinuouspresenceeversince.IncreasedrecentmigrationfromChinahasgrowntheChinesediasporacommunityinAustralia(Box4.7).The2011Censusrecorded319,000AustralianresidentswhowereborninChina,andapproximately865,000peopleinAustraliareportedthattheyhadChineseancestry,or4percentofthetotalpopulation(ABS2011).Thisdiasporaisavaluablesharedassetforthebilateralrelationship.

BecauseofAustralia’sChinesediaspora,MandarinChinesehasbecomethesecond-mostwidelyspokenlanguageotherthanEnglishinAustralia.Accordingtothe2011Census,336,410peopleinAustraliaspeakMandarinathome.Significantly,thenumberofMandarinspeakershadincreasedbyover125,000sincethe2006Census.Morethanaquarter-millionpeoplespeakCantonese,meaningthatover600,000AustraliansalreadyspeakaChineselanguage.

BOx 4.7: THe CHinese DiAsPORA in AusTRALiA

TheAustralianCouncilofLearnedAcademies’(ACOLA)2015reportSmartEngagementwithAsiaand2016reportAustralia’sDiasporaAdvantagelookedattheroleofdiasporacommunitiesasoneaspectofthelong-termengagementneededforlastingsocial,economicandpoliticalbenefits(Angetal2015;Rizvietal2016).ACOLAstressesthatpolicymakersmustengagewithabroadlyconceived‘diaspora’thatincludesmigrants,subsequentAustralian-borngenerations,thoseofmixedculturalheritage,andtemporaryresidentsinAustraliaforworkorstudy.

Diasporasareimportant,notjustbecausetheycontributetosocialandculturaldiversity,butalsoforthebusinessandprofessionallinksthattheymaintainwiththeircountriesoffamilyorigin.Diasporasusetheirlanguagecapabilities,culturalunderstandingandglobalnetworkstocirculatebusiness,informationandresources.Particularlyindevelopingtradingrelationshipswithcountrieswherelegalprotectionsandmarketnormsarestilldeveloping,theinformalnetworksoftrustandreputationamongdiasporacommunitiesareabletofacilitateinvestmentandexchange.

Sincethedaysofthegoldrush,ChinesediasporacommunitieshaveplayedacontinuousroleinAustraliansociety.Since2000,thenumberofmainlandChineseresidinginAustraliahasgrowndramatically—overhalfoftheChinesemigrantpopulationinAustraliaarrivedafter2000.Today,AustraliaboastsoneofthelargestChinesediasporacommunitiesintheWesternworld.ProjectionsestimatethatAustralia’sChinese-bornpopulationwillreach1.3millionpeoplein2031.

FourpercentofAustralianresidentsreportsomekindofChineseheritage(ABS2011).ThisproportionisthesameinNewZealand(4.0percent;171,000),muchsmallerintheUS(1.0percent;3.14million)andEnglandandWales(0.7percent;393,000),andslightlygreaterinCanada(4.5percent;1.49million)(StatisticsCanada2011;StatisticsNewZealand2013).In2014,447,400Australianresidents,or1.9percentofthepopulation,wereborninChina.Chinaisnowthethirdmostcommoncountryofbirthforoverseas-bornAustralians,behindtheUnitedKingdomandNewZealand(ABS2016d).InCanada,Chinaisthesecondmostcommoncountryofbirthforrecentimmigrants,afterthePhilippines.InNewZealand,ChinaissecondtotheUnitedKingdomonthismeasure.

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Migration,tourism,educationandinvestmenttoAustraliaallprovidearouteforChinesetoformpermanentbondswithAustralia.In2014–2015,Australiaissued27,872permanentmigrationvisastoChinesenationals,makingChinathesecond-largestsourceofnewmigrantsafterIndia(DIBP2015a).ChinawasAustralia’sfourth-largestsourceofnewlynaturalisedcitizensin2014–2015,constituting7549(5.5percent)of136,572newcitizensinthatyear,withmoreChinesethanNewZealanderstakingupAustraliancitizenship(DIBP2016a).

ButthemovementofpeoplebetweenAustraliaandChinacansometimesbeproblematic.TheChineseLawonNationalitydoesnotrecognisedualnationality,andsomenewAustraliancitizensmaynotrenouncetheirChinesecitizenship.ThismeansthattheymaycontinuetobetreatedasChinesecitizenswheninChina,andthereforenotbeinapositiontoavailthemselvesofAustralianstatusandconsularassistanceintheeventoflegalissues.ThisisparticularlyanissueforAustralianbusinesspeopleofChineseoriginconductingcommercialactivitiesinChina.

Ultimately,itistheresponsibilityofindividualstoensurethattheircitizenshipstatusisclearwithrespecttothelawsofbothcountries,anditisintheinterestsofbothcountriestohaveclearunderstandingsandagreementsregardingtherightsandlegaltreatmentoftheircitizensineachother’scountry(seefurtherdiscussioninChapter6).

Visas for significant investors

TheAustraliangovernmentalsoprovidesvisasleadingtopotentialresidencyandcitizenshipforbusinessownersandinvestors.TheseprogramsaredominatedbyChineseinvestors,whoreceivedalmost90percentoftheSignificantInvestorVisasgrantedfrom2012toMay2016.

ThereareseparatestreamsforbusinessownersandinvestorsinAustralia(A$1.5millioninvestmentthreshold)and‘significantinvestors’(A$5millioninvestmentthreshold).SuchinvestorsneedtobenominatedeitherbyastategovernmentorbyAustrade.AnewPremiumInvestmentVisa,availableonlyoninvitationfromAustrade,providesapathwaytopermanentresidencyinAustraliaafter12monthsforaninvestmentofA$15million,andisinitiallytargetedatUSinvestors.

ThesevisatypesencouragewealthyChinesetomakeapermanentconnectionwithAustralia.Australiaisnottheonlycountrythatdoesthis.Otherdevelopedeconomies,includedtheUnitedKingdom(Box4.8),alsooffervisasforpotentialinvestors,withouttryingtodirectinvestmentintoparticularsectors.

BOx 4.8: visAs FOR invesTORs AnD TOuRism in THe uniTeD KingDOm

TherearenumerousvisacategoriesforpeopleinvolvedwithFDIprojects:investors(thoseoutsidetheEuropeanEconomicAreawhowanttoinvestGBP2millionintheUK);entrepreneurs(thosewhowanttostartabusinessintheUnitedKingdom);graduateentrepreneurs(graduatesofUKuniversitieswithanapprovedbusinessidea);representativesofoverseasbusinesses;andgeneralvisas.InvestorsfromwithintheEUhavetherighttoliveandworkintheUK(UKTI2011).InvestmentpromotionprogramssuchasthoseofferedbyUKTIservetoreducetheliabilityofforeignnessfacedbyoverseasinvestors(Driffieldetal2013).TheUnitedKingdomalsoextendsvisasto‘maximise’thespendingpowerofChinesetourists(Inmanetal2015).

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SinceJuly2015,Australia’sinvestorvisashavebeenlinkedtothegovernment’sinnovationpolicy.Thiscompelssubstantialinvestmentinventurecapitalorprivateequityfunds,managedfundsorothervehiclesthatinvestinemergingcompanies.Thisisintendedtodirectinvestmentawayfromareasthatalreadyreceivelargecapitalflowsintoriskierandless-establishedareas.

Whileitisdesirabletohaveamigrationpathwaythatisopentotalentedentrepreneurs,managinginvestmentdecisionsthroughimmigrationpolicyratherthangeneralmarketprovisionsriskscreatingbubblesanddistortionsratherthandevelopingasustainableinnovationagenda.Therefore,theSignificantInvestorVisaprogramshouldhaveregularreviewsthatcontinuetoimproveitsimplementation.

ChinaalsoprovidesavisaforsignificantforeigninvestorstoresideandworkpermanentlyinChina.InlinewithChina’sforeigninvestmentpolicy,investmentthresholdsareassociatedwithwhetheraninvestmentisan‘encouraged’sectorandwhetheritisinWesternChina(US$500,000threshold),CentralChina(US$1million)orotherregions(US$2million).Permanentresidencyisalsoavailableafteratimetohigh-rankingprofessionalsanduniversityresearchers.

Butuptakeofthisvisahasbeenverylow.In2012,only1202residencypermitsweregrantedtoallcountries.UnlikeAustralia’sinvestmentvisas,whichareheavilypromotedbyAustrade,thewebsiteoftheChineseEmbassyinCanberradoesnotprovideinformationaboutpermanentresidencyopportunitiesforsignificantinvestors.BetterpublicityandpromotionofthisvisaprogramcouldhelpChinaattractforeigninvestmentandencouragemoreinvestmentinservices.

temporary skilled labour flows

OneadvantageofFDIistheopportunitytoshareknowledge,businesspracticesandtechnologyacrossbordersbywayofthemovementofskilledlabour.The1988Australia–ChinaBITsecuredtherightofinvestorsfromeachcountrytovisittheothertocarryoninvestmentbusiness,andprovidesfortheappointmentofkeytechnicalandmanagementrolesregardlessofnationality.Thisprovidespracticalsupportfordirectinvestmentonbothsides,andprovidesenoughtimetoallowbusinessprofessionalstoestablishprofessional,personalandculturalbondsbetweenthetwocountries.TheAustraliantemporaryskilledmigrationprogramisdesignedtomeetonlygenuineskillsshortagesinAustraliabutgiventheissuesthatmanyChineseinvestorsencounterinAustralia,thoughtcouldbegiventoencouragingmoreChineseskilledprofessionalstoutilisethisprogram.ThenumberofskilledChineseprofessionalsworkinginAustraliaunderthesearrangements,however,isverylow.AccordingtotheAustralianDepartmentofImmigrationandBorderProtection(DIBP2016b),from1July2015to31March2016,2080applicantsfromChinaweregrantedtemporaryworkvisas.ChinawasthethirdmostpopularsourceofworkersafterIndia(8320grants)andtheUnitedKingdom(5750).

ChAFTAprovidedmorespecificcommitments,allowingfour-yearAustralianvisastotheexecutives,managersandspecialistsofChinesefirmsoperatinginAustralia,andthree-yearvisasfortheAustralianexecutives,managersandspecialistsofAustralianfirmsinChina.Inbothcases,familyvisasarealsooffered.ThesenumbersarealsolikelytoexpandthroughtheoperationoftheInvestmentFacilitationArrangement(IFA)thatcameintoforcewithChAFTA.

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TheIFAexpandedthescopeoftemporaryskilledlabourmovementtoAustraliatomeetthelabourneedsofChinese-registeredcompaniesinvolvedinlargeinfrastructureprojectsinpriorityindustrysectors,includingfoodandagribusiness,resourcesandenergy,transport,telecommunications,powersupplyandgeneration,environmentandtourism.WheretheChineseinvestorcannotmeettheirdemandforskilledlabourfromthelocallabourmarket,theymaynegotiatewithDIBPtoimportskilledlabourerstoworkinAustraliatemporarily.

Thisisclearlyawin–winarrangement.WhiletemporarymigrantworkersaresometimesseenasdeprivingAustraliansofjobs,undertheIFAtheyarecontributingtoprojectsthatinmanycaseswouldnothavegoneaheadbutfortheforeigninvestmentandtheavailabilityofskilledtemporarylabour.Importantly,theworkersaresubjecttoAustralianemploymentstandardsandassuranceofproperimplementationofthatprovisionisimportant.Inaddition,theycreatedemandforotherless-skilledlocalworkerswhiletheprojectisunderway.Tobolstercommunityconfidenceinthescheme,regulatingbodiesneedtohaveenoughresourcestobeabletoassesswhethercompaniesarecompliantwithsafeguardobligations.

tourism

TheprospectsfortheAustralia–ChinatourismtradearediscussedinChapter3.Torealisethepotentialofthismarketoverthenextdecade,thepromotionofAustralia’snaturalenvironmentneedstobecombinedwithinvestmentinfacilitiesandlabourthatareadequatetomeetthedemandsofChinesetourists.AnexampleofamajortourisminvestmentistheA$900millioninvestmentbyChinesecompaniesWandaandRidongGrouptobuildthreehoteltowersontheGoldCoast,anareathatisnowservicedbydirectflightsfromWuhan,acityofmorethan8millionpeople.

Inadditiontoincreasedinvestment,arrangementsfacilitatingincreasedtemporarymovementsoftouristsarewelcome.TheAustraliangovernment’sannouncementofa10-yearmultiple-entrytouristvisaforChinesetouristsisanenablerofthis.Tofacilitatebusinessandtouristexchanges,theChinesegovernmentshouldextendthesametreatmenttoAustraliancitizens.Attheleast,provisionsthatprovideshortvisa-freeentrytoChinatocitizensfromBrunei,JapanandSingaporeshouldbeextendedtoAustraliancitizensonthebasisofMFNtreatment.

From1July2014to30June2015,theAustraliangovernmentgrantedover226,812temporaryvisasforyoungpeoplefromothercountriestoworkandholidayinAustraliaforuptooneyear(thesevisascanbeextendedforonemoreyear).Theseworkingholidayvisasprovidevaluableopportunitiesforyoungpeopletolearnabouteachother’sculturesandgainworkexperience,oftenbeforefinalisingtheirlonger-termstudyandcareerplans.TheyhavebeenaseedbedofinnovationandcreativityinAustralia’sexternaleconomicandculturalrelations(Figure4.4).

AgreementswerefirstsignedwiththeUK,CanadaandIrelandin1975.WithinAsia,AustraliahasbilateralagreementswithJapan(1980),SouthKorea(1995),HongKong(2001),Taiwan(2004),Thailand(2005),MalaysiaandIndonesia(2009)andBangladesh(2010).AtthesametimeasconcludingChAFTA,AustraliaandChinasignedabilateralagreementallowing5000ChinesecitizenstocometoAustraliaonworkingholidaysvisaeachyear.

Almost2900workandholidayvisasweregrantedtoChinesebetweenthecommencementoftheprograminSeptember2015andtheendofDecember(DIBP2015b).ThereisenormousdemandfortheprograminChina,withthefirst1500visaapplications‘filledinminutes’(MinisterforImmigrationandBorderProtection2015).Butbasedonthegrantsofworking

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holidayvisastoapplicantsfromothercountriesoverthe2014–2015financialyear,the5000visacapmeansthatChinawouldonlybethetwelfth-largestsourceofworkingholidaymakers,accountingforjustover2percentofthetotal.

The5000visacapimposedonChinaisonlyaroundhalfthenumberofvisasgrantedtoChinesefromHongKong,andonlyone-fifthofthenumbergrantedtoTaiwanese.UnlikemainlandChina,bothTaiwanandHongKongofferreciprocalopportunitiesforyoungAustralians,andarenotsubjecttoaquota.

Thequotashouldbeexpandedatleastsix-foldtomatchthenumberofworkingholidaymakerscurrentlyacceptedfromTaiwan.GiventheopportunitiestoexpandAustralia’sdomestictourismindustryandtomeetthevacationingdemandsofthenewChinesemiddleclass,thiswouldbeasensibleapproachbothtoincreasedemandfortourisminAustralia,andtosupplyasourceoflanguage-equippedandculturallyawareseasonalworkerstomeetthatdemand.

ChinashouldmakereciprocalopportunitiesavailableforyoungAustralianstolive,workandstudyinChina.Stepstowardthisshouldcommenceimmediately,andneednotwaituntiltheformalreviewofthebilateralagreementin2018.

Figure 4.4: Working holiday visas granted from 1 July 2014 to 30 June 2015

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Education

AustraliaandChinahavealonghistoryofeducationalexchange.China’sfirstacademicexchangeagreementwithaforeignuniversityafter1978wasestablishedbetweenPekingUniversityandtheANUinDecember1980.Sincethen,therelationshiphasexpandeddramatically.Australianuniversitieshavesignedover1200agreementswithChineseinstitutions,evenmorethanwiththeUnitedStates(UniversitiesAustralia2014).Scientificexchangeandresearchcollaborationisburgeoning(Box4.9).

ExportincomerelatedtointernationaleducationistoutedasAustralia’sthird-largestexportafterironoreandcoal,worthalmostA$20billionperyear(DepartmentofEducationandTraining2015).Australiaisthethird-mostpopulardestinationforChinesestudentsafterthe

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UnitedStatesandtheUnitedKingdom.ChinahasbeenthelargestsourceofinternationalstudentstoAustraliasince2011.Nowone-fifthofforeignstudentvisaholdersareChinese,mostofwhomstudyathighvalue-addeduniversitiesratherthanatlanguageorvocationalinstitutes(Figure4.5).

AnexampleofanewdevelopmentistherecentlyestablishedGlobalBusinessCollegeofAustralialaunchedinMelbournebyaprivateChinesefirm.ThisisthefirstChinese-ownededucationalinstitutiontoopeninAustraliathathasstudentsfromAustralia,Chinaandothercountries.ItdemonstratesthepotentialforAustraliatotapintotheexpertise(andaccesstocapital)ofChineseeducationalinvestorstoexpanditsowneducationsector.

Bycontrast,thelargestsourceofforeignstudentstoChinain2014wasSouthKorea(62,923students),followedbytheUnitedStates(24,203)andThailand(21,296).Around4700AustralianstudentsstudiedinChinain2014(ProjectAtlas2016).

Australianeducationpolicyencouragesbothshortandlonger-terminternationalstudyexperiences.Chinawasthethird-largestdestinationforshort-termexperiencesin2013,with2614Australianundergraduatesgoing,placingitbehindonlytheUnitedStatesandtheUnitedKingdom.TheAustraliangovernment’s‘NewColomboPlan’mobilityprogramsupportsover1400Australianundergraduatestoundertakeshorteducationalorwork-basedplacementinChina.In2016,Chinawasthemostpopularofthe38possibledestinations.

TheNewColomboPlanallowsforoverseasstudyofuptooneyear,inadditiontosixmonthsofinternshipplacements.However,therearefeweropportunitiesforAustralianstoaccessChinesedegree-grantinginstitutions.TheChinaScholarshipCouncilprovidesscholarshipsforoverseasstudentstostudydegreesatChineseuniversities.Privateinitiatives,suchastheBHPBillitonAustraliaChinaScholarships,whichprovideuptoA$60,000peryearforAustralianspursuingpostgraduateeducationinChina,aremostwelcome(FASIC2016).Yetbytheirnatureaccesstothesescholarshipswillbeverylimited.

BOx 4.9: COLLABORATive ReseARCH AnD sCienTiFiC exCHAnge

Collaborativeresearchisfacilitatedthroughhigh-levelprogramssuchastheAustralia–ChinaScienceandResearchFund.TheDepartmentofIndustry,InnovationandScienceandtheChineseMinistryofScienceandTechnologyjointlymanagethisfund.ItsupportsJointResearchCentres,theAustralia–ChinaScienceAcademiesSymposiaSeries,aswellasaYoungScientistExchangeProgram.Themostrecentroundofjointresearchgrants,betweenAustralianandChineseuniversitiesandgovernmentresearchinstitutions,coversfieldsrangingfromdairymanufacturing,oceanography,mineralsensingandagriculture.TheseinitiativesconcurrentlysupporttheAustraliangovernment’sNationalInnovationandScienceAgenda(MinisterforIndustry,InnovationandScience2016),aswellastheinnovationstrategyinChina’s13thFiveYearPlan.

In2015,theAustralia–ChinaYoungScientistExchangeProgramsupported13AustralianresearchersvisitingChina,and16ChineseresearchersvisitingAustraliafortwoweeks.Thisisintendedtodevelopthepotentialofearlyandmid-careerscientistsas‘scienceambassadors’andtocatalysefutureresearchcollaboration(ATSE2016).

In2012,ChinaovertooktheUnitedStatesasthenationwiththemostformalagreementsbetweendomestichighereducationinstitutionsandAustralianuniversities.

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Theseagreementsincludestudentandstaffexchangearrangementsandresearchcollaborations(UniversitiesAustralia2014).InApril2015,Australia’sGroupofEightuniversitiesbecamethefirstuniversityumbrellagrouptosignanagreementwiththeChinaScholarshipCouncil,toincreasetwo-waymobilityofstudentsandacademics.

Theimportanceofscientificandresearchexchangetostayingabreastwiththefrontiersofinnovationrecommendsthesharpelevationoftheseandotherexchangesunderthenewbi-nationalAustralia-ChinaCommissionproposedinthisReport.

TheAustraliangovernment’sHigherEducationLoansProgram(HELP),whichprovidesincome-contingentloanstoAustraliantertiarystudents,alsoprovidesloansforexpensesforuptotwosix-monthstudy-abroadexperiencesthatcontributetoanAustraliandegree.ToensurethatAustralianswithstrongChinaskillsbuildastrongfoundationforfutureacademicandbusinessrelationshipswithChina,overseasHELPloansshouldbemadeavailableforAustralianstudentstoenrolindouble-structureddegreeprogramsathighlyregardedChineseinstitutions.

ThisinitiativerecognisesthecontinuedprogressofChineseeducation.AccordingtotheQSWorldUniversityRankings,ofthetop250universitiesworldwide,11areinAustraliaandnineareinChina.BecauseHELPloansaredesignedtoberepaidatthresholdincomes,regardlessofwhethertherecipientlivesinAustraliaornot,itwouldbealower-costwayofequippingAustralianstudentswithChinaskills.

Figure 4.5: student visa holders in Australia, 30 June 2015

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Goingtheotherway,theoveronehundredthousandChinesestudentswhoalreadystudyatAustralianuniversitieseachyearwillcontinuetobuildafirmfoundationforfuturebilateraleducation.Moreover,therearealready36universitiesinChinathathaveanAustralianStudiesCentre,providinganopportunityforongoingscholarshipinChinaconcerningAustralia.TheproposedAustralia–China(Ao–Zhong)Commissioncanservetosupportandfacilitatetheseinstitutionstodevelopcapacitiesthatallowthemtobeusedasasourceofnewpolicyideasforbothgovernmentsintheareasofeconomics,trade,publicpolicy,politicalscience,internationalrelationsandthehumanities.

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Language

WhilemanyChineselearnEnglishthroughouttheirschoolandtertiaryeducation,AustraliacannotexpecttohaveacloserelationshipwithChinabyrelyingonEnglishalone.Establishingdeeprelationshipsforofficial,businessandsociallevelsrequiresmutualcomprehensionoflanguage.Thisisdifficult.LearningChinesenotonlyinvolvesbecomingproficientatthetonesofthespokenlanguage,butalsocommittingtomemorythousandsofChinesecharactersthatarerequiredforbasicliteracy.ButthereareveryfewyoungAustralianswhoareinvolvedinthiscourseofstudy.Bytheirfinalyearofschooling,only0.1ofAustralianstudentsstudyChinese,andofthese,onlyaround400arefromanon-Chinesebackground(ACRI2016).

Allstudentsshouldhaveaccesstoappropriatelanguagestreamstoensuretheireffortsandinterestcanbeappropriatelyrewarded.ThosewhoseekanopportunitytostudyChineseinschooloruniversitybutdonothaveabackgroundinChineseoutsidetheclassroommayfindthemselvesatadisadvantageiftheymustcompeteforgradeswithstudentsfromChinesebackgrounds.Bycontrast,studentswhoarealreadyproficientinChinesecanbechallengedfurthertoensuretheyhavetop-levellanguageskillsnecessaryforprofessionalcompetenceinbusiness,governmentandeducation.

OnewaytohelpyoungstudentsachieveproficiencyisbyattendingschoolsthatareformallybilingualinChineseandEnglish.OnlyahandfulofAustraliangovernmentprimaryschoolsofferbilingualeducationinwhichclassroominstructionissplitbetweenEnglishandChinese.TherearetwoVictorianprimaryschools,andoneineachoftheACT,SouthAustralia,NewSouthWalesandWesternAustraliathatteachbilingualChinese–Englishprograms(ACRI2016).Buttheseareinsufficientandad-hocwhencomparedtonationalpolicygoals—therearemorebilingualJapanese–EnglishschoolsinVictoriathanthereareChinese–Englishschoolsnationwide.

GiventhestrategicimportanceoftheAustralia–Chinarelationship,thenetworkofbilingualschoolsteachingChineseinAustraliashouldbeexpanded.ThesecouldbenetworkedandlinkedwithanequivalentnumberofbilingualschoolsinChina.ItisestimatedthatinAustraliathecostofabilinguallanguage-programinaprimaryschoolisaroundA$500,000peryear(ACRI2016).AlthoughrunningschoolsisnotafunctionalresponsibilityoftheAustralianfederalorChinesecentralgovernments,itisappropriategiventhestrategicimportanceofthiscapacity,thataportionoftheseadditionalcostsisprovidedfrompublicfunds.

TheexpansionofChinese-languageeducationsuggestedhere—boththroughincreasingtheopportunitiestostudyChinesefornon-nativespeakersthroughtohighschoolandtheexpansionofbilingualschoolnetwork—alsorequiresanexpansionofsupplyoftalentedChineseteachers.ChAFTAdoesprovideaprovisionforalimitednumberofChineselanguagetutorsonuptofour-yearcontracts.

Thegainsfromservicesandinvestmentpolicyreformsareadditionalto,andpotentiallymuchmoreimportantthan,thegainsfrommerchandisetradeliberalisation.UsingtheopeningofservicessectorsinChAFTAtoleverageupproductivity-enhancingreformsinthesesectorsinChinaandAustraliadomesticallywouldaddconsiderablytobothcountries’incomes.And,asdiscussedinChapter5indetail,financialmarketreformwithintheservicessectorwillhelpintermediatesavingstoinvestmentswherethesesavingsaremostproductive,improveaccesstocapitalandreducetheriskpremiumoncapitalinvestmentgenerally.

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CHAPTER5Financial integration

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Key messAges

Chinaisatacriticalpointofitseconomictransition,committedtocontinuedfinancialreformandcapitalaccountliberalisationwhilesimultaneouslymanagingassociateddomesticandexternalchallenges.Financialreform,capitalaccountliberalisationandinternationalisationoftheRMBareinterdependentreformprocessesthatareoccurringsimultaneously.Capitalaccountopeningmustbesequencedcarefullywithreformstostrengthenthefinancialsystem,maintainmacro-financialstabilityandallowforexchangerateflexibility.Chinesecapitalandfinancearealreadymajorforcesininternationalcapitalmarkets,creatingnewopportunitiesforinvestmentaroundtheglobe.TheongoingopeningoftheChinesecapitalaccountrepresentsawatershedinthefinancialdevelopmentoftheAsiaPacificeconomy.Managingthischangewillrequireprudent,well-informedandstrategicpolicymakinginChinaandineachoftheregion’seconomies.

IfthegovernmentsandprivatesectorsofAustraliaandChinapositionthemselvesstrategically,thesereformsofferaonce-in-a-generationopportunitytodeepentheirrelationshipinfinancialservicesandfinancialflows.AustraliahastheunprecedentedopportunitytoexportfinancialservicesintolargeandgrowingChinesemarkets,andimportincreasedvolumesofChinesecapitaltofinanceinvestment.ChinahastheopportunitytouseAustraliaasatestinggroundasitdeepensitsfinancialreformsandopensitseconomy,gainingaccesstooneofthemostdevelopedfinancialsystemsintheregionandincreasingitsreturnoncapital.TheAustralianandChinesegovernmentsshouldengagewiththebusinesssectorsofbothcountrieswhiledevelopingaformalprogramonfinancialservices,developmentandreform.ItwouldcomplementtheStrategicEconomicDialogueandengageministers,officials,regulatorsandfirmsinaworkprogramtodeepenbilateralfinancialintegrationthatwouldbefocusedon:

• PilotingtheselectreleaseofregulatoryandlicensingrestrictionsonAustralianfirmsinChinaasaphase-inforregionalliberalisation,throughexpandingthefinancialservicescomponentsofChAFTA.

• Developingaregulardialogueandamutualrecognitionframeworkbetweenfinancialregulators,andfurthersupportingthedevelopmentofRMB-denominatedassetsandsecuritieslistingsinAustralia.

• Reviewingregulatorybarriers,includingaroundtaxationandtheimpactofmacroprudentialregulationsandtaxationpolicytoensurethatAustralianandChineseentitiesarebetterabletoengagewithoneanotherintheregion.

• Promotingthebilateralandregionalopportunitiesarisingfromfinancialtechnology(FinTech).

• ResearchbetweenAustralianandChineseinstitutionsonfinancialservicestradeandcross-borderinvestment.

• Astrongerfocusonbuildingfinancialinfrastructureintoregionalinitiativesthatseektoimproveconnectivity—suchasOneBelt,OneRoad(OBOR),theAsianInfrastructureInvestmentBank(AIIB)andtheAsianDevelopmentBank(ADB)includingpaymentsystems,creditinformation,collateralregistriesandfinancialinstitutions,andensuringChinasignsonto,andAustraliaimplements,APEC’sAsiaRegionFundsPassportandbothcountriesadvocateitsuseintheregion.

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Chinaisnowatacriticalpointofitseconomictransition.Itiscommittedtodeepeningeconomicandfinancialreforminachallengingdomesticandexternalenvironment.Economicgrowthhasslowedasaresultofbothcyclicalandstructuralfactors.Theglobaleconomyisexperiencingaprolongedperiodofbelow-trendgrowthaftertheglobalfinancialcrisis,whichisimpactingadverselyonexternaldemandandcreatingmacroeconomicconditionsthatmakeChina’sreformagendamorechallengingbutevenmoreessential.Againstthisbackground,theChinesegovernmentisaimingtoadvancereformswhilemaintainingastablemacroeconomicenvironment.

The13thFiveYearPlanstatesthatChina’sfinancialsystemreformaimstocompletetheestablishmentoffinancialinstitutionsandmarketmechanisms,topromotethehealthydevelopmentofcapitalmarkets,toestablishmonetarypolicytransmissionmechanisms,todeepenreformsofthefinancialregulationframework,toraisetheefficiencyoffinancialservicesinservingtherealsectors,andtoeffectivelymitigatefinancialrisks.

Thesereforms—howevercompletelytheyareimplemented—willprofoundlyshapethefutureoftheAustralia–Chinaeconomicrelationship.Theywillhaveimplicationsacrosseconomic,politicalandsocialdimensions.ButifthegovernmentsandprivatesectorsinAustraliaandChinapositionthemselvesstrategically,thesereformsofferaonce-in-a-generationopportunitytodeepentherelationshipinfinancialservices,financialflowsandtwo-wayinvestmentwhich,atpresent,isnascentcomparedtotherelationshipinmerchandisetrade.In2015,Chinaaccountedfor31.8percentofAustralia’smerchandiseexportsbutjust11.1percentofAustralia’sfinancialservicesexports(ABS2015a).

TheearlierreformchallengeoffullyintegratingChinesecommoditiesmarketsintointernationalcommoditiesmarkets,accomplishedafterChina’sentryintotheWTOin2001,tookthetimeanddeterminedleadershipofformerpremierZhuRongjiandformerassistantministeranddirector-generaloftheInternationalRelationsDepartmentoftheMinistryofForeignEconomicRelationsandTrade,LongYongtu.OpeningChina’sfinancialsystemissimilarlyanambitionthatwillnotbeachievedquickly.Itwillrequirepoliticalcommitmentatthehighestlevels.

FinancialservicesarethelargestsinglecomponentoftheAustralianeconomy.WithA$6.4trillioninassets,thefourth-largestsuperannuationsystemintheworld,arobustregulatoryframework,thefourthmost-tradedcurrencyintheworld,someofthelargestbanksintheworldbymarketcapitalisation,andoneoftheleastrestrictivefinancialindustriesintheregion,Australiahasaclearcomparativeadvantageinexportingfinancialservicesintotheregion(AusterandFoo2015).InvestingindeeperlinksandgreaterengagementwithgrowingChinesemarketsoffersanimmenseopportunitytotheAustralianfinancialservicesindustry.

Astheworld’slargestsaver,Chinawillplayamajorroleinshapingtheglobalfinancialsystemintothefutureasitsinternationalinvestmentpositiondeepensanditallocatesitssavingsglobally.TheroleofChinesecapitalintheglobaleconomyispoisedtogrowsubstantially.Basedonthehistoricalexperienceofothercountries,Chinawillbecomeoneoftheworld’slargestcross-borderinvestorsbytheendofthisdecade,withoffshoreassetstriplingby2020(HanemannandHuotari2016).InthesamewayChina’stradesurplushasshapedtheglobaltradingsysteminthepastfewdecades,China’soutboundcapitalwillprofoundlyshapetheglobalfinancialsystemoverthecomingdecades.

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CHAPtER 5: Financial integration

ForChina,Australiacanhelpprovidethefinancialproductsandservicesinbanking,insurance,pensionservicesandwealthmanagementthatwillbeincreasinglydemandedbytheChinesepeopleasChina’sreformsdeepen.Moreimportantly,AustraliaoffersChinatheopportunityofatestinggroundforreformsthatwillsupportitscontinuedopeningandfinancialintegration,bothregionallyandglobally.Australia’ssophisticated,globallycompetitiveandwell-regulatedfinancialmarketscanactasaneffectivestepping-stoneforChina’scontinuedopeningtotheregion.AustraliacansupportChinaacrossmanyofthereformsitisundertaking,includingexpandingaccesstoinsurance,liberalisinginterestrates,continuingtheinternationalisationoftherenminbi(RMB),raisingtheproportionofdirectfinancialintermediation,promotinginclusivefinanceandhelpingstrengthenfinancialandprudentialregulationsandtheinstitutionsthatunderpinthem.

Butbuildingthisrelationshipwillnothappenonitsown.Itisanambitionthatwillnotbeachievedquicklyandwillbemuchmorechallengingthanwasthecaseinbuildingtherelationshipinmerchandisetrade.AustralianandChinesegovernmentsandprivatesectorsneedtostrategicallypositionthemselvesandbuildthepolicyinfrastructurenecessarytofosterthisrelationship.

Thereareanumberofmeasuresthroughwhichthispositioningcanbeachieved.TheAustralianandChinesegovernmentsshoulddevelopaprogramofformalengagementonfinancialservicesreform.ItwouldcomplementtheStrategicEconomicDialogue(SED)andengageministers,officials,regulatorsandfirmsinaworkprogramtodeepenbilateralfinancialintegration.

Therearealsoopportunitiesforpartnershipinregionalfinancialcooperation.ThisincludesbuildingabilateralfocusonfinancialinfrastructureinregionalinitiativessuchasOBORandtheAIIB,toimprovepaymentsystems,creditinformationbureaus,collateralregistriesandfinancialintermediariesandinstitutionsthroughouttheAsiaPacific.Chinashouldalsosignonto,andAustraliashouldimplement,APEC’sAsiaRegionFundsPassport.Bothcountriesshouldadvocateitsgreateruseintheregion.

Thesereformsalsoinvolverisksthatneedtobemanaged.Themostsignificantriskisassociatedwiththesequencingofthereforms.Thereisadangerofprecipitouslyremovingrestrictionsoncapitalaccounttransactionsbeforethedomesticfinancialsystemisabletomanagetheebbsandflowsofforeigncapital.Capitalaccountopeningmustbecarefullysequencedwithreformstostrengthenthefinancialsystem,safeguardmacro-financialstabilityandmaketheexchangeratemoreflexible(IMF2015b).Deepeningfinancialmarketsandincreasingcapitalflowscanalsocarryrisksfortheregion.Thesereformswillchangethenatureofregionalfinanciallinkages,astradeliberalisationdidtwodecadesago,withimplicationsnotjustforfinancebutalsofortheflowsoftrade,capitalandpeople.Finally,thereisariskthatslowinggrowthreducesthemomentumforreform,whichcouldthenslowgrowthfurtherandcreateevengreateruncertaintyandvolatility.

FinancialintegrationisthevitalnextstepinstrengtheningtherelationshipbetweenAustraliaandChina.ItcontinuesastrongtraditionintheAustralia–Chinarelationship,exemplifiedinthehistoryoftherelationship(seeChapters1and6).GiventhealreadycloseeconomicandtradelinkagesbetweenAustraliaandChina,AustraliahasaspecialroletoplayintheprogressingofreformandfinancialdeepeninginChina.

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integration to date: Australia, China and the region

AustraliaandChinaarehighlyintegratedintwo-waymerchandisetrade,butmuchlesssoinfinancialservicesandcross-borderfinancialflows.In2015,Chinaaccountedforalmost35percentofAustralia’smerchandiseexports,butjust11.1percentofAustralia’sfinancialservicesexports(ABS2015b).

Australiahasaservices-basedeconomy,withtheservicessectoraccountingforaround82percentoftheeconomy’srealgrossvalueadded(GVA)andmorethan85percentofemployment(AusterandFoo2015).Financialservicesplayaparticularlystrongrole.ThefinancialservicesindustryisthelargestsingleindustrialsegmentintheAustralianeconomyonaGVAbasis,generatingA$146.4billionor8.8percentoftotaloutputasatMarch2016—slightlymorethantheminingindustryat8.8percent(ABS2016e).

Despiteitslowbase,China’sshareofAustralia’sfinancialservicesexportsisgrowingrapidly.Forexample,exportsofinsuranceandpensionservicesfromAustraliatoChinaincreasedfromA$5millionin2000toA$49millionin2014(downfromapeakofA$53millionin2013),andnowmakeup9.1percentofallexportsinthatcategorycomparedto0.6percentin2000(ABS2015b).

GreaterfinancialintegrationbetweenAustraliaandChinahasbeenfacilitatedbyacombinationofofficialandprivate-sectorengagement.DirecttradingbetweentheRMBandtheAustraliandollarwasfacilitatedbyabilateralagreementsignedbytheAustralianprimeministerandtheChinesepresidentinApril2013inShanghai.Thepracticalimpactofthiswastoreducethecostsofcurrencyconversionbyremovingintermediarycurrencies.ThisagreementsawanincreaseintradingbetweenthetwocurrenciesintheonshorespotmarketfromUS$324millioninMarch2013tooverUS$3.1billioninMaythesameyear(Finsia2014).However,thistradehascomebacksincethen.

TheuseoftheRMBforcross-bordertradeandinvestmenttransactionshasincreasednoticeablyoverrecentyearsandthemarketfortheRMBinanumberofjurisdictionsoutsideofmainlandChina—knownas‘offshorecentres’—hasdevelopedfurther.ThistrendisalsoevidentinAustralia(Hatzvietal2014).TheuseofRMBbyAustralianentitieshasincreased,althoughthereremainsmuchscopeforfurthergrowth.AnumberofpolicyinitiativeshavebeenrecentlyagreedbetweentheChineseandAustralianauthoritiesdesignedtoallowthelocalRMBmarkettodevelop.TheseincludetheestablishmentofanofficialRMBclearingbankinAustraliaandaquotathatallowsAustralian-basedentitiestoinvestinmainlandChina’sfinancialmarketsaspartoftheRMBQualifiedForeignInstitutionalInvestor(RQFII)programdiscussedfurtherbelow(Hatzvietal2014).

HavinganofficialRMBclearinghubmeansthattherewillbeimprovedefficiencyinprocessingRMBpaymentsandconversions,therewillbebetterliquidityinthemarketand,mostimportantly,thiswillincreaseconfidenceforAustraliancorporatesindealingwithfamiliarlocalinstitutions.Similarly,in2014,theAustralianSecuritiesExchange(ASX)launchedanRMBsettlementservice,enablingAustraliancompaniestotakeormakepaymentsinChinesecurrencyinnearreal-time,reducingtheriskandthecostofdoingbusinesswithChina.ThesewillbecrucialstepsindrivingincreasedintegrationbetweenAustraliaandChina.

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Thesedevelopmentsbuildonexistinginitiatives,includingthelocalcurrencyswapagreementbetweentheReserveBankofAustralia(RBA)andthePeople’sBankofChina(PBoC)signedin2012andrenewedin2015,andtheRBA’sinvestmentofaportionofitsforeigncurrencyreservesinRMB-denominatedassets.TherehasalsobeenongoingengagementonRMBinternationalisationbetweenAustralianofficials(includingfromtheRBAandtheTreasury)andtheprivatesectorthroughforumssuchastheAustralia–HongKongRMBTradeandInvestmentDialogueandthenew‘SydneyforRMBCommittee’,aprivatesectorledinitiative(seeHatzvietal2014).

Thesepoliciesandrelatedprivate-sectorinitiativeshavepositionedAustraliatotakeadvantageofemergingRMBbusinessopportunities.Sydney,asthemainfinancialcentreinAustralia,hasemergedasafast,safeandreliablehubforRMBcashandsecuritiessettlementintheAsiaPacificregion.Butdespitetheseinitiatives,theAustralianuptakeforRMBsettlementbyimportersandexportersremainslow.TheRBAhasidentifiedseveralreasonsforthis,includingshortcomingsintheavailabilityofinstrumentsallowinghedginginRMB,unfamiliarityaroundtheRMBtradesettlementprocessandadministrativedifficultiesandconcernsregardingpaymentdelaysandrejections(WeirandWalsh2014).AmorerecentsurveyofChinesefirmsfoundthatawarenessanduseofRMBfortradesettlementremainslow,althoughthenumberofthoseusingRMBtradesettlementthatreportedpaymentdifficultieshadfallensignificantly(WeirandWalsh2015).

Financial integration in the Asia Pacific

ThefinancialintegrationofAustraliaandChinaneedstobeconsideredinthecontextofachangingfinanciallandscapeacrosstheAsiaPacific.Decadesofstrongeconomicgrowthhavegeneratedgreaterhouseholdwealthandincreasingcross-borderfinancialflows,leadingtosignificantgrowthindemandforfinancialservicesandproducts.Bankbalancesheetsareexpanding,householdwealthisincreasing,ageingpopulationsaredemandingmoresophisticatedservicesandproducts,andtechnologyisenablinggreatereaseoftransactionsacrossnationalborders.AllofthesetrendswillimpactAustraliaandChina.

FinancialintegrationintheAsiaPacificregionisdeepening,comparedwiththeadvancedeconomieswherefinancialintegrationhasbacktrackedsincetheglobalfinancialcrisis.Whilecross-bordercapitalflowsasashareofGDPhavefallenglobally,inAsiathemagnitudeofcross-borderflowsisgrowingfasterthanGDP,andinmanycasesexternalassetsandliabilitiesnowexceedGDP(AusterandFoo2015).TheincreasingsizeandsophisticationofthefinancialservicessectorthroughouttheAsiaPacifichasenabledrisingcross-borderflows.Cross-borderflowsintheregionarestrongestintheareasofbanklendingandforeigndirectinvestment,whileportfolioinvestmenttendstolag(AusterandFoo2015).

ThefinancialservicesindustryinAustraliaemploys450,000peopleandisthebiggestnetcontributortocorporateincometax.Australia’sfinancialsystemhasprovedtobesound,resilientandwellmanaged.IntheaftermathoftheglobalfinancialcrisisandtheAsianfinancialcrisis,boththeAustralianeconomyandthefinancialsystemoutperformedmostoftheirpeers(AusterandFoo2015).Australia’sfinancialservicesindustryhassignificantdepth,withassetsofaroundA$6.4trillion—overfourtimesAustralia’snominalGDP(Austrade2015).Australia’sA$2.0trillionsuperannuationsystemisthefourth-largestintheworld.ThispoolofassetsisexpectedtogrowtoA$7.6trillionoverthenexttwodecades,largelyduetothelegislatedsuperannuationscheme(AusterandFoo2015).

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Figure5.1showsthegrossvalueaddedofthefinancialservicesindustryacrosstheregionin2012.Itrangesfromabout3.3percentofeconomicoutputinIndonesiatoalmost16percentinHongKong.ThisgraphalsohighlightsthesignificantdifferencesbetweenAustraliaandChina.ForAustralia,grossvalueaddedisaround8.7percentwhileitisonly5.5percentinChina.But,unlikeAustralia,thegrowthoffinancialservicesinChinahasbeensubstantial,morethandoublingfrom2005to2012andreaching8.5percentin2015(NBS2016).

Figure 5.1: gross value added by the financial services industry as a percentage of total output

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Indonesia

Vietnam

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tes

Japan

Hong Kong SAR

Singapore

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orea

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ingdomChina

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2005 2012

Source:AusterandFoo2015,usingdatafromAggregatesandDetailedTables2013;UnitedStatesBureauofEconomicAnalysis;andUnitedNationsDepartmentofEconomicandSocialAffairs.FiguresforIndiaareat2005and2011becauseofalackof2012data.

Despiteahighrateofgrowth,thereisstilladegreeoffinancialsystemunderdevelopmentacrosstheAsiaPacific.Assetsundermanagementintheregionareonly15percentoftheglobaltotal,andChinaisonlythefifth-largestholderofassetsundermanagementintheregion,wellbelowitsrelativeGDPshare.Theseunderdevelopedfinancialsystemsareinefficientinchannellingcredittofirmsandhouseholds,andmaybothinhibiteconomicgrowthandreducetheeconomy’sabilitytoadjusttoexternalshocks.

Inaddition,theAsiaPacificregionremainsfairlyrestrictiveinrelationtomanyaspectsofcross-bordertradeinfinancialservicesandfinancialflows.TheOECDproducesaseriesof‘traderestrictiveness’indicesforservicesthatmeasuretherelativeopennessofeconomiesbyattemptingtoquantifytheeffectofrelevantlawsandregulations.

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Figure 5.2: OeCD services trade restrictiveness index for commercial banking, 2015

0 0.1 0.2 0.3 0.4 0.5 0.6 Indonesia

India China Brazil

Mexico Russia Iceland

South Africa Israel

Turkey Austria

Chile AVERAGE

Switzerland New Zealand

Finland Czech Republic

Colombia Poland Japan

Denmark Germany

Italy Norway

Korea Portugal

Netherlands Slovenia

United States Ireland

Australia Belgium Canada

Slovak Republic Luxembourg

Greece Estonia

Latvia United Kingdom

Sweden France Spain

Hungary

Source:OECD2015.

Intheareaoftradeinfinancialservices,theOECDevaluatescommercialbanking(Figure5.2)andinsurance(Figure5.3).TheseshowAsiahasamongthemostrestrictivepracticesinbothcommercialbankingandinsurance,withChina,IndonesiaandIndiabeingthemostrestrictive.Australiasitswellbelow(lessrestrictive)theOECDaverageinbothindices,withthelargestcontributiontorestrictivenesscomingfromAustralia’srestrictionsonforeignownershipandothermarketentryconditions.

Developments in China’s reform agenda and implications for the relationship

Theprocessesoffinancialreform,capitalaccountliberalisationandthecontinuedinternationalisationoftheRMBwillfundamentallytransformtheChinesefinancialsysteminthecomingyears,withthepotentialtobringsignificantbenefitstotheChinesepeople.

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The13thFiveYearPlanhasaspecialfocusonfinancialreform.Thisincludesacceleratingthepaceoffinancialsystemreform,completingtheestablishmentoffinancialinstitutionsandmarketmechanisms,deepeningreformsoffinancialregulationframeworks,raisingtheefficiencyofthefinancialsectorinservingtherealeconomy,furtherdevelopingcapitalmarketstolowerthefinancingcostsofmedium,smallandmicroenterprises,andeffectivelymitigatingfinancialrisks.

Figure 5.3: OeCD services trade restrictiveness index for insurance, 2015

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 India

Indonesia China

Russia Brazil

Iceland Finland Mexico

Colombia United States

Norway Denmark

Austria AVERAGE Portugal

South Africa Latvia Israel

Hungary Italy

Canada Spain

Slovak Republic Turkey Japan

Greece Czech Republic

United Kingdom New Zealand

Chile Germany

Switzerland Poland

Sweden Australia

Ireland Luxembourg

Slovenia Belgium

France Korea

Netherlands Estonia

Source:OECD2015.

ThebankingmarketinChinaislargeanddominant,accountingformostfinancialintermediationinthefinancialsystem.PensionandwealthservicesareanascentindustryandinsuranceisonlybeginningtopenetratetheChinesemarket.Furtherprogresswillallowthefinancialservicessectortoproperlyintermediatefundsbetweenhouseholdsandfirms,andacrosstheeconomy.Overtime,thiswillsupportdomesticinterestrateliberalisationthatwill,inturn,improvetheefficiencyofcapitalallocation,enabletransparentpricing,allowfor

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smoothersavings–consumptionpatternsandenableimprovedriskmitigationstrategies.AllofthesearenecessarydevelopmentsforChinatocontinueitseconomicrebalancing,andtomovefromamiddle-incometoahigh-incomeeconomy.

China’sdomesticmarketsarealreadylargebyglobalstandards.Evenwithoutanopencapitalaccount,Chinaalreadyaccountsfor6percentofglobalcross-borderfinancialtransactions(Finsia2014).China’sdomesticbankcreditstockislargerthananyotherintheregion,includingJapan’s(AusterandFoo2015).Itsequityandfixedincomemarketsarenowamongthelargestintheworld,althoughtheyplayarelativelysmallerroleintheoperationoftheeconomy.China’sequitymarkethasgrownsubstantiallytoapeakvaluationofoverUS$10trillion.Whilerecentvolatilityhassignificantlyreducedstockmarketvalues,thesereductionsneedtobeconsideredinthecontextoflongrungrowthinChina’sequitymarkets.FromJune2014toJune2015,theShanghaiCompositeIndexincreasedby154percent.Butthisincreasewasunsustainableandnotbasedonfundamentals.Despiterecentvolatilitythatsawa45percentreductionintheindexfromJune2015totheendofMay2016,theindexisnevertheless40percenthigherthanitwasinJune2014(Bloomberg2016a).

Throughinitialpublicoffering(IPO)listingsactivitywassuspendedfromJulytoNovember2015,China’sexchangesnonethelessledtheworldintermsofIPOsin2015.Therewere89IPOsvaluedatUS$17.6billionin2015inShanghaialone—anincreaseof107percentonthepreviousyear.MainlandexchangesreopenedinNovember2015toapipelineof690companiesreadytogopublic(EY2015).Howeverthis,inpart,reflectsadistortioninChina’sfinancialmarkets,asIPOsrequireanapproachtotheChinaSecuritiesRegulatoryCommission(CSRC),whichcancauseabacklog.

China’sfundmanagementandinsurancesectorshavealsogrownsubstantially.Thefundmanagementindustryfirstemergedintheearly1990sandhasexperiencedtremendousadvancesinscaleandsophistication.Bytheendof1998,therewerefewerthan10fundmanagementcompaniesmanaginglessthanRMB500billion.ByMay2014,therewere91fundmanagementcompanies,with48foreignjointventuresand43domesticChinesecompaniesmanagingtotalassetsofRMB5.13trillion.RMB3.73trillionwasmanagedbymutualfundsandRMB1.04trillionbyprivatefunds(Austrade2014).

TheChineseinsuranceindustry’stotalassetswereRMB8.3trillionin2013,whilenetassetswereRMB847.5billion(Austrade2014).ThelaunchoftheShanghai–HongKongStockConnectprogram(StockConnect)inNovember2014andtheannouncementofmutualrecognitionoffunds(MRF)betweenmainlandChinaandHongKongon22May2015markedsignificantdevelopmentsinaseriesofmoveswhichrelaxChina’stightcontrolofcross-bordercapitalflows(KingandWoodMallesons2015).

LaunchedinNovember2014,StockConnectisajointinitiativeoftheCSRCandHongKong’sSecuritiesandFuturesCommission.ItallowsmutualstockmarketaccessbetweentheShanghaiStockExchangeandtheHongKongStockExchange.StockConnectisnowcomplementedbyasimilarlinkformutualfunds.TheorganisationssignedaMemorandumofRegulatoryCooperationconcerningMutualRecognitionofFundsbetweentheMainlandandHongKongin2015,whichallowsretailpublicfundsinitiallyofferedintheMainlandorHongKongtobesoldtoretailinvestorsacrosstheborder(KingandWoodMallesons2015).

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ChinaalsohasaburgeoningFinTechsector(anareaalsoreferredtoas‘internetfinance’)thatnowsupportsanumberoflargefirmssupplyingfinancialservicesandproducts.CompaniessuchasAliPayandWeChatdemonstratetherisingdemandforsophisticatedfinancialproductsandservicesinChina.

china’s reform agenda

Financialreformisatthecentreofthenewreformagenda.Thisincludesdevelopingefficientcreditmarketstobetterintermediatesavingstoproductiveinvestmentatthelowestpossiblecost,improvingthefinancialsystem’sabilityandefficiencyinallocatingrisk,andensuringappropriateregulatoryandinstitutionalsettingsareinplacetosustainmacro-financialstability.

Arelatedbutseparateaspectoffinancialreformisfinancialintegration.ThismeansincreasingChina’sintegrationwithregionalandglobalmarketssothatsavings,investmentandriskcanbemediatedglobally,expandingthefrontiersofproduction,investmentandconsumption.ForChina,financialintegrationwillbeachievedthroughtworelatedprocesses:increasedtradeinfinancialserviceswithoverseastradingpartners,andopeningofthecapitalaccounttoallowforincreasedcross-borderinvestment.

Chinamaintainsarestrictivepostureinrelationtotradeinfinancialservices(AusterandFoo2015).Unliketradeingoods,therestrictivenessoftradeinfinancialservicescannotbemeasuredthroughtariffs.Aprimarymodeofdeliveryfortradeinfinancialproductsandservicesistheprovisionoftheseservicesthroughthebranchesorsubsidiariesofforeignfirmsoperatinginthecountry.Restrictionsontheopeningortheoperationsofbranchesorsubsidiariesrepresentasignificantbehind-the-borderrestrictiontotradeinfinancialservices.Therestrictionsmaylimitaforeignfirm’sabilitytogenerateaprofitinthecountry,ormaymakethecostofoperatinginthatcountrymoreexpensivethanwouldotherwisebethecase.Examplesofsuchrestrictionsinclude:limitationsonthenumberorsizeofbranchesorsubsidiariesofforeigncompanies;limitedlicensestoofferproductsorservicesin-country;requirementstohireacertainnumberofdomesticstaffperofficeortosetupaminimumnumberofofficesinordertoreceiveregulatoryapprovals;requirementstocontributeaminimumamountofcapitalinthecountry;orlimitationsontheprofitsthatcanberemittedfromthebranchorsubsidiarybacktothehomecountry.ThesetypesofrestrictionsaretypicalofwhathasbeeninplaceinChinaduringthelastthreedecadesofreform.

Capitalaccountliberalisation—thatis,easingrestrictionsoncapitalflowsacrossacountry’sborders—willbekeytoChinaaccessingforeignmarkets,increasingreturnsonitssavings,andusingforeignfinancingtobuilditscapitalstockandgrowtheeconomyintothefuture.TheinternationalisationoftheRMBispartoftheopeningofChina’scapitalaccount,andwillenabletheinterestrateandexchangerateflexibilitythatwillhelptheeconomytomanageanyshocksarisingfromsuddenshiftsincapitalflows.Todate,therehasbeenanincreasingopennesstosometypesofcross-borderinvestmentinChina,withflowsofbothforeigndirectinvestmentandbanklendingrisingsignificantlyoverthepasttwodecades(Robertsetal2016).Incontrast,cross-borderportfolioinvestmentremainshighlyrestrictedandabindingconstraintinthecapitalaccount.RMBliberalisationanditsincreasinguseoffshoredoesnotguaranteecapitalaccountopening—itisconnected,butnotsynonymous.RMBinternationalisationisbothacatalystandanoutcomeofaliberalisedcapitalaccount,andiskeytoChina’sfuturecapacityforsustainablegrowthandabilitytoplayalargerroleintheglobaleconomy.

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Financialreform,capitalaccountliberalisationandinternationalisationoftheRMBareinterdependentreformprocessesthatmustbesequencedcarefully.Inparticular,capitalaccountopeninghastobesequencedcarefullywithreformstostrengthenthefinancialsystem,maintainmacro-financialstabilityandallowforexchangerateflexibility.Themostimportantdifficultyinthesequencingofcapitalmarketliberalisationisthedangerofprecipitouslyremovingrestrictionsoncapitalaccounttransactionsbeforethedomesticfinancialsystemisabletomanagevolatilityintheexchangerateandcross-bordercapitalflows.

Financial reform in china

Chinahasquickenedthepaceofdomesticfinancialmarketderegulation,afterperiodsinwhichtheacceleratingdevelopmentofdomesticfinancialinfrastructureandrisingbankingsectorfragilityinthemid-1990sandearly2000sledtomoregradualisminreformduringthelate2000s.China’sfinancialreformshavebeenpartofthegradualandcloselymanagedtransitionfromacentrallycontrolledeconomytowardsamarket-basedeconomy.Therapidexpansionofdomesticfinancialinfrastructureinthe1980sand1990sresultedfromthesubstantialgrowthintheagriculturalsectorandtheemergenceofsmall-andmedium-sizedenterprisesaftertheinitiationofthereformandopeningpolicyin1978.

Chinahasmadesubstantialprogressoninterestratederegulation.Ithasmovedfromasituationwherebothdepositratesandlendingrateswerecentrallycontrolled,toonewheredepositrateceilingsandlendingratefloorsarenowbeingremovedfromofficialcontrol.Chinahaspartiallyshiftedawayfromarelianceonpublishedbenchmarkinterestrates.Overthereformperiod,theChinesegovernmenthascautiouslyproceededwithincreasingtheflexibilityofretailinterestratesaroundbenchmarkratesthroughpilotprogramsandexperiments,withtheobjectiveofprotectingtheprofitabilityofenterprises.

Interestrateliberalisationalsohasimportantimplicationsformakingthetransmissionmechanismofmonetarypolicymoreeffective.Chinaisinthemiddleoftransformingitsmonetarypolicyframeworkfromonebasedonaquantityruletoonebasedonapricerule.Theoldquantityrulebasedsystem,whichreliedondirectcontrolofcreditandlendingthroughstate-ownedbanks,andinterferedwiththemarketallocatingscarcecapitaltoitsmostproductiveuse,hasbecomeincreasinglyineffective.Thenewpricerulebasedsystemisnowbeingputinplace,althoughthePBoCisyettoindicatewhichinterestrateitwilltargetorwhatthetimingofthechangewillbe.

ThesereformswillalsorequireasignificantstrengtheningofChineseinstitutionstoensurethatregulatoryandinstitutionalsettingsareproperlycalibratedtosustainmacro-financialstability.Amongtheproblemsinthisareaare:

• ensuringadequateaccounting,auditinganddisclosurepracticesinthefinancialandcorporatesectorsthatstrengthenmarketdisciplinewithinarobustcorporategovernanceframework;

• avoidingimplicitgovernmentguaranteesthatleadtothemisallocationofcapital;and

• ensuringadequateprudentialsupervisionandregulationofdomesticfinancialinstitutionsandmarkets,whichmayhelpdefeatcorruption,connectedlendingandgamblingforredemption(thepursuitofhigh-returnbutlow-probabilityinvestmentsbyinstitutionswithlowornegativenetworth)(EichengreenandMussa1998).

Ofcourse,thesereformsarenotjustnarrowtechnicalchallenges.Theywillrequireamuchmoreopenandtransparentsetofinstitutionalarrangementsthatpushattheenvelopeof

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politicalreform.ThesechallengesareembeddeddeepinChina’spoliticaleconomy.TheyhaveapoliticaldimensionthatwillcutdeeplyintothecloserelationshipbetweenSOEsandthestate.Thepoliticaleconomyimplicationsofreformshouldnotbeunderestimated.

ThesuccessofChina’sdomesticfinancialreformswillbeparticularlyimportantforAustralia.Whencompleted,theywillenhanceregionalstabilityandthedepthofregionalmarketsbylayingthegroundworkforaliberalisedcapitalaccountandaninternationalisedRMB.Importantly,thereformsalsoprovidesignificantopportunitiestoAustralianfinancialfirmsinsupplyingfinancialservicesandproductsintoChinesemarkets.Australia,asaleadingregionalfinancialhub,hasthepotentialtobenefitsignificantlyfromthis.Australiaalsohassignificantexperienceinfinancialliberalisation,which,throughstrongerengagementofministers,officialsandfinancialfirms,couldbeanassettoChina.

capital account liberalisation in china

China’scapitalaccounthasundergonesignificantliberalisationsincethe1990s,withtheexceptionofportfolioinvestment,whichisstillunderstrictcontrol,althoughsignificantprogresshasbeenmadethroughinvestmentschemessuchasRQFIIandRQDII(Ballantyneetal2014).Figure5.4showsthereductionintheindexofcontrolsonthecapitalaccountandcurrentaccountfrom1999to2013.In1996,thecurrentaccountachievedfullconvertibility,whilethecapitalaccountremainedlargelycontrolledbythegovernment.CapitalaccountliberalisationwasslowedbybankingsectorfragilitythatemergedinthewakeoftheAsianfinancialcrisisofthelate1990s.Onlyrecentlyhasthisprocessresumed.

CapitalaccountliberalisationwillprovidesignificantopportunitiesforChina.Itislikelytoresultinahigherdegreeoffinancialintegrationwiththeglobaleconomythroughrisingvolumesofcapitalinflowsandoutflows.Greateroffshoreintegrationcomplementsinterestrateliberalisationandensuresamoreefficientallocationofcapitalacrossmarkets,diversificationofriskandinter-temporaltrade.Theexchangerateliberalisationthataccompaniestheopeningofthecapitalaccountalsoallowsforasmootherpathofadjustmentforexogenousshocks.

Figure 5.4: index of controls on China’s capital account (ka) and current account (ca) over recent years

0.4

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-2.099 00 01 02 03 04

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Financial Crisis

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ForAustralia,theincrementalliberalisationoftheChinesecapitalaccountwillincreaseChina’sroleininternationalcommerceandfinance,includingtheprevalenceoftheRMBasaglobalcurrency.ItwillpotentiallyhaveimportantimplicationsinrebalancingtheglobaleconomyinthefutureasdemandforgoodsandservicesincreasesinChinarelativetoadvanceddeficiteconomies.Overtime,theintegrationofChina’sfinancialsystemintotheglobalmarketviaanopencapitalaccountwillalsofundamentallychangetheregionalfinanciallandscapeandthenatureoffinancialmarketlinkagesintheAsiaPacific.

Asoneoftheregion’skeyfinancialcentres,andasanetimporterofcapital,Australiastandstobenefitfromincreasedflowsofcapitalatpotentiallylowercost.This,inturn,helpsfundinvestment,buildtheAustraliancapitalstockandgrowtheeconomy.ThebigfourbanksinChinahavealreadyincreasedtheirpresenceinAustralia,whichwillhelpfacilitatethisincreasedflowofcapital(Box5.1).Liberalisationcan,however,causefluctuationsinassetpricesandinternationaltradeflows.Intheshorttomediumterm,capitalflowsmaybecomemorevolatileintheregionasChina’scapitalaccountisfurtherliberalised,andcapitalmovementsintoandoutofChinacouldaffectAustralia.

ThereisalotofuncertaintyastowhatthesizeanddirectionofcapitalflowswouldinitiallybeifChinaweretoliberalisefurther.RecentresearchbytheHongKongMonetaryAuthority(HKMA)andtheIMFonthelikelyimplicationsoffullcapitalaccountliberalisationinChinagenerallysuggestthatgrossportfoliooutflowsarelikelytobesubstantial,althoughthesepapersdisagreeonthenetimpact.TheriseinregionalcapitalflowswillalsotestAustralia’scapacitytoabsorbtheseflows,althoughAustralia’sfloatingexchangerateandstronginstitutionalsettingssuggestthatitiswellplacedtodoso.

InFebruary2016,thePBoCtookanimportantstepinliberalisingChina’scapitalaccountbyopeningitsinterbankbondmarkettoforeigninvestors(PBoC2016).Thisbuildsonthedevelopmentoftheonshore(‘panda’)andoffshore(‘dimsum’)primaryissuances.TheinterbankbondmarketaccountsforthebulkofChina’sfixedincomemarket.Previously,foreigninvestorswantingtoaccessChina’sdomesticbondmarkethadtousetheQFIIdiscussedaboveorsimilarprograms,whichplacedanumberofrestrictionsoninvestors(PBoC2016).ThePBoChasstatedthataccesstothemarketwillberestrictedtomediumandlongterminvestors.AllianceBernsteinestimatethatthisreformwillcauseaninflowofaroundUS$3trillionintoChina’sbondmarket(GriggandMurray2016).TheChinesegovernmenthasvalueditstotalbondmarketataroundUS$10.4trillioninsize,butanalystsprojectthatthiswillincreasesignificantlyincomingyearsastheChinesegovernmentrunslargerdeficits(GriggandMurray2016).However,aswithanyeconomy,ariseinChina’sdebt-to-GDPratioalsocarrieswithitcertainrisksthatinvestorswillneedtoassesscarefullyindecidingtheirlevelofexposure.AsoutlinedrecentlybytheIMF,badloanshavesincebeenpilinguponbanks’books.Theoveralldebt-to-GDPratioinChinaisestimatedtobe237percent,whiletheIMFestimatescorporatedebt-to-GDPat145percentandraisesconcernsaboutChinesefinancialfragility(DonnanandMitchell2016).

ThesebondmarketreformsshouldbenefittheChineseeconomyinanumberofways.Increaseddemandfortheexistingstockofbondswouldreducebondyields,allelsebeingequal.ThiswouldreducethefiscalburdenofthesedebtinstrumentsontheChinesegovernmentandreducethecostoffundingacrosstheeconomy.Totheextentthatincreasedflowsalsocontributetoimprovedmarketliquidity,offshoreparticipationmayalsoimprovemarketfunctioningandenablethefixedincomemarkettorepresentachanneloftransmissionformonetarypolicy.Thishighlightstheimportantstabilisationrolethatcapitalflowscanplayininternationalcurrencymarkets(McKibbinetal1999).

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BOx 5.1: CHinA’s ‘Big FOuR’ BAnKs in AusTRALiA

AlthoughChinesebankinghasarelativelylonghistoryinAustralia,thenumberofChinesebanks,branchesandtheservicestheyprovidehaveincreasedsignificantlyoverthelast10years.ThesebankshaveplayedakeyroleacrossanumberoffinancialmarketsandhavehelpedfinancemanysubstantialprojectsinAustralia.

industrial and commercial Bank of china (icBc) istheworld’slargestbankbymarketcapitalisation.ItopenedabranchinSydneyin2008andwasapprovedbytheAustralianPrudentialandRegulationAuthority(APRA)asaforeignauthoriseddeposittakinginstitution.ThesuccessfulestablishmentoftheSydneybranchwasregardedasasignificantbreakthroughinthebank’sprogresstowardsgreaterinternationalisation,improvingitsinternationalmanagementstandardsandprovidingacomprehensiverangeofbankingservicestotheAustralianandNewZealandmarkets,whichICBCidentifiesasoneofthemostprosperousregionsintheSouthernhemisphere(ICBC2016).ICBChassinceexpandeditsnetworktoPerth,MelbourneandBrisbane,offeringbankingservicesintradefinance,projectfinance,syndicatedloans,corporateloans,deposits,foreignexchange,derivatives,remittances,settlementandclearingservices.AthirdofitsSydneybranch’scorporateclientsincludeAustraliancompaniessuchasWestfieldandQantas,andithasprovidedcapitalfortheStateofVictoria’sdesalinationplant,theRoyalAdelaideHospitalrenovation,andcoalloadersinNewcastleandnearGladstoneinQueensland(IndustryNSW2015).

Bank of chinafirstestablishedoperationsinSydneyin1942andnowhasninebranchesinAustralia,themostofanyChinesebank—fiveinSydney,twoinMelbourne,oneinPerthandoneinBrisbane.ThefinancialservicesofferedbyBankofChinafocusontradefinance,expressremittance,localandforeigncurrencydeposits,residentialmortgages,commercial,constructionandsyndicatedloans,overdraftfacilities,foreignexchangemargintradingandAustraliandollarclearingandsettlementservices(BankofChina2016).TheAustralianFinancialReviewrecentlynotedtheimportantrolethatBankofChinaandotherChinese-ownedbanksareplayinginfillingthegapsleftintheareaofforeignlendingbythebigfourAustralianbanks(Tan2016).

china construction Bank (ccB)isthesecond-largestbankintheworldbymarketcapitalisation.CCBopenedarepresentativeofficeinSydneyin2007andinAugust2010,APRAapprovedCCBasaforeignauthoriseddeposittakinginstitution,authorisingittocarryonbankingbusinessinAustralia.CCB’sSydneyBranchisCCB’sfirstbranchinAustralasia.ItconductswholesalebankingbusinessinAustralia,includingcorporatelendinganddeposit,internationalsettlement,tradefinanceandAustraliandollarclearingandsettlementservices.CCBhasnotedthat‘theestablishmentofCCBSydneyBranchwillenableCCBtoexpanditsglobalnetworkandenhancecustomerservicecapabilitytofacilitatetheeconomicandtradecooperationbetweenAustraliaandChina’(CCB2016).

the Agricultural Bank of china (ABc)wasChina’sfirstcommercialbank.IthasthelargestnetworkofbranchesinChinaandthelargestcustomerbase,with350millioncustomersandassetsofUS$2trillion(IndustryNSW2015).TheABCSydneyBranchobtainedtheauthoritytocarryonbankingbusinessfromAPRAinMarch2014.Itconsistsofsevendepartmentsincludingcorporatebanking,treasury,tradefinance,operations,

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riskmanagementandcompliance,financeandaccounting,andadministration.ABCprovidesitsclientswithbankingproductsincludingcorporatelending,tradefinance,multi-currencysettlements,remittancesandotherservices.TheSydneyBranchconductsbusinessactivitieswithmultinationalenterprises,ChineseinboundinvestorsinAustralia,Australiancompaniesandotherfinancialinstitutions(ABC2016).

internationalisation of the RmB and the development of an offshore RmB market

TheinternationalisationoftheRMBandthedevelopmentofoffshoreRMBmarketsaretwoimportantgovernment-supportedpolicyinitiativesthathaveprogressedsignificantlysincebeinglaunchedmanyyearsago.TherehasbeenincreaseduseoftheRMBasatransactionalcurrencyoverthelastfewyears.Bytheendof2014,RMB-denominatedcurrentaccounttransactionsaccountedforaboutone-fifthofChina’stotalcurrentaccounttransactions.RMB-denominatedinvestmenthasalsoincreasedinrecentyears,butremainssmallrelativetothevalueofRMB-denominatedtradesettlements.

TheRMBhasgraduallymovedtowardsamoreflexibleexchangerateregimeoverthesameperiod(seeFigure5.5).In1994,theofficialandmarket-determinedexchangerateswereunified,leadingtoalargeRMBdepreciation.TheexchangeratewaspeggedtotheUSdollarfromduringtheAsianfinancialcrisisto2005toreducethevolatilityofthecurrency.From2005to2010,theofficialpeggingtargetoftheRMBwasswitchedfromtheUSdollartoabasketofcurrenciesandthepeggingwasmanagedwithinatradingbandof0.3percent(later0.5percent).From2012to2014,thePBoCwidenedthedailytradingbandoftheRMBagainsttheUSdollarfrom0.5percenttoeventually2percent.InAugust2015,thePBoCdevaluedtheRMBbyalmost2percent.Despitea2percentdevaluationbeingsmallbythestandardsofmostcurrencies,thismovecausedoneofthelargestcentralparityshiftsintheRMB’shistory(secondonlytothatfollowingthecessationoftheUSdollarpeg).Moreimportantly,whiletheRMB’sfixingratewaspreviouslypersistentlyhigherthanthespotrate,inAugust2015thePBoCdepreciatedthefixingrateandmovedtoasystemwherethefixingratereflectsthepreviousday’sspotcloseandovernightdevelopments.Thischangeindicatesanincreasinglymarket-drivenapproachtocurrencyreformfromthePBoCandalsoactstoclosethegapbetweenonshore(CNY)andoffshore(CNH)markets(Bloomberg2015).

TheinternationalisationoftheRMBhasanimportantmeaningforChina’sglobaleconomicstatus.CapitalaccountliberalisationisessentialtomakingtheRMBatrulyglobalcurrencyandincreasingChina’sroleininternationalfinance.ThisincludestheRMB’srecentinclusionintheIMF’sSpecialDrawingRightsbasket.ThisinclusionandinternationalisationoftheRMBbringsbenefitsfromreducingcurrencyrisksforChineseexportersandimportersascapitalaccountliberalisationandexchangerateregimereformproceeds.Inthelongerterm,thisalsohaspotentiallysignificantimplicationsforthestructureoffinancialandcommoditymarketsgloballyastransactionsandcontractsmaybecomeincreasinglydenominatedinRMB.

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Figure 5.5: nominal and nominal effective exchange rates — the RmB against the us dollar

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The opportunities for financial service providers in China

AustraliacanseektoengageactivelyintheprocessofChina’sfinancialreform,buildingoffthecloseandestablishedeconomicandtradelinkagesbetweenChinaandAustralia,andthegrowingpotentialforfurtherfinancialintegration.Australiamustadaptandpositionitselfstrategicallyifitistobenefitfromthesereforms.Onewaytodothiswouldbetoincreasethevolumeandvalueoftradeinfinancialservicesbetweenthetwoeconomies.

Atfirstglance,tradeinfinancialservicesdoesnotappeartobeanimportantpartofAustraliantrade,oroftheAustralianeconomy.AccordingtotheABS,totalexportsof‘financialservices’and‘insuranceandpensionservices’stoodatA$3.9billionin2014,orjust6.4percentofAustralia’sservicesexportsandslightlyover1percentofoverallexports.FinancialservicesaccountforA$3.3billion(86.4percentofthetotal),andinsuranceandpensionservicesaccountfortheremainingA$539million(13.9percent)offinancialsectorexports(ABS2015b).

TheseABSfiguresomitfinancialservicesthatareprovidedonshoreinChinabybranchesorsubsidiariesofAustralianfirms—theoffshoreoperationsofAustraliancompanies.Technicallythesearecalled‘foreignaffiliatesales’.Ifforeignaffiliatesalesareincluded,financialservicesarepossiblyAustralia’slargestsingleservicesexportcategory,withavaluethatislikelyoverA$50billionannually(AusterandFoo2015).Whenforeignaffiliatesalesareincluded,ChinaisamuchsmallerfinancialservicestradepartnerforAustraliawhencomparedwiththeUnitedStates,theUnitedKingdomandNewZealand—butalsoSingapore,Thailand,IndonesiaandJapan(Figures5.6,5.7and5.8).Highbarrierstofinancialservicestradeandcross-borderinvestmentinChinamaybeinhibitingAustralianfirmsandinvestorsfromgrowingtheirconnectionswiththecountry.AccordingtotheOECD,ChinahashighlyrestrictiveregulatoryandlegalregimesinbothcommercialbankingandinsurancecomparedtoOECDnations.AustraliaisamongthemostopeneconomiesintheAsiaPacificregion,withadegreeofopennessthatexceedstheOECDaverage.

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DoingbusinessinChina’sfinancialservicesindustryremainsverychallenging.Therearestronggovernmentregulationsandvastlydifferentbusinessculturesandmarketenvironments.Butthepotentialrewardsforcompaniesthataresuccessfularesignificant.AlthoughChinaisperceivedasachallengingmarketforforeigninsurers,Australianfinancialservicescompanieshaveenteredandmanyhaveestablishedlocalrepresentativeoffices(Box5.2)orjointventuresinnumerousareas(Box5.3).RecentresearchfromMunichRepredictsthatChina’srankinginglobalinsurancepremiumvolumeswillclimbfrom10thin2006tothirdin2020,behindonlytheUnitedStatesandJapan(Austrade2014).

Figure 5.6: Australia’s exports of financial services to the Asia Pacific region

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Figure 5.8: Total sales of financial services and insurance and pension services by Australia by mode of supply, 2009–2010

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BOx 5.2: AusTRALiA’s ‘Big FOuR’ BAnKs in CHinA

Australia and new Zealand Banking group (AnZ) hasbeeninChinasince1986andtodayithassevenbranchesandfoursub-branchesaswellasanoperationshubinChengdu.Overthepastthreedecades,ANZhascontinuedtoexpanditsfootprintandremainsoneofAustralia’slargestinvestorsinChinawithsuccessfulpartnershipswiththeBankofTianjinandtheShanghaiRuralCommercialBank.In2010,theAustraliaandNewZealandBank(China)CompanyLimited(ANZChina)wasestablished,makingANZthefirstAustralianbanktobelocallyincorporatedinChina.ANZistheonlyAustralianbankwithbothlocalandforeigncurrencycapabilitiesinretailandcorporatebankinginmainlandChina.ANZChinahasaround500employeesasofApril2016.

commonwealth Bank (cBA),Australia’slargestbank,hasbeenoperatinginChinaforovertwodecades.IthasbeengrantedaRMBlicenceforitsShanghaiBranchbytheChinaBankingRegulatoryCommission(CBA2015).TheRMBlicenceenablesCBAtobroadenitsinstitutionalofferingstoincorporateallaspectsoftradeandinvestmentforclientsdoingbusinessinthefastgrowinganddeeptradecorridorbetweenAustraliaandChina(CBA2015).CBAhasabranchinShanghai,abranchinBeijing,apresenceintherecentlyexpandedShanghaiFreeTradeZone,anetworkof15branchesacrossHenanandHebeiprovinces,alifeinsurancejointventurewiththeBankofCommunicationsandtwootherkeyjointventures(Finsia2014).Theseare:

• JinanCityCommercialBank(QiluBank)inShandongprovince,northernChina,ofwhichCBAownsa20percentstakepurchasedin2004.Thisisthe10th-largest

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citycommercialbankbyassetsinChina,andCBA’spartnershipaimstointroducenewfinancialproductsandtechnicalskills,speedupcompliancewithinternationalstandardsandimprovethebank’scompetitiveness.

• BankofHangzhou:CBAhasowned19.9percentofthisbanksince2005,withA$100millioninvested.

national Australia Bank (nAB)providesarangeofcorporate,institutional,tradeandselectedpersonalbankingservicesfromabranchlocationinShanghaiandanewlyestablishedbranchinBeijing.ThesebranchessupportAustralianandNewZealandbusinesseslookingtotradewithorinvestinChinaandtherestofAsia.NAB’sstatedpurposeisalso‘tosupportinstitutionalandcorporatecustomersfromChinaandAsialookingtotradewithorinvestinAustraliaandNewZealand,particularlyinthebank’sareasofexpertise:theenergy,utilities,naturalresources,foodandagribusinesssectors’(NAB2015).

NABfirstopenedanofficeinChinain1982,andcurrentlyhasarepresentativeofficelocatedintheChinaWorldTowerinBeijing.NABhaspartnershipsandrelationshipswithnationalbankcardassociationChinaUnionPayandbanksincludingChinaDevelopmentBank,AgriculturalDevelopmentBankofChina,ShanghaiPudongDevelopmentBankandIndustrialBank.ItalsoworkswithwealthmanagementinstitutionsChinaInternationalIndustrialTrustandChinaHuarongAssetManagementCorporation(Finsia2014).InadditiontothenewBeijingbranch,NAB’srecentapprovalfromtheChinaBankingRegulatoryCommissionforaRMBlicenseforitsShanghaibranchwillalsohelpcustomersexplorewiderbusinessopportunities,bettermanageforeignexchangerisksandenhancebusinessefficienciesinChina(NAB2015).

WestpacfirstopenedanofficeinChinain1982,andsincethenhasestablishedofficesinHongKong,Beijing,ShanghaiandaShanghaiFreeTradeZonesub-branchwithspecialistteamsfocusedontrade,structuredcommodityandassetfinance,debtcapitalmarkets,derivatives,foreignexchangeandnaturalresources(Finsia2014;Westpac2016).IthasrecentlydeepeneditsofferingstosupportincreasingdomesticandinternationalRMBflows,andin2013wasawardedaRMB-dollarmarketmakerslicencetotradethecurrencypairsinmainlandChina,followedbyaderivativeslicence.WestpacestablishedanAsiaAdvisoryBoardinNovember2013tostrengthenitsconnectivityacrossAsia.

InApril2012,InsuranceAustraliaGrouppurchaseda20percentstake(sincedilutedtoa16.9percentstake)inChinesegeneralinsurerBohaiPropertyInsuranceCompanyLtdtoformastrategicpartnershipandincreaseitsfootprintinChina.Similarly,inJanuary2010,CBAandChina’sBankofCommunicationsformeda51:49percentlifeinsurancejointventure(Austrade2014).

Theseacquisitions,combinedwithorganicgrowthstrategiesamongsomefirms,suggestthattheAustralianfinancialsectorcanbeoneofthelargestdirectinvestorsintoChina.RecentlytherehasbeenaslowinginthisprocessassomeAustralianfinancialservicesprovidersreducetheirinvestmentsinChina.ANZ,forexample,recentlyreduceditsstakeinChina’sBankofTianjin,reportedlybecauseofonerouscapitalrequirementsandrestrictionsitfacedinoperatinginChina.Theseissuesarediscussedindetailinthesectionsbelow.

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BOx 5.3: AmP CAPiTAL AnD CHinA LiFe

InApril2006,AustralianfinancialservicescompanyAMPCapitalsecuredAustralia’sfirstQFIIlicence.PlatinumInvestmentCompanyandMacquarieBankfollowedin2008and2012respectively(ChinaXBR2016).TheQFIIprogramallowsselectedinternationalinvestorstoaccessRMB-denominatedcapitalmarketssuchasthe‘A-shares’tradedontheShanghaiandShenzhenstockexchanges.

ThoughAMPCapitalhashadapresenceinChinasince1997,itsengagementandcooperationwiththeChinesefinancialsectorexpandedsubstantiallyfollowingitsQFIIapproval.ThepartnershipbetweenAMPandChinaLife,China’slargestlifeinsurancecompany,beganin2006.AfterthreeyearsofcollaborationonQFIIinvestments,thetwocompaniesenteredaMoUtoexplorepotentialpartnershipsinpensionsandfundmanagementinlate2009(Somasundaram2013).

InJune2013,regulationscameintoeffectthatallowedinsurancecompaniesinChinatoestablishfundmanagementcompaniesofferingpublicmutualfundstoretailandinstitutionalinvestors(AMP2013).AMPwentintoapartnershiplaterthatyearwiththeChinaLifeAssetManagementCompany(aChinaLifesubsidiary),establishingtheChinaLifeAMPAssetManagementCompany.ByJanuary2014,thenewcompanyhadraisedRMB11.9billion(A$2.2billion)oninitialpublicofferingforitsfirstpublicmutualfund(AMP2014).AccordingtotheAssetManagementAssociationofChina,China’smanagedfundsmarketwasworthUS$2.5trillionin2015,upfromUS$100billion10yearsearlier(Smith2015).

In2014,AMPannounceditsacquisitionofa19.99percentstakeinChinaLifePensionCompany,thelargestpensioncompanyinChina.Theacquisition,worthA$240million,meantthatAMPwasthefirstforeigncompanyintheworldtopurchaseastakeinaChinesepensioncompanywithfulllicensesallowingend-to-endservicesthroughoutChina(Austrade2014).

NotallofAMPCapital’sventureshavebeenasstableasitscollaborationwithChinaLife.Thecompany’sChinaGrowthFundincreasinglycameunderfirefromactivistinvestorsduetoitsdiscountedtradingvalue,beforeinvestorsvotedtowinditupinJuly2016(Robertson2016).TheAMPCapitalAsiaQuantFund,along-shortequity-focusedfund,closedoperationsinFebruary2016(WilleandWaite2016).Onbalance,however,AMP’sinitiativesinChinahavecontinuallybeenoneofthecompany’smostsignificantenginesofprofit,withstandingthevolatileequitymarketperiodsinthesecondhalfof2015andJanuary2016.

Overall,AMPandChinaLife’spartnershipshavebeenasuccessstoryofongoingbilateralcooperation.TheChinaLifeAMPAssetManagementventure’sexceptionalgrowthwasamajorforcebehindAMP’srecordprofitsin2015(Letts2016).Flow-ongainsfromthepartnershiphaverunbothways.AMP’spropertyfundshavebenefitedsubstantiallyfromChinesecapitalsupport,whiletheAustraliancompanyisinitiatingapilotprogramforChinaLifeinsuranceagentstogainfinancialadvisoryskills(Smith2015).

Thesuccess,accordingtoformerAMPCapitalCEOStephenDunne,isduetotheclosenessofthepartnership.‘WecouldhavepartneredwithasecuritiescompanyoraregionalbankbutwetookastrongviewthatChinaLifewasagoodpartnerbecausewesharealotofsimilaritiesandweliketheirdistributionreach,’DunnetoldtheAustralianFinancialReviewin2015.‘Wecan’treallyputnumbersaroundtheopportunitythatexistsforusinChina’,saidDunne(Smith2015).

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A formal engagement program on financial integration

Australiahasastrongcomparativeadvantageinfinancialservicesintheregion.ItoffersChinatheopportunityofatestinggroundforreformsthatwillsupportChina’scontinuedopeningandintegration,globallyandregionally.ThecurrentreformprocessesinChinaofferAustraliaaonce-in-a-generationopportunitytoestablishthelinksnecessarytosupplythefinancialproductsandservicesthatChinaneedsandtostrengthenAustralia’spositioninglobalmarkets.

Thisoutcomewillnothappenofitsownaccord.ItrequirestheAustralianandChinesegovernmentsandprivatesectorstostrategicallypositionthemselvesandcreatethebilateralarchitecturenecessaryforcollaborationtooccur.Thisarchitectureshouldbecentredonaformalengagementprogramonfinancialservicesandreform.ThiswouldcomplementtheAustralia–ChinaSED,includingtheAustralia-ChinaInvestmentCooperationFramework(Box5.4),andengageministers,officialsandfirmsinaworkprogramtodeepenbilateralfinancialintegration.Theengagementprogramwouldhavefivekeyareasoffocus(eachisdiscussedinturn):

• pilotingtheselectreleaseofregulatoryandlicensingrestrictionsonAustralianfirmsinChinaasaphase-inforregionalliberalisation,expandingthefinancialservicescomponentsofChAFTA.

• developingaregulardialogueandamutualrecognitionframeworkbetweenfinancialregulators,andsupportingthedevelopmentofRMB-denominatedassetsandsecuritieslistingsinAustralia.

• reviewingregulatoryrestrictions,includingthoserelatingtotaxationandtomacroprudentialregulationsanddividendimputationschemestoensurethatAustralianandChineseentitiesarebetterabletoinvestandworktogetherintheregion.

• exploringthebilateralandregionalopportunitiesarisingfromFinTechanddigitalfinancetopromotefinancialinclusion.

• commissioningresearchbetweenAustralianandChineseinstitutionsonfinancialservicestradeandcross-borderinvestment.

Australiahasexperiencedthebenefitsandthecostsofeconomicliberalisation,havingopeneditseconomyanddevelopeditsfinancialinfrastructure,institutions,regulatorysettingsandmacro-financialframeworksoverthelastthreedecades.Thesereformshavebeendifficult,complexandtime-consuming.Theyhaverequiredyearsofcommitmentfromsuccessivegovernmentsandhave,attimes,resultedinsignificantfinancialandeconomicvolatility.Australia’sexperienceinundertakingthesedifficultreformsisanassetforChinaasitundertakesthedifficultprocessesoffinancialreform,capitalaccountliberalisationandRMBinternationalisation.

ThereissignificantscopeforAustralianministersandpoliticians,governmentofficials,corporateregulatorsandprivate-sectorfinancialfirmstocollaboratewiththeChinesegovernmentandChinesebusinessesonfinancialreform.ThereisgreatinterestwithinAustraliatosharethisexperiencewithChina.

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BOx 5.4: THe AusTRALiA–CHinA invesTmenT COOPeRATiOn FRAmeWORK

AsdiscussedindetailinChapter4,theelevationoftheComprehensiveStrategicPartnershipintoaComprehensiveStrategicPartnershipforChangewillbeimportanttodeepeningtheAustralia–Chinarelationship.Thiswilladdmomentumoverthenextdecadeformovingtoputinplaceatreaty-levelcommitmentcoveringbothcountries’mutualinterestsinopenmarkets,resourceandenergysecurity,sustainableagriculturaldevelopmentandfoodsecurity,andreliableaccessforforeigninvestmentinbothcountries.TheAustralia–ChinaStrategicEconomicDialogueprovidesanopportunityforAustraliaandChinatoexploreopportunitiesforclosereconomictiesandtodiscussissueswithintheglobaleconomicenvironment.TheinauguralSEDwasheldin2014inBeijingandwasattendedbythentreasurerJoeHockey,thenministerfortradeandinvestmentAndrewRobbandtheChairmanofChina’sNationalDevelopmentandReformCommission,XuShaoshi.

Attheinauguralmeeting,AustraliaandChinaestablishedanInvestmentCooperationFramework.TheFrameworkgoesbeyondChAFTAandcreatesnewpathwaysforpromotingtheexportoffinancialservices,forrealisingtwo-wayinvestmentinnewsectors,andforidentifyingroadblocksforinvestorsfrombothcountries.ThisallowssignificantopportunitytodeepentherelationshipatanumberoflevelsincludingexpandingservicesexportsfromAustraliatoChinaandimprovinginvestmentopportunities.

‘Theinvestmentcooperationframeworkgoesbeyondthefreetradeagreement’,AustralianTreasurerJoeHockeysaid.‘ThefocusistodeepentheeverydayengagementbetweenChinaandAustraliawithsomeidentifiableprojects,andthisisasmuchaboutinvestmentinAustraliaasitisaboutAustraliainvestinginChina’.(seeChapter4.)

Piloting the select release of regulatory and licensing restrictions

Australia’ssophisticated,globallycompetitiveandwell-regulatedfinancialmarketscanactasaneffectivestepping-stoneforChina’scontinuedopeningtotheregion.AustraliacansupportChinaacrossmanyofthereformsitisundertaking,bypilotingtheselectreleaseofregulatoryandlicensingrestrictionsforAustralianfirmsinChinaasaphase-infornon-preferentialregionalandgloballiberalisation.

TherearemultiplereformprioritiesthathavebeenoutlinedbytheChinesegovernment,andwhichAustraliacanassist.Thesearediscussedinmoredetailinthesectionsthatfollow,butinclude:

• loweringbarrierstoentry—forexample,byfast-trackinglicensingforAustralianfirmsandremovingrestrictionsonbranchlocations,thenumberofbranches,openinghoursandotherrestrictionsonforeignfinancialinstitutions.

• reformingpolicyinstitutions—bydeepeningofficialengagementbetweenAustralianandChinesefinancialregulatorsanddevelopingamutualrecognitionframeworkbetweenthem.

• raisingtheproportionofdirectfinancialintermediation—bypilotingtheselectreleaseofregulatoryandlicensingrestrictionsonAustralianfinancialintermediariesoperatinginChina.

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• expandingaccesstoinsuranceandreducingprecautionarysavings—byeasingrestrictionsonAustralianinsurancefirmsandreformingmacroprudentialregulationstofacilitatejoint-partnerships,suchasthatbetweenAMPandChinaLife.

• promotinginclusivefinance—bysharinginformationonfinancialinclusionandfinancialresilienceprogramsinAustraliaandbydevelopingaprivatesectorfundedgrantprogramonprogramstopromotefinancialliteracy.

• promotingfinancialinnovationthroughnewmarketsandproducts—byexploringthebilateralandregionalopportunitiesarisingfromFinTechanddigitalfinancetopromotefinancialinclusionandintermediation.

• liberalisinginterestrates,exchangeratesandgovernmentbonds—bysharingAustralia’sexperienceinundertakingsuchreformsthroughtheprogramofformalengagementonfinancialservicesandreform.

• achievinginternationalisationoftheRMB—bysupportingthedevelopmentofRMB-denominatedassetsandsecuritieslistingsinAustralia,includingforbondsbutpossiblyalsoextendingtocommoditiescontractsingold,coalandironore.

• strengtheningfinancialregulationandprudentialregulation—throughtheabove-mentionedmutualrecognitionframeworkandbyundertakingmutualreformstoallowbetterengagementbetweenAustralianandChinesefirms.

• developingthedepositinsurancesystemandresolutionmechanisms—byeasingrestrictionsonAustralianinsurancefirms.

• developingfinancialinfrastructure—bycollaboratingtogivetheOBORinitiativeandtheAIIBafocusonregionalfinancialinfrastructureinvestment(seebelow).

ChAFTAcanserveasabridgeheadfortheexpansionofbilateralfinancialservicestrade.ChAFTA,andtheinstitutionalmechanismsthatunderpinitandcanbebuiltaroundit,offersignificantopportunitiestobothcountriesindesigningeffectiveandefficientfinanciallinkagesthroughagradualandpragmaticprocess.ChAFTAsecuresarangeoffinancialservicescommitmentsbetweenChinaandAustralia.ThesecommitmentsrepresentthemostsubstantialmarketaccesscommitmentsthatChinahasagreedtowithanyFTApartner,andcouldcreatenewcommercialopportunitiesforAustralianbanks,insurersandsecuritiesfirms.TheyfacilitatedeeperparticipationbyAustralianfinancialinstitutionsinChina,strengthenfinancialservicestradeandinvestmentinbothdirections,andenablefuturegrowthinthebroaderbilateraleconomicrelationship(DFAT2014a).

UnderChAFTA,Chinaagreedtocomprehensivetreaty-levelcommitmentsonfinancialservices,includingagreementtoprovisionsontransparency,regulatorydecision-makingandstreamliningoffinancialserviceslicenceapplications.AfinancialservicescommitteewillbeestablishedunderChAFTAprovidingfordeepengagementbetweenChineseandAustralianfinancialregulatorsonissuesofmutualinterest,allowingissuestobeaddressedquicklyandefficiently(DFAT2014a).TheworkofthiscommitteeneedstobesupportedbytheformalengagementprogramonfinancialintegrationthroughtheAustralia–ChinaSED,toensurethatitadvancesreformprioritiesanddealswiththeregulatorychallengesoutlinedabove.Importantly,AustralianandChineseofficialsshouldengagemorecomprehensivelywithbusinessandindustryrepresentativespriortothesebilateralnegotiationssoastoprovideamechanismfortheirinputtobeconsideredascommitmentsaredeveloped.

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Bothsideshaveidentifiedarangeofareasforfurthercooperationtoreducebarriersinthesupplyoffinancialservices,whichcovermanyoftheissueslistedabove.TheseincludeAustralia’sforeigninvestmentregime,aswellasarangeofbarriersthatAustralianandotherforeignfirmsfaceinChina,suchaslimitationsonbankbranchopenings,minimumcapitalcontributions,maximumoffshorefundingfromwithinthesameinstitution,requiredonshorepresence,domestichiringrequirements,domestichousingofdata,andlimitedorlongwaittimesforlicensestotakeRMBdeposits.IssuesaroundtheserestrictionshavebeenraisedbymanyofthefinancialinstitutionsconsultedforthisReport.

strengthening dialogue and mutual recognition between governments and private sectors

AustralianandChinesepolicyleaders,ministersandseniorofficialshaveagreaterrangeofopportunitiesforengagementnowthaneverbefore.ThebilateralrelationshipisofficiallyaComprehensiveStrategicPartnership,whichincludestheannualAustralia–ChinaSED.

ButdespitethesignificantimplicationsofChina’sreformprocesses,andthesignificantopportunitiesforfinancialserviceproviders,thereisnodesignatedbilateralframeworkthroughwhichaspecificfocusontheseissuescantakeplacebetweenpolicymakersinbothAustraliaandChina.Bycomparison,inotherareassuchastourism,AustraliaandChinahaveaMoUonstrengtheningcooperation.

Theformalengagementprogramonfinancialservicesdescribedaboveneedstobeaproactive,strategically-ledprocess,withaframeworkforbilateralpolicydevelopmentsetoutthroughtheannualvisitsoffinanceandtradeministers(supportedbyotherrelevantministersforfinancialservices)followedthroughbytaskforcesofofficialsfromthreekeyareas:financeministries,centralbanksandfinancialregulators.

ThereisalsoscopeforexpandingbilateralengagementbetweenthecentralbanksofAustraliaandChina.ThiswouldcomplementexistingmultilateralengagementthroughinstitutionsandforumssuchastheG20,andwouldbuildonbilateralinitiativessuchasthelocalcurrencyswaplineagreedbetweenAustraliaandChina.AstrongerbilateraldialoguewillbeincreasinglyimportantasChinadeepensitsreformprocessandachievesgreaterfinancialintegrationwithAustraliaandtheregion.Aroutinedialoguecanbeparticularlyimportantintimesoffinancialvolatilityandcrisiswhensafetynetarrangements,includingbilateralswaplines,regionalarrangements(suchastheChiangMaiInitiativeMultilateralization,whichdoesnotincludeAustralia)andmultilateralarrangements(suchastheIMF),mayneedtobeaccessedandcoordinated.

InrecentyearstheAustraliangovernmenthasdevelopedmutualrecognitionframeworkswithothercountries.Mutualrecognitionmeansthattheregulatorsinonecountryrecognisetheregulationsofothercountriessothatbusinessesarenotrequiredtosatisfytwoparallelsetsofregulationswhentheyareworkingacrossborders.Mutualrecognitionframeworksimprovetheeaseofdoingcross-borderbusinessbyreducinginefficiencies,decreasingcompliancecostsandsavingtime.

Mutualrecognitionframeworkscancoverarangeofdifferentregulatorysettings,includingsecuritiesmarketregulations,fundmanagement,collectiveinvestmentschemesandlicensingrequirementsforfinancialadvisors,accountants,fundmanagersandlawyers.ThegeneralapproachoftheAustraliangovernmenttorecognisingforeignregulationoffinancialmarketsandfinancialservicesprovidershasbeenbasedonunilateralrecognitionoftheforeignjurisdiction.

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InJune2008,AustraliaundertookitsfirstmutualrecognitionagreementonsecuritiesofferingswithNewZealand.Issuersofsecuritiescannowuseoneprospectustooffershares,debenturesormanagedorcollectiveinvestmentschemestoinvestorsonbothsidesoftheTasmanSea,subjecttocertainrequirements.

Followingthis,AustraliaandHongKongextendedmutualrecognitiontoauthorisedcollectiveinvestmentschemes,whichwillfacilitatethesaleofretailfundsineachother’smarket.TheAPECAsiaRegionFundsPassport(discussedbelow)issimilarlyaformamutualrecognitionthatAustraliaisleadinginAPEC.

InAugust2008,Australianauthoritiessignedathirdmutualrecognitionarrangement,withtheUnitedStatesSecuritiesandExchangeCommission(SEC).ThemutualrecognitionarrangementprovidesaframeworkfortheSEC,theAustraliangovernmentandASICtoconsiderregulatoryexemptionsthatwouldpermitUSandeligibleAustralianstockexchangesandbroker-dealerstooperateinbothjurisdictions,withoutcertainneedfortheseentitiestobeseparatelyregulatedinbothcountries.ItreducesthebarriersthatUSandAustralianinvestorsfaceininvestingineachother’smarkets.

AsChina’sreformprocessesdeepen,agoalshouldbethedevelopmentofamutualrecognitionframeworkbetweenAustraliaandChina.Oneofthepre-conditionsofmutualrecognitionisthattheregulatoryframeworkofeachjurisdictionmustbesubstantiallyequivalent,thusensuringinvestorprotectionandmarketintegrityirrespectiveofthelocationoftheinvestor.Forthisreason,amutualrecognitionframeworkbetweenAustraliaandChinaisnotagoalthatwillbeachievedinthenearterm,butisagoalthatshouldbepartofthebroaderfutureengagementprogrambetweenthetwocountries.Importantly,thisengagementprogramandgreatercollaborationbetweenAustralianandChineseregulatorswillitselffacilitatethemovetowardsamutualrecognitionframework.

Intheprivatesector,therehasbeenongoing,albeitinformal,collaborationoneconomicandfinancialreform.GiventheopportunitiesforincreasingthefinancialconnectionsbetweenAustraliaandChina—andthevitalroleoftheprivatesectorinmakingthishappen—amoreformalapproachtoprivatesectorengagementisnecessary.Furtheringthiscollaborationthroughtheformalengagementprogramonfinancialservicesshouldthereforebeakeypriority.AustralianfinancialfirmshavehosteddozensofdelegationsfromChinaovertheyears—frompolicymakingandregulatorybodiesaswellasfromfinancialservicesfirms—toshareknowledgeaboutAustralia’sfinancialsystemandreformhistory.WithinChina,severalofAustralia’slargestfinancialinstitutionshavesignificantjointventurepartnershipsthroughwhichthetransferoftechnicalandmanagerialknowledgeandexpertisehasbeentakingplace.ChinesefinancialservicesfirmsthathaveestablishedoperationswithinAustraliahaveengagedproactivelywiththeAustralianfinancialservicessector,includingthroughgroupssuchastheAustralia–ChinaBusinessCouncil.

AmoreformalmodeofengagementbytheprivatesectorinChina’sfinancialsectorreformhasrecentlydeveloped—theSydneyforRMBCommittee.Formedin2013,theCommitteenowcomprises30seniorfinancialsectorprofessionalsrepresentingorganisationsthathaveadeepinterestindevelopinggreaterfinancialconnectednessbetweenAustraliaandChina.ItisledbytheprivatesectorbuthasthesupportoftheNSWandfederalgovernments.TheCommitteehaswrittenseveralwhitepapersandsupportedRMBoffshoredevelopmentbyidentifyingthekeyblockagestoincreasedtake-upofRMBamongAustralianfirmsandbypromotingSydneyasanimportanthubforRMBtrade,financeandinvestmenttransactionsintheAsiaPacificregion.

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mutual regulatory reforms to increase engagement

Alongwiththemutualrecognitionframeworkdiscussedabove,thereisscopeforotherreformsinregardstoprofessionalservices,regulatoryrestrictionsaroundtaxationandmacroprudentialregulations,whichshouldalsobeexploredtoincreasefinancialintegrationbetweenAustraliaandChina.

AccordingtotheAustralianChamberofCommerceinBeijing,thetrainedtalentpoolinChina’sfinancialservicessectorislimited,particularlywhentakingaccountofforeignlanguageskillsanddepthofexperience.Forsomespecialistroles,itisincreasinglydifficulttorecruitandretainstaff(AustCham2016).

AustralianandChineseacademicinstitutionshaveanimportantroletoplayinsupplyingthenextgenerationoffinancialservicesadvisors.ThereisscopeforjointventuresbetweenChineseuniversitiesandAustralianfinancialinstitutions,whichwouldresultinaspecialisttalentpoolthatistrainedoncurrentinternationalindustrypractices.Alonger-termtalentmanagementplanneedstoincludeaneducationpushtoenhanceprofessionalskillswithinthefinancialservicessector.

TheChineseandAustraliangovernmentscouldalsoimprovetheattractivenessoftheirfinancialservicessectorsascareerdestinationsforinternationaltalent.TheChinesegovernmentcouldgiveconsiderationtoprovidingtaxincentivescomparabletoHongKongorSingaporeforemployees,aswellasforemployerstoinvestinexperiencedforeigntrainerswhocaneducatelocaltalent.TheAustralianandChinesegovernmentscouldpartnerwithprivatefirmsfrombothcountriestoprovidetrainingandpolicysupportinthedevelopmentoftheChinesefinancialsystemthroughprogramsthatencouragecollaborationbetweenAustralianandChinesefinancialfirms.

WhilemuchofthischapterhasconsideredreformprocessesinChina,therearedomesticregulatorysettingsthattheindustrysuggestsinhibitAustralianfirmsfromexpandingintoChinaandtheAsiaPacific.Regulatorysettings,includingcapitalreserverequirementssetbytheAustralianPrudentialRegulationAuthority,needtobecarefullycalibratedtoensuretherearenounnecessarybarrierstoAustralianfirms’take-upofopportunitiesprovidedbyfreetradeagreementsthatraisethemaximumthresholdofforeignequityinajointventurefinancialservicesfirminAsia(AusterandFoo2015).

The2014FinancialSystemInquiryrecommendedreviewingthestateofcompetitioninthefinancialsector,includingidentifyingbarrierstothecross-borderprovisionoffinancialservices.TheAustraliangovernmentendorsedthisrecommendationandcommittedtotasktheProductivityCommissiontoundertakethisreviewbytheendof2017.Itnotedthat‘deepercross-borderlinkagespromiseenormousopportunities,ifproperlyharnessed’andthat‘ourpolicysettingsmustfacilitateentryofthesedisruptersratherthanactingasablockage’(GovernmentofAustralia2015c).ItisimportantthatthisreviewgoesbeyondAustralia’straditionalinvestmentpartnersandlooksspecificallyatthebarrierstoinvestinginChinaandothercountriesintheAsiaPacificregion.

TheAustralianFinancialCentreForum’s2010reporton‘Australiaasafinancialcentre’(JohnsonReport2010)alsoraisedanumberoftaxissueswhereAustralianregulationscurrentlyraisethecostsofoffshorecapitalborrowingandrestrictAustralianbanksfromaccessingoffshoreretailandwholesaledeposits(Finsia2014).TheseissuesshouldbeexaminedaspartoftheAustraliangovernment’sfocusontaxreform.

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Australia’sProductivityCommission(2015)notesthatstrongcompetitionandthegrowinglevelsofwealthinAsiameanthatbarrierstofinancialserviceexportsfromAustraliawillbeincreasinglycostly.ItnotesthereareregulatorybarriersconstrainingthegrowthofexportsfromthemanagedfundsectorinAustralia(inparticular,frommanagedinvestmentschemes)aswellasthroughtaxationarrangementsforinternationalinvestmentinmanagedfunds.

Bilateral and regional opportunities arising from Fintech

Financialtechnology—orFinTech—istransformingfinancialsystemsandpotentiallyentireeconomies.Globally,FinTechinvestmentreachedanestimatedUS$20billionin2015,ajumpofaroundseven-foldoverthelastthreeyears(AustralianTreasury2016).TheFinTechindustryhasgreatpotentialtonotonlyhelpdriveexpansionandgrowthinfinancialservicesandexports,butwillalsodeliverbenefitsthroughnewservicesthatcreatevalueorbringnewefficiencies.Forthesereasons,theengagementprogramonfinancialservicesshouldhaveaspecialfocusontheopportunitiesarisingfromthissector.

ChinahasaburgeoningFinTechsectorthatsupportsanumberoflargefirmssupplyingfinancialservicesandproducts.CompaniessuchasAliPayandWeChatdemonstratetherisingdemandforsophisticatedfinancialproductsandservicesinChina.Thishighlightsthecrucialimportanceofafreeandopeninternet.TheOECDrecentlywarnedthatworldwideeffortstoclampdownoncybercrimeandterrorism,inparticular,areputtingtheeconomicbenefitsofthefreeandopeninternetatrisk.TheOECDhighlightstheimportantlinkbetweeninnovationandinternetfreedom(OECD2016)AustraliaandChinamustensureafreeandopeninternetiftheyaretocapturethebenefitsofincreasingeconomicactivityinFinTechandotherinnovativesectorsthatarecrucialtofutureprosperity.ItisestimatedthattheuptakeofinformationandcommunicationstechnologiesinAustraliainthe1990saddedupwardsof0.2percentagepointsofmultifactorproductivitygrowthtoAustralia’sannualeconomicgrowth(Gretton2003).Theabsenceofdomesticandinternationalimpedimentstointernetaccessisessentialtocapturingtheproductivity-enhancingbenefitsofthesetechnologies.Thepositiveproductivity-enhancingeffectsofopennesstoFinTechinnovationarelikelytobeincreasinglyimportantastheindustrymatures.

DuringaFinTechroundtableorganisedbytheChinesegovernmentinShanghaiinFebruary2016,Lufax,thesecond-largestpeer-to-peerlenderinChina,spokeaboutreal-timepersonalisedinsuranceoptionssuchascarinsurancethatcouldaccountfortheplacesyoumightbedrivingthroughortoonaparticularday,includingweatherandtrafficconditions.DuringanotherFinTechroundtableinShanghai,ChineseinternetservicesgiantBaidu,explainedtheir‘InternetPlus’strategywasnotaboutbecomingaFinTechoperator,buttoenablethemtoactasanaggregator.Theyarefocusedonbringingtogetherthepartnersneededtorealiseanewproductorservicetofillthegapsandtosatisfyconsumerdemandsbyleveragingtheirdigitaldistributionnetworks,dataandinsights(AustralianTreasury2016).

FinTechisaboutstimulatingtechnologicalinnovationsothatfinancialmarketsandsystemscanbecomemoreefficientandconsumer-focused.Thiscanhelpdriveimprovementsintraditionalfinancialservicesand,perhapsmoreimportantly,promotedisruptionthroughinnovativenewproductsandservices,whichcanofferbenefitstoconsumersandothersectorsoftheeconomy.FinTechisalsoreducinginformationasymmetryinthemarketplaceandtherebyhelpingtomitigateriskandpromotetheefficientallocationofscarceresources(AustralianTreasury2016).

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FinTechsolutionsholdenormouspotentialbenefitstoallbusiness,especiallynewandexistingsmallbusinesses.Small-andmedium-sizedenterprises(SMEs)arecrucialforeconomicgrowthandjobsbutsomecanfacedifficultyinsecuringthefinancingtheyneedtosurviveandprosper.FinTechcanoffersolutionsthatareefficientandeffectiveatlowerscale,whichwillbenefitsmallbusinessesandprovidethemwithincreasedaccesstomorediversefundingoptions.InnovativeFinTechproductscanbebettertailoredtotheneedsofsmallbusinesses.Theseincludemarketplace(peer-to-peer)lending,merchantande-commercefinance,invoicefinance,onlinesupplychainfinanceandonlinetradefinance(AustralianTreasury2016).

Inadditiontofinancingandaccesstocapital,FinTechcanhelpallbusinessesthroughimprovedpaymentsystems,customerrelationshipmanagementandinvoicingandcollections.FinTechsolutionsincludee-invoicemanagementportalsandsupplychainfinancesolutions.

TheAustraliangovernmentoutlinedinarecentreport(AustralianTreasury2016)thatitiscommittedtoworkingwiththeFinTechindustry,regulatorsandotherstakeholders,onthekeyissuesthatunderpinthiscontinuedinnovationinfinancialservices.Thegovernmenthaspubliclysupportedtheindustry’sobjectiveofmakingAustraliatheleadingmarketforFinTechinnovationandinvestmentinAsiaby2017.Australia’sfledglingbutflourishingFinTechindustryisattractingtalent,promotinginnovationinAustralia’sfinancialservicesindustryandexportingtalentabroad,suchas:

• incubators(StoneandChalk,andTyro);

• venturecapitalfundswithafocusonFinTech(H2andReinventure);

• personalandbusinessfinance(SocietyOne,Prospa,Ratesetter,SpotcapandMoula);

• capitalmarkettechnology(OzForexandPepperstone);

• paymentsproviders(TyroPaymentsandPromisePay);

• wealthmanagementproviders(Stockspot,SimplyWallStreetandPocketBook);

• business-enablingtechnologiesanddataanalytics(Avoka,Metamako,andQuantium);and

• crowdfundingplatforms(Equitise,TMeffectandCrowdFundUp).

Research on financial services trade and cross-border investment

TheAustralianCentreforFinancialStudies(AusterandFoo2015)identifiesalackofresearchanddataasanimpedimenttofinancialservicesintegrationintheAsiaPacificregion.Itarguesthatmanyoftheenablersandimpedimentstogreaterintegration,ortheirpotentialimpact,arenotwellresearchedorunderstoodandthatpolicymakers,regulatorsandpractitionerslackastrongevidentiarybasefromwhichtomakewell-informeddecisionsonmattersofsignificancetotheAustralianandChineseeconomies.

AustralianandChineseorganisationsshouldcommissionandencouragecollaborativeresearchprogramstobecarriedoutbyAustralianandChineseinstitutions,tobetterunderstandandassesstheimpactoffinancialintegrationintheAsiaPacific.Theresearchshouldlookspecificallyatthedriversandmechanismsoffinancialintegration,theimpactofglobalregulatoryreformssuchasthoseresultingfromBaselIIIandtheFinancialStabilityBoard,theinstitutionalmechanismsthatdrivereforms,andAsia’svoiceinthesemechanisms.

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Thisresearchcouldhaveaspecificfocuson‘behindtheborder’barriersandthebroaderimpactsofChina’sreformprocessesforAustraliaandtheregion.ThereislittlesubstantiveresearchthatanalysestheimpactsoftheopeningofChina’scapitalaccountontheAustralianeconomyfromawhole-of-economyperspective.Someindustrystudiespredictincreasedinvestmentorcommercialflowsinparticularsectors,butnostudieshavelookedattheAustralianeconomyasawhole,ortheimpactonrelevantsectorswithinfinancialservices.Further,thereissignificantdatadevelopmentstilltodoonmeasuringandreportingChina’sfinancialdata,includingcross-bordercapitalandinvestmentflows.

Regional collaboration on financial services and flows

AstheChinesefinancialsystemopenstotheregion,thereisasignificantopportunityfortheseflowstofinanceproductiveinvestment,buildcapitalstocksandincreaseeconomicgrowthintheregion.ForAustralia,asacapitalimportingcountry,thereisagreatopportunitytoimportChinesecapitaltofinanceinvestmentandreducethecostofcapitaltoAustralianfirmsandhouseholds.ForChina,thesereformsoffertheopportunitytoincreasethereturnsonthecapitaloffirmsandhouseholds,whichiskeytoimprovinglivingstandardsandaddressingchallengesrelatedtotheageingpopulation.Thissectionidentifiesanumberofinitiativestohelpfacilitateregionalintegrationinfinancialservicesandflows.

One Belt, One Road

Asthe‘topandtail’oftheregionidentifiedbytheOBORvision,collaborationbetweenAustraliaandChinaonfinancialsectorreformanddevelopingfinancialinfrastructureacrosstheregionwillbeanimportantsourceofstabilitytohelpensureeconomicprosperityforfuturegenerations.AsdiscussedindetailinChapter4,thepartnershipbetweenAustraliaandChinamustbeenabledonbothsidesbytheprovisionofsupportingfinancialinfrastructure(includingaccesstoeachother’sfinancialservicesmarkets),theabilitytomakeinvestmentsthatsupportfurthertradeandservicedelivery,andcontinuedandeasierflowsofpeoplebetweenthetwocountries.

TheOBORinitiativeinvolvesbuildingahostofnewinfrastructureconnectionsbetweenChina,Asia,Africa,theMiddleEastandEurope.AcomplementaryseriesofportsandotherinfrastructureprojectsacrosstheIndianOceanandsurroundingseascalledtheMaritimeSilkRouteaddsamaritimelegtoland-basedconnectionsincludingtheChina–PakistanEconomicCorridor(CPEC)andtheproposedBangladesh–China–India–MyanmarEconomicCorridor(BCIM).

Chinahasalreadyestablishedmajorfinancingbodies,includingtheAIIBandtheSilkRoadFund,tohelpfundanestimatedUS$250billionworthofOBORprojects(Australia–ChinaOBORInitiative2016;Brewster2015).OBORrepresentsanopportunitytofurtherstrengthenfinancialintegrationbycomplementingitstradenetworksandphysicalinfrastructureinvestmentswithgreaterinvestmentinfinancialinfrastructure.

AlongwithinfrastructureinvestmentinNorthernAustralia,thisrepresentsanotherkeywayinwhichAustraliaandChinacancollaborateonOBOR.Investmentinfinancialinfrastructuresuchasfinancialinstitutions,financialintermediaries,paymentsystems,creditinformationbureausandcollateralregistriesshouldbeseenascriticalcomplementstothebroaderOBORobjectivesofdeepeningtradeandcommerciallinks,andthusshouldreceivethesamelevelofattentionandfinancialsupport.

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APEc’s Asia Region Funds Passport

UndertheauspicesofAPEC,theAsiaRegionFundsPassport(ARFP)will,onceimplemented,provideamultilaterallyagreeduponframeworktofacilitatethecross-bordermarketingofmanagedfundsacrossparticipatingeconomiesintheAsiaPacific.Theviewisthatamutualrecognitionapproachmaybemorerealisticthanpursuingregulatoryharmonisation;infundsmanagement,theARFPisthepreferredregionalvehicleforcross-bordermarketingofmanagedfunds.Inthelongerterm,theARFPcouldalsofacilitatefundsfromtheAsiaPacificregionbeingmarketedinEuropethroughanAsian/Europeanmutualrecognitionagreement.

TheAustralianFinancialMarketsAssociationstatesthatthePassportprovidesa‘practicaltemplateforcooperationintheAsianregion’.TheFinancialServicesCouncil(FSC)saysthattheARFPisits‘preferredmechanismforcrossbordertradeinfundsmanagement,alongsidebilateralandmultilateralfreetradeagreements’.TheFSCalsonotesthattaxationregimes,bothinAustraliaandoverseas,arecomplexandthat‘Australiawillnotbeasuccessfulparticipantin[theARFP]unlessaccompanyingdomesticreformsareundertaken’(ProductivityCommission2015).

TheARFPisaregion-wideinitiativethatwasinitiatedbyAustralia,NewZealand,SouthKoreaandSingapore.InSeptember2013,thesefourcountriessignedaStatementofIntenttojointlydeveloptheARFPtofacilitatecross-borderoffersoffundsintheAPECregion.InApril2014,thesignatories,togetherwiththePhilippinesandThailand,issuedajointconsultationpaperontheproposedrulesandarrangementsfortheARFP.Japansignalleditsinterestinparticipatingin2015.Theseseven‘pilot’economieshavebeenworkingtowardsthelaunchoftheARFP.FiveotherAPECmembersnotcurrentlysigneduptotheARFP—China,HongKong,Indonesia,MalaysiaandVietnam—haveneverthelessjoinedparalleldiscussionsontheARFPrules(APEC2015).

On28April2016,aMemorandumofCooperation(MoC)wassignedbyAustralia,Japan,SouthKoreaandNewZealand.TheMoCcomesintoeffecton30June2016.TheARFPinitiativeisopentoanyAPECeconomythatsignson,andparticipatingeconomieshaveupto18monthsfrom30June2016toimplementdomesticarrangements.ActivationoftheARFPwilloccurassoonasanytwoparticipatingeconomiesimplementthearrangementsundertheMoC.

TheAustraliangovernmentintendstolegislatetogiveeffecttotheARFPinthesecondhalfof2016(ProductivityCommission2015).ThegovernmentshouldcontinuetoprogresstheARFPand,throughworkininternationalforums,encourageotherjurisdictionstoparticipate.ChinahasbeeninvolvedindiscussionsaroundtherulesoftheARFPandcouldconsidersigningupformallytotheinitiativeasakeywayofattractingtalentandexpertiseintoitsfinancesector(APEC2014b).

RcEP negotiations

ThereissignificantscopetouseRCEPnegotiationstostrengthenthesupplyoffinancialservicesthroughouttheAsianregion.Inthefinancialservicessector,manytypesofservicescanbeperformedacrossborders,withoutsacrificingappropriateprudentialsupervision.Theseservicesincludebuyingandsellingfinancialproducts,participatinginandstructuringtransactions,andprovidinginvestmentadvice.RCEPshouldconsiderpermittingfirmstoprovidecross-borderservicestoclientsandqualifiedinvestorswithoutestablishingan

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in-countrycommercialpresenceorbeingsubjecttotheseparatelicensingandapprovalrequirementsthatgenerallyapplytofirmscommerciallypresentinamarket(seeChapter7;andseediscussioninAustralianServicesRoundtable2013).

managing risks

TheliberalisationandopeningoftheChinesefinancialsystembringswithitgreatopportunitiesforbothChinaandAustralia,but,aswithAustralia’sreformexperience,carrieswithitanumberofrisks(seeChapter6).Theseincludegreaterexposuretonegativeexternalshocksandcontagion,challengesinrelationtocross-bordersupervisionandenforcement,andadverseeffectsfrompotentiallyhighervolatilityincapitalflows—whichcancauserapidchangesindomesticassetpricesforequities,bonds,commodities,foreignexchangeandderivatives.

Increasinglycorrelatedpricesbetweendifferentcountriesandassetclassesreducethebenefitsofportfoliodiversification,whilealsopotentiallycreatingchannelsforcontagion.Theglobalfinancialcrisishighlightedthefactthatlargecapitalflowscanincreasevulnerabilitiesatthemacroeconomiclevelandexacerbatesystemicrisksinfinancialsystems.TheliberalisationandopeningofChina’sfinancialsystemwillfundamentallychangethenatureoffinanciallinkagesintheAsiaPacificregion,withimplicationsnotjustforfinancebutalsoforflowsoftrade,capitalandpeople.

TheflexibilityofAustralia’seconomy,particularlyitsfloatingexchangerateandinflation-targetingmonetarypolicy,helpsitweathervolatilityfrominternationalmarkets.Asithasdoneinthepast,thiswillplayafundamentalroleinAustraliamanaginganyfuturevolatilityresultingfromChina’sreformsandregionalintegrationmorebroadly.FinancialreformsofpastdecadesandtheintegrationofAustralia’scapitalmarketsintotheglobalsystemhavedeliveredthebasisforsoundermacroeconomicpolicy,morediversifiedportfoliosforAustralianinvestorsandthedevelopmentoftoolsforhedgingrisk.TheAustralianfinancialsystemprovedresilientthroughouttheglobalfinancialcrisiswhileothersdidnot.

ForChina,riskmanagementshouldbebasedonensuringthatreformsareproperlysequencedintheirimplementationandundertakenattheappropriatepace.TheAustralianexperiencesupportsthenotionthatstronginstitutionsandregulatorypracticescangoalongwaytowardmitigatingtherisksofdeepfinancialreform.

BothAustraliaandChinahaveastrongincentivetoensurethatthereisawell-resourcedandflexiblefinancialsafetynetintheregion.On4February2016,IMFManagingDirectorChristineLagardewarnedthattheglobalfinancialsafetynethasbecometoofragmented,particularlyinAsia,andneedstobereformedandstrengthened.ReformingthesafetynetwouldbenefitChina,AustraliaandtheAsiaPacificregion(Lagarde2016).ThiscrucialtaskisdiscussedinmoredetailinChapter8.

AustraliaandChinamustfocustheireffortsintheG20andintheIMFonensuringthatthereisaholisticapproachtoaddressingtherootcausesofsafetynetfragmentationintheAsiaPacific.ThisrequiresafocusonincreasedandmorepermanentfundingfortheIMF(althoughtherearerealconstraintsonthis),better-tailoredfinancingfacilitiestomeettheneedsofAsianeconomies,anewphaseofIMFreformsthatgiveAsianeconomiesagreatervoice,andbettercooperationbetweentheIMFandregionalfinancingarrangements.TheseareperspectivesthatAustraliaandChinashouldadvocateforintheIMFandintheG20(seeChapter8).

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Regionalandbilateralarrangements,suchastheuseofcurrencyswaplinesandarrangementsliketheChiangMaiInitiativeMultilateralization,shouldnotbediscounted.TheyplayanimportantandcomplementaryroletotheIMF.TheIMFneedstolookathowitcanbettercooperatewiththesearrangementsbysettingupguidelinesbeforeacrisiseruptsinordertohelpguidehowthatcooperationwouldtakeplaceduringacrisis.Thisiscriticaltothesafetynet’sabilitytorespondquickly,flexiblyandconsistentlytocrisesandiskeytopromotingmarketconfidenceinthesafetynet.

Whilemanyofthesemeasuresarepoliticallydifficult,China’sG20hostyearhasseenincrementalandpragmaticfirststeps,throughtheIMF’sreporttoG20financeministersinApril2016,tobolstertheadequacyofthesafetynet.TheG20mustseizethisopportunitytobeginaconversationontheseissues(seeChapter8).

Finally,thereisanincreasingriskthatslowinggrowthinChina,aswellasslowinggrowthregionallyandglobally,coulddampenthemotivationanddriveforundertakingthereformsoutlinedinthischapter.Losingthemomentumforreformwouldhavesignificantconsequences.Itwouldnotonlyriskthegainsachievedthusfarbutcouldleadtoincreasedvolatilityfromanegativemarketresponse.TheAustralianandChinesegovernmentsshouldemphasisetheimportanceofthesesupply-sidereformsincreatinggrowthandboostingjobcreationinasustainableandbalancedwayintothefuture.Aweakglobaleconomy,combinedwiththedecreasingeffectivenessofmacroeconomicpoliciesinmanycountries,meansachievingstructuralreformsandreducingbarrierstointernationaltradearenowmoreimportantthanever.

The future of bilateral financial cooperation

Chinahasachievedsignificantprogressregardingtheliberalisationofitsdomesticfinancialsystem,retaillendinganddepositrates,usageofitscurrencyinglobaltradesettlementsandoffshoreRMBmarkets,flexibilityinitsexchangerateregime,andopennessofcapitalflowsintoandoutofChina.ThesedevelopmentshaveimportantimplicationsforChina’sinstitutionalandeconomicstructurethroughreducingdistortionsinfactorandfinancialmarketsandallowingalargerroleforthemarketintheeconomy,whilestillmaintaininganactivestatecontroloftheprocessandincreasingChina’spositionintheglobalfinancialsystem.

Howevertheyturnout,thereformprocessesunderwayinChinawillprofoundlyshapethefutureoftheAustralia–Chinaeconomicrelationship.Theywillhaveimplicationsacrosseconomic,politicalandsocialdimensions.Thecentralargumentofthischapteristhat,ifthegovernmentsandprivatesectorsofAustraliaandChinapositionthemselvesstrategically,thesereformprocessesofferaonce-in-a-generationopportunitytodeepentherelationshipinfinancialservicesandfinancialflowswhich,atpresent,isnascentcomparedtotherelationshipinmerchandisetrade.Thiswillbealongprocess,butthischapterhasoutlinedanumberofstepsthroughwhichitcanbeachieved.

Mostimportantly,thischapterproposesthattheAustralianandChinesegovernmentsdevelopaprogramofformalengagementonfinancialservicesandreform.TheprogramwouldcomplementtheStrategicEconomicDialogueandengageministers,officials,regulatorsandfirmsinaworkprogramtodeepenbilateralfinancialintegration.ItisrecommendedthatakeyfocusofthisprogrambeonpilotingtheselectreleaseofregulatoryandlicensingrestrictionsonAustralianfirmsinChinaasaphase-inor‘testingground’forregionalliberalisation.

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Thechapteralsorecommendsmeasures,whichshouldbedrivenbybilateralcommercialneed,toimprovethedialoguebetweenAustralianandChinesecentralbanksandregulators.Theaimshouldbetodevelopamutualrecognitionframeworktoimprovetheeaseofdoingbusiness,progressthedevelopmentofRMB-denominatedassetsandsecuritieslistingsinAustralia,reviewregulatoryrestrictionsincludinginregardtotaxationandmacroprudentialregulations,promotethebilateralandregionalopportunitiesarisingfromFinTechanddigitalfinance,andcommissionresearchbetweenAustralianandChineseinstitutionsonfinancialservicestradeandcross-borderinvestment.

Thechapteralsorecommendsthatthesebilateralinitiativesbecomplementedbyafocusonregionalfinancialcooperation.ThisincludesbuildingabilateralfinancialinfrastructurefocusinregionalinitiativessuchasOBORandtheAIIBtoimprovepaymentsystems,creditinformationbureaus,collateralregistriesandfinancialintermediariesandinstitutionsthroughouttheAsiaPacific.Chinashouldalsosignonto,andAustraliaimplement,APEC’sAsiaRegionFundsPassportandbothcountriesshouldadvocateitsgreateruseintheregion.

Thiscombinationofastrengthenedbilateralarchitectureandregionalinitiativesaimedspecificallyatfinancialservicesandfinancialintegrationwillbekeytocatalysinggreaterfinancialintegration.ThisisthevitalnextstepinstrengtheningtherelationshipbetweenAustraliaandChina.

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CHAPTER6Framework for capturing opportunities and managing risks

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Key messAges

AustraliaandChinashouldaspiretoabilateralrelationshipofthehighlevelandscopethattheyestablishedduringthefoundationalperiodofeconomictiesinthe1980s,whentheyagreedona‘modelrelationship’forcooperationbetweencountrieswithdifferentpoliticalandsocialsystemsandatdifferentstagesofeconomicdevelopment.TheenormoustransformationtoneweconomicmodelsthatAustraliaandChinaarecurrentlyundergoingcallsfortheelevationanddirectionoftheirpartnershipinasimilarway.

Therearesignificantuntappedopportunitiestoincreasetwo-waybilateraltrade,investment,financeandcooperationonregionalandglobalissues.Realisingtheseopportunitieswillbeimportantforthelong-termeconomicperformanceandsecurityofbothcountries.

Therearethreemajortypesofriskinthebilateralrelationship:commercialrisks;macroeconomicrisks;andsystemdifferencerisks.Commercialandmacroeconomicrisksrequiretheadoptionofnormalbusinessstrategiesandpolicycapabilitiestoavoidoramelioratetheircost.Systemdifferencerisksarestructuralandsubjecttochangeovertime.Theyaremorecomplextomitigate,requiringpoliticalaswellasbusinessleadershipinordertoframestrategicarrangementsfortheconductoftherelationship.

Theopportunitiesarebestrealisedandtherisksbestmitigatedthroughpoliticalleadershiponbothsidesthatmobilisesbi-nationalworkprogramstoadvancepriorityinterestsandworkthroughissuesintherelationship.Thisprovidesimpetusandaunitingvisionthatiskeytocommandingtheattentionandfocusingtheresourcesofofficialandprivateactors.

• AustraliaandChinashouldupgradetheirbilateralrelationshipfroma‘ComprehensiveStrategicPartnership’toa‘ComprehensiveStrategicPartnershipforChange’.ThisuniquecategorisationoftheAustralia–Chinarelationshipwouldsignalbilateralcommitmenttostayingaheadofthereformcurveinimplementingneededeconomicpolicyinitiativesandstrategies,andprovideanexceptionalopportunityforChinatoworkwiththesmaller-scaleyetmoredevelopedAustralianeconomyasatestinggroundforchange.

• AustraliaandChinashouldworkoverthecomingyearstodeveloptheirnewpartnershipintoacomprehensivebilateralBasicTreatyofCooperationthatembedsfrequenthigh-levelpoliticaldialogue;institutionalisesofficialbilateralexchangesandtechnicalcooperationprogramsbetweenministriesandbranchesofthemilitary;poolsapproachesbetweenfederal–stategovernmentsinAustraliaandcentral–provincialgovernmentsinChina;andprovidesforthecomprehensivesettingofstrategicbilateralobjectivesandforwardworkagendaseveryfiveyears.

• TheComprehensiveStrategicPartnershipforChangeshouldencourageinvestmentinnationalcentresofresearchexcellencetosupportunderstandingoftheforcesthatwillshapethedevelopmentoftheeconomicrelationshipbetweenAustraliaandChinainitsregionalandglobalsettings.Thatwillensuretherelationshiphasthenecessaryintellectualunderpinningstothrive.

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• AustraliaandChinashouldestablishabi-nationalAustralia–China(Ao–Zhong)Commissiontodramaticallyboostthelevelandrangeofscientific,official,businessandcommunityexchangesbetweenthetwocountriesanddrivetheaccumulationofhumancapitalandnetworksneededtotakeAustralia–Chinaeconomicrelationstothenextlevel.Itwillpromoteanambitiousbilateralprogramof‘literacy’capacitybuilding,multi-levelscholarlyexchange,bureaucraticnetworkbuilding,politicalinteractionsandsustainedhigh-levelbusinessdialogue,anddevelopaforwardworkagendaforimprovingeconomicpolicymakingcoordination.

ThisisatimeofgreatchangeinChina,Australia,theregionandtheworld.Thereareenormousopportunitiesstilltobegraspedonbothsides.Thischapterwillreviewkeyopportunitiesintherelationship,identifythemajorrisksinrealisingthoseopportunitiesandproposeaframeworkformanagingtheserisksandgettingthemostoutoftherelationship.

AsbothcountriesadapttoChina’stransitiontoaneweconomicmodel,thisReportproposesthattheyupgradetheirrelationshipfromaComprehensiveStrategicPartnershiptoanewanduniquelevelasa‘ComprehensiveStrategicPartnershipforChange’.Thiswouldsignalthedeterminationofbothcountriestofocustherelationshiponachievingtheirgoalsforeconomicandsocialchange.Thetaskofsuchapartnershipwouldbetoenergiseanddeepenthecurrentbilateralinstitutionalarrangements,buildtrustaroundcommoneconomicandpoliticalinterests,managetheuncertaintiesofchange,anddeveloptheclosecommercialandbusinessengagementneededasthestructureoftheeconomicrelationshipshiftstowardsservicesandconsumers(seeChapter1).

Opportunities

TheopportunitiesintheAustralia–ChinarelationshipderivefromthegrowthofChina’swealthanditsimportanceintheworldeconomy,thestronglycomplementaryrelationshipofAustraliatoChina’stradeandindustrialtransformationbecauseofAustralia’scompetitivenessininternationalresourceandenergymarkets,Australia’sabilitytomeetmanyofChina’snewdemands,theirrelativegeographicproximityandtheirclosepoliticalengagementsinceChina’sreformandopeningbeganinthelate1970s.

Foundations

ThefoundationoftheinteractionbetweenAustraliaandChinaistheirdeeplycomplementaryeconomicpartnership,whichcontinuesasthebridgeheadofbilateralengagement.ThenaturalcomplementaritybetweentheireconomieshasdeepenedtherelationshipsinceAustraliacommittedtoengagementinChina’sreformandopeningprocess.Australia’sabundant,stableandlow-costsuppliesofresourcesarecriticaltoChina’scontinuinggrowth,investmentandurbanisation.China’sdemandfortheseresourceshassustainedstrongtradeandeconomicgrowthinAustralia—directtradewithChinaiscalculatedbytheAustralia–ChinaBusinessCouncil(ACBC2015)tohavecontributedover5.5percentofAustralianGDPbetween1995and2011.Thisisthebiggestcontributionofanycountryandtwiceaslargeasthatofagriculture,forestryandfishing.

Thefoundationsofthebilateralrelationshipalsoencompasstheassetsthathavebeenbuiltthroughthesuccessoftherelationship,symbolisedinthepresentComprehensiveStrategicPartnership.

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CHAPtER 6: Framework for capturing opportunities and managing risks

new economic model

Whiletheresourcetraderemainsacentralelementinthebilateraltraderelationship,theendofthecommoditiesboomandtheemergingtransformationofChina’seconomyfromaninvestment-exportmodeltoconsumptionandservices-ledgrowthopensnewopportunitiesinthetraderelationship.Theopportunitiesforgrowthintherelationshipnowlieinenergy,agriculture,high-valuemanufacturesandespeciallyinservices.ChinawillcontinuetoexportmanufacturesandbeastrongnetsourceofmigrationtoAustraliawhilecapitalexportswillgrowanddiversify.TheupgradingofChina’sindustrialeconomywillpushgrowthinitstradewithAustraliaintonewmarketsformachinery,highvalue-addedmanufacturesandequipment,andcapitalintoallsectorsoftheAustralianeconomy.

MajorflowsofChinesetourists,students,investorsandmigrantsintoAustraliaandmoreAustraliansstudents,touristsandinvestorsspendingtimeinChinawillequipmoreAustraliansandChinesewithinterestsandcapabilitiesinimprovingbusiness,culturalandpoliticalrelations.

investment and financial opening

Two-wayflowsoninvestment,particularlyFDI,willbecriticaltonewtradeandcommercialgrowthbetweenthetwocountries.ChineseinvestmentcanhelpAustraliatoaddressitssignificantinfrastructuregap,whileAustralianinvestmentisinjectingdeveloped-marketexpertiseintoemergingsectorsoftheChineseeconomy.FDIineachother’seconomieswillendowbusinesspeopleinbothAustraliaandChinawithalong-termcommitmenttomanagingnotonlycommercialbutalsopublicissuesthathavetobenavigatedintherelationshipasitchangestoonethatinvolvescloserengagementinbusinessineachcountry.

ThefinancialintegrationthatwillflowfromChina’songoingprocessoffinancialmarketandcapitalaccountliberalisationisanareaofparticularopportunityandimportance.LiberalisationwillreleasemassivevolumesofChinesesavingssearchingforhigherreturns,creatingamajorinvestmentpoolasAustraliaseekstoupgradeitsinfrastructure,internationaliseitssupplychainsandinvestininnovation.Reducingbarrierstotradeinfinancialservicesispartofthestep-by-stepprocessinvolvedinthesereformsandAustraliacanworkwithChinainpioneeringchangeinthesemarkets.Liberalfinancialmarkets,fullyconvertiblecurrencies,andopencurrentandcapitalaccountswilldiversifyandstabilisetheinteractionbetweenChineseandinternationalcapitalmarkets,butthisgoalwilltaketimetoachieve.Meanwhile,steadyexperimentationandsharingofpolicyexperiencecanhelpalongtheway.

TheComprehensiveStrategicPartnershipforChangewouldencourageandsupportnewcommercialpartnershipsbetweenAustraliaandChinathatmakeuseofbothcountries’innovationagendastoharnesstechnologytoimprovebilateraltradeandcommercialties.

Partnershipsmakecommercialsenseinbuildingbusinessonlywherelocal,up-closeengagementdeliversreturns.Gettingclosetothecustomerrequiresknowingthecustomerwell.PartnershipsareaneffectivevehicleforbringingsuppliersandcustomersinChinaorAustraliaclosertogether,expandingmarkets,improvingefficiencyanddeliveringcompetitiveproductsandservice.

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common regional and global assets

AustraliaandChinahaveastronginterestinapeacefulandprosperousregionalandinternationalsystem.Crucialpartsofthisorderarewellestablishedinthepost-BrettonWoodsinstitutionsandtheUnitedNationsframework,buttherearegapsandtheorderneedstoevolvetomeetnewchallenges.SomeoftheprioritiesaredealtwithinChapters7and8.Herethefocusisontheprinciplesandapproachesthatwillhelpcreatetheconsensusthatisneededtomakeprogresswheresignificantdeficienciesremain.

AustraliaandChinahavethechancetobuildbilateralpartnershipsthatareaheadoftheeconomicreformcurveinbothcountriesandthatsetthebenchmarksforbroaderregionalandglobaleconomiccollaboration(Box6.1).Chinaisfacingadecadeofchallengingyetcrucialdomesticandinternationaleconomicpolicyreforms,andAustraliaprovidesaprovinggroundforChinatotestthepathwaysthroughmanyofthesereformsonthewaytohigher-incomeadvancedeconomystatus.AustralianandChinesepolicymakerscanusetheirpartnershiptohelppushthroughdomesticeconomicreformsandtostrengthenthestructureofregionaleconomicarchitecture.

China’sstandingintheAustralianandAsiaPacificeconomiesisboundtoriseifitsucceedswithitscontinuedprogramofeconomicandsocialreform.Intheinternationalarena,Chinaisbecominganincreasinglyglobalpowerandnaturallyseekstosecurecommensuraterepresentationinglobalgovernanceandtoplayamoreimportantroleininternationalaffairs.Australiacanplayaconstructiveroleinsupportingthesedevelopments.

Theeconomicchangesunderwaywillalsoimpactonpoliticalrelations.Bothcountriesshareinterestsindevelopingarrangementsthatstrengthenregionalandglobalpoliticalsecurity.

BOx 6.1: AusTRALiA, CHinA AnD RegiOnAL inFRAsTRuCTuRe invesTmenT

TheNorthernAustralianeconomyisheavilydependentontheminingsectorandisnowseekingeconomicdiversification.Whileresources,includingenergy,willcontinuetodominateNorthernAustralianindustry,theAustraliangovernmentisanticipatingthatgrowthsectorsforitsfutureinclude:foodandagribusiness;tourismandhospitality;internationaleducation;andhealthcare,medicalresearchandagedcare.NorthernAustraliahasasizeabledeficitintheinfrastructurethatisneededtorealisethisgrowthpotential.TheAustraliangovernmenthassetupanA$5billionconcessionalloanmechanism,theNorthernAustraliaInfrastructureFacility(NAIF).Businessesfromanycountryarepotentiallyabletoaccesstheseloans,butitisclearthatstillmuchmorecapitalwillbeneededtodeveloptheregion(GovernmentofAustralia2015b).

TheNorthisalreadyveryopentoforeigninvestment.Muchofthecapitalusedtofinancetheresourcesectorisalreadyforeign-owned.Thereisastronglinkbetweenforeigninvestmentandlocalwagesandcommunitydevelopment.TheNorth’ssparsepopulationalsomakesfindingthespaceforlargedevelopmentseasierthaninmanyotherareasofAustralia.Mostimportantly,Australiasimplydoesnothavethedomesticsavingsnecessarytobuildandupgradeports,pipelines,logisticsnetworksandtransportationfacilities.Australiahaspersistentlyrunlargecurrentaccountdeficits,averagingabove3percentofGDPbetween1960and2015.Anyoverallexpansionininvestment—whetherintheNorthoranywhereelseinthecountry—willlikelycomefromforeignsavings.

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ThereareotherreasonswhyChineseinvestmentintheNorthmaybefavourabletobothChinaandAustralia.Chinahasdevelopedaworld-classinfrastructureindustry,whiletheNorthneedslarge-scaleinfrastructuredevelopment.Northerninfrastructurecanserviceandintegratewithtransportandcommunicationnetworkselsewhereintheregion,potentiallyachievingeconomiesofscaleandscope.Australia’sdemandforinfrastructureinvestmentintheNorthandacrossthecountrymatchesChina’sappetiteforbothinfrastructureinvestmentandforitsfirmstobeinvolvedinlarge-scaleinfrastructureprojects.InvestmentinNorthernAustraliawillfacilitateregionaltrade,increasingAustralia’sregionalintegrationwithSoutheastAsiaandprovidingtheregionwithbetteraccesstoitsland,resourcesandknowledge.Withcapacitytodeliverabroad,China’sstrategyistoinvestoutwardstoaddresstheUS$8trillionregionalinfrastructuregapviainitiativessuchasOBOR.

OBORconsistsoftheNewSilkRoadEconomicBeltandthe21stCenturyMaritimeSilkRoad.TheBeltandRoadareenvisionedasextensivenetworksofChinesecommerce,investmentandinfrastructureprojectsextendingalongthecountry’skeystrategictraderouteswestandsouth.ChinahascommittedUS$40billiontoaSilkRoadFundandcreatedthemultinationalUS$100billionAIIB,whichcouldhelpfinanceOBORprojects.InhisspeechtoajointsittingoftheAustralianparliamenton17November2014,ChinesePresidentXiJinpingdeclaredthatOceaniawasa‘naturalextension’oftheMaritimeSilkRoad,andheinvitedAustraliatoparticipateinOBOR(Thomas2015).

Thewheelsarealreadyinmotion.The2015roundoftheAustralia–ChinaStrategicEconomicDialoguefocusedonregionalinfrastructureinvestment,andformedworkinggroupstoexploreopportunitiesinNorthernAustraliaandtheregion,includingthepotentialroleoftheNAIFandAIIB(TreasurerofAustralia2015c).RepresentativesfrommajorChineseinvestorsparticipatedintheNorthernAustraliaInvestmentForumthatwashostedbythethenMinisterforTradeandInvestmentAndrewRobbinDarwininNovember2015.AustraliashouldseektosupporttheAIIBfundingprojectsthatareapartofOBOR,suchasbyusingtheAIIBtosourcecapitalforworldclassinfrastructure.

OBORandtheAIIBalsohavethepotentialtofacilitatepartnershipsbetweenAustraliaandChinaoninfrastructureprojectsinthirdcountries.Forexample,aChinesestate-ownedassetmanagementcompanycouldprovidethecapital,aChineseconstructioncompanycouldprovidethematerialsandlabour,andanAustralianconsultancycouldprovidetheprojectplanning,financialforecasting,riskandtalentmanagement,andcontractingoutspecialisedtechnicalinputsforamajorinfrastructurefacilityprojectinacountrylikeMyanmarorIndonesia(Lumsdenetal2015).AjointapproachtoregionalinfrastructurecanbefurtherenhancedthroughtheGlobalInfrastructureHubinSydney.

UndertheComprehensiveStrategicPartnershipforChange,theAustralianandChinesegovernmentsshouldupgradetheircooperationonOBORthroughappointingadedicatedhigh-leveljointworkinggrouptodeepenandextendtheworkalreadybeingundertakenbytheSECInvestmentWorkingGrouptoexplorethepracticalitiesofhowthetwocountriescanbetterworktogethertoenhancedomesticandregionalinfrastructure.

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Risks

Inallbigeconomicandpoliticalrelationships,suchasthatbetweenAustraliaandChina,thereareuncertaintiesandunpredictableoccurrencesthatcreaterisksthathavetobemanaged.Inpartnershipsthatarerelativelynewandgrowingrapidly,especiallywherethescaleandactivitiesofonepartnerchangesrapidly,ashasbeenthecasewithChina,associateduncertaintiesandheightenedchancesofunpredictableeventsexaggerateperceptionsofrisk.Betweencountriesthathavedifferenthistoriesandpoliticalcultures,systemdifferencesaddanotherdimensiontoriskinmanagingrelationships.Learningandexperiencewillreducetheserisks.Butprivateandpubliceffortisimportanttotheunderstandingoftherisksbornofchangeandthedifferencesthatwillremain—andfindingwaystoworkaroundthemtoachieveeconomicallyandsociallyproductiveoutcomesfromexchange.ThisReportsetsoutataxonomyofrisksthatconfronttheAustralia–Chinarelationship:commercialrisks,macroeconomicrisks,andsystemdifferencerisks.ThegoaloftheComprehensiveStrategicPartnershipforChangeshouldbetoforgeabilateralrelationshipthatgoesbeyondthatwhichisbasicbetweentwocountriesandthatcanwithstandandthrivearoundunexpectedchangesineithercountry.

commercial risks

Therearefirm-andindustry-levelcommercialrisksacrossallmarkets.Theseincludeissuesofduediligence,marketaccess,regulatoryenforcementandlocaloperationsinothercountriesthatimpactuponspecificactorsinthebilateraleconomicrelationship.

Commercialrisksareanormalpartofthedecisioncalculusofacompanyseekingtoexpanditstrade,investmentoroperationsinanothercountry.Companiesthatassumetheserisksinsearchofhigherreturnsneedtohaveastronggraspoflocalmarkets,regulationsandbusinesspractices.Still,suchrisksareamplifiedinnewmarketswherecompanieshavenopriorexperienceandlittlebackground.ThishasbeenthecaseforsomefirmsinAustraliaandChinawho,attractedbytheexcitementofnewpossibilitiesforprofitableinvestmentintheothercountry,weredrawnintoventuresthatunderestimatedorotherwisemiscalculatedcommercialrisks.Whilethefirst-moveradvantageisreal,itneedstobeadequatelybalancedbynormalbusinessconsiderations.

ItisnottheroleoftheAustralianorChinesegovernmentstoconductduediligenceonbehalfofcompaniesandcovertheirfailures.Butbothleadershipshaveanimportantmessagingroletoplay:infosteringbilateralbusinesssentimentthatisrealisticaboutopportunities,whileencouraginginvestmentprojectswheretherearethecapabilitiesandrelationshipstoforgesustainablecommercialpartnerships;inupgradingmarketawareness(throughAustradeinAustraliaandMOFCOMinChina);andinbuildingcompetenciesforbothAustralianandChinesefirms(Box6.2).

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BOx 6.2: exPeRienCe WiTH COmmeRCiAL RisKs

TwoearlyAustralianmoversintotheenormousandpotentiallylucrativeChinesemarketwereitsmajorbrewingcompanies,LionNathan(nowLion)andFoster’s(Gettler2004;Slocumetal2006;Chung2011).LionNathanspentoverA$350millionbuildingbreweriesandbuyingintojointventuresintheChinesemarketfromthemid-1990s,buteventuallysoldoffitsbusinessesforonlyA$220millionin2004.Lion’sstrategyinChinawassimilartoitsapproachinAustralia,whichwastoinvestheavilyinvolume-buildingandcompetitivepricing.However,confrontedbyhighdistributioncostsandintensecompetitionfromlocalbrandsinthelow-endofthemarket,ithadtowithdraw.ForaforeigncompanyinChina’sfragmentedandstillmaturingbeermarket,otherareassuchasbranding,marketingandthelogisticsofdistributionshouldhavebeenmoreimportantconsiderations.Theseareasrequiredsophisticatedmarketengagementandhigh-levelknowledgeoflocaloperationsthatcomprehendedChinesemarketrealitiesandemployedbiculturalhumanresources.Foster’sGrouplimpedoutofChinain2006afterexperiencingsimilarchallenges.ThechallengesfacedbyLionNathanandFoster’sshowthenecessityofadvancedmarketandregulatoryknowledge,sustainedon-the-groundengagementandtheprudentassessmentoflogisticalrisks.

TheSinoIronprojectinWesternAustraliais‘famousinChinaasthesinglemostdisastrousoutboundinvestmentdealinChinesehistory’(Garnaut2014;AustralianCentreonChinaintheWorld2015).In2006,Chinesestate-ownedholdingcompanyCITICPacificsignedaA$5billion25-yeardealwithAustralianminerMineralogytominemagnetiteironoreinWesternAustralia’sPilbararegion—thelargest-everChineseinvestmentinAustralia.WhenCITICboughtintotheSinoIronprojectitlackedexperienceinboththeironoreindustryandintheAustralianmarket,butwasattractedbygettingasliceofthelucrativeAustralianironoretrade.TheSinoIronprojectsufferedmassivecostblowoutsfromarangeofpredictablerisks—transportationbottlenecks,weatherevents,risinglabourandcapitalcosts,andastrengtheningAustraliandollar.AhighlypubliciseddisputebetweenMineralogy’sownerClivePalmerandCITICoverroyaltypayments,amongotherissues,exacerbatedtheproject’scommercialproblems.

ButattheheartofSinoIron’sproblemswasthelackofaclearassessmentoflocalconditionsandregulatoryprocesses(CITIC2012;Duffy2012).DifferencesinChineseandAustraliancommissioningrequirements,suchasthecertificationofsafetydocumentsbylicensedengineers,werenotadequatelyconsidered.CITIC’sbudgetandtimeframewerestretchedfurtherbyashortageofthequalifiedelectriciansrequiredbyAustralianregulationstocommissioncontrolsystems.Personnelmovementposedproblemsastheprocessingofhundredsofequipmentserviceproviders’visasfarexceededtheexpectedtimeframe.AplannedinvestmentofA$3.46billionballoonedtoexpendituresofoverA$10billion.WhenmagnetiteexportscommencedinDecember2013,theprojectwasfouryearsbehindschedule.ThisdelaycostCITICdearly,asironorepriceshadstartedplummetingin2013,leadingCITICtowrite-downSinoIronbybillionsofdollars.

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macroeconomic risks

Therearecountry-levelmacroeconomicrisksarounduncertaintiesabouttheeconomicandpoliticalstabilityandgrowthpotentialofanothercountry’seconomyaswellastheprospectsforexpandingbilateraltrade,investmentandflowsofpeopleandideas.

China’seconomyfacesanumberofdifficult,butinevitable,transitions.ThesetransitionswillbenefitChinaandAustraliasignificantlyinthemediumtolongrun(seeChapter5).Butintheshortterm,theyhavebrought,andwilllikelycontinuetobring,adjustmentcostsaswellascommercialopportunitiesforpartnerslikeAustralia,andbethesourceofinternationaleconomicshocks.

WhatarethepotentialimpactsofshocksintheChineseeconomyonAustralia?TherearetwobroadmechanismsbetweentheAustralianandChineseeconomiesthroughwhichshockscanbetransmitted:tradeandfinance.Movementofpeoplecouldbeathird.

Fortrade,AustraliawillbenegativelyimpactedbyshocksinChinathatseeasignificantreductionindemandforAustralia’smajorexports.ItisinstructivehowrelativelycomfortablyAustraliahasweathereda60percentdropinthepriceofironoresincethecommodityboomburst.

YetanalysisfromtheIMFfindsthatAustraliawouldbeoneoftheworsthitadvancedeconomyfromslowingChineseinvestmentgrowth—onlyIran,Kazakhstan,SaudiArabia,ZambiaandChilecouldsufferbiggereffectsontheireconomies(Box6.3).

Reducingrelianceoninvestmentandexport-ledgrowthisakeyaspectofChina’seconomicrebalancinganddirectlyaffectsAustralia.TheIMFanalysissuggeststhatforeachpercentagepointdeclineinChineseinvestmentgrowth,Australia’spotentialGDPfallsby0.2percentagepoints(Greber2015).TheseestimatesarebuiltontheChinesegovernment’sexpectationthatinvestmentwillfallsteadilyacrosstheworld’ssecond-largesteconomyfrom46percentofGDPtoaround35percentoverthenextfiveto10years.ThisimpliesAustralia’sGDPcouldbe2percentbelowthelevelsthatwouldoccurifChina’sinvestment-ledgrowthweretocontinue.

TheprojectionisconditionalondecliningdemandforAustralia’sminingandresourcesexports—othercommodityexportingcountriesarealsohitbythischangeintheChineseeconomy.TheanalysisdoesnottakeintoaccountthepotentialincreaseinAustralianexportsinothersectors,includingservicessectoradjustmentsinthenon-tradeandimport-competingsectors,norassociatedresponsesintheAustralianeconomythatcanbeachievedfromimprovedengagementwithChina.Itisanexercisethatsimplymeasurestheimmediateimpactofamajorshocktoexistingtrade.Australianengagementandpolicysettingsarethereforecrucialtothefinaleffectontheeconomy.Iftheexchangeratefallswithreduceddemandforestablishedexports,therewillbeafilliptoexpansionofothersectors.Cruciallythiswillbeassistedbymoreproactivere-positioningbyAustraliabilaterally,regionallyandmultilaterallytotakefulladvantageoftheseopportunities.AsshowninChapter5,Australia’seconomicflexibilityallowstheseshockstobeabsorbedwithoutlossofthegainsfromtrade.

Forfinance,directinvestmentandfinanciallinkagesthroughequity,bond,currencyandpropertymarketsrepresentthekeytransmissionmechanismsforshocksfromtheChineseeconomies.Financialreform,capitalaccountliberalisationandinternationalisationoftherenminbiwillhavearangeofimplicationsforAustralia.Theywillbringdeeperfinancialmarketstotheregion,increasedcapitalflows,areductioninthecostofcapital,andgreateropportunitiestosupplyfinancialservicesintothesemarkets.However,theywillalsobeasourceofshockstoinvestmentinAustralia,AustralianfinancialmarketsandAustralia’smacroeconomicsituation.

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BOx 6.3: AusTRALiA’s ReACTiOn TO sHOCKs FROm sHiFTs in CHinese mARKeT senTimenT

RecentvolatilityinChinesestockmarketsillustratesthewayinwhichshockscanbetransmittedthroughfinancialmarkets.China’sstockmarketisstillveryunderdevelopedanditplaysaverysmallroleintheeconomy.ThestockmarketisaboutathirdofGDP,comparedwithmorethan100percentindevelopedeconomies.Lessthan15percentofhouseholdfinancialassetsareinvestedinthestockmarket.Theseshocksare,however,transmittedtoAustralia,causingvolatilityinAustralianequityandcurrencymarketsandpotentiallyhurtinggrowththroughwealtheffects.

TheASX200,alongwithotherindicesgloballyandintheregion,followedthedownwardtrendintheShanghaiCompositethrough2015.CommonwealthBankChinaandAsiaeconomistWeiLiasserts‘thatChina’sfinancialmarketisbecomingmoreintegratedinglobalinvestorsentiment’(quotedinDesloiresandCauchi2016).AnalysisbyRodriguezandRen(2015)findsthattheAustraliandollarisespeciallysusceptibletovolatilityinChinesefinancialmarkets.Theyfinda20-daycorrelationof0.38betweentheAustraliandollarandtheShanghaiShenzhen300,thelargestcorrelationforanycurrency,includingtheJapaneseyen.

AmoresignificantfinancialriskisifthereisagenerallossofconfidencebyinvestorsinChina,potentiallytriggeredbyabroaderlossofconfidenceintheemergingmarketeconomiesgiventhechallengesfacingBrazilandRussia,inparticular.Usinganinter-temporalmulti-sectoralDSGE(DynamicStochasticGeneralEquilibrium)modelcalledG-Cubed—thetheoreticalstructureisoutlinedbyMcKibbinandWilcoxen(1999)—theconsequencesofa200basispointincreaseintheriskpremiumofholdingassetsinemergingmarketeconomiescouldbesignificantforAustralia.

TheAustralianeconomyisalsoinaperiodoftransition.Capital,labourandothereconomicresourcesaremovingfromtheminingandresourcessectorstowardsothersectorsoftheeconomy.ItisinAustralia’sinteresttoensurethatthisreallocationofresourcesiscarefullymanaged.Theimpactofa200basispointriskpremiumshockthroughalossofinvestorconfidenceinChinawouldbetospeedupthischangesignificantly.TheearningsfromAustralia’sminingandresourcesexportsarealreadylowcomparedtotheminingboomperiod,andmuchofthisdemandcomesfromtheemergingmarketeconomies.ReducedgrowthintheseeconomieswouldseefurthercontractionsindemandforAustralia’sexports.Investmentfallsby10percentinAustralia’sminingsectorand5percentinitsenergysector(Greber2015).

Butonthefinancialside,capitalflowingoutoftheemergingmarketeconomiesflowsintotheadvancedeconomies,includingAustralia.Thisappreciatestheexchangerateby3percent,whichfurtherexacerbatesdecliningdemandforAustralianexportsandweakensthetradebalance.ThecapitalflowingintotheAustralianeconomyfavoursthenon-tradeexposedsectors,whichactuallyboostsinvestmentinthosesectors.OveralltheshockhastheeffectofspeedinguptheeconomictransitioninAustraliathroughsubstantialreductionininvestmentandeconomicactivityinAustralia’strade-exposedsectorsandincreasedinvestmentelsewhere.Although,counter-intuitively,theneteffectismarginallypositiveforAustralianGDP(around0.6percent),thisshockteststheflexibilityoftheAustralianeconomyanditsabilitytorelocatecapitalandlabouratarapidpace.

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ThekeypolicymessageforAustraliainconsideringhowtodealwithChineseeconomicshocksistounderlinetheimportanceofhavinganopenandflexibleeconomysoastomanagetheseshocksandfacilitatethesmoothtransitionoftheAustralianeconomy.Australia’sfloatingexchangerate,stronginstitutionsandrobustmacroeconomicframeworksarecritical.Theseneedtobecomplementedwithreformstostrengthentheflexibilityoflabourmarkets(particularlythroughimprovingworkplaceregulationandtheeducation,trainingandre-skillingofworkers)andproductmarketsthroughmicroeconomicreformstoboostcompetitionandreducebarrierstoentryandexit.

system difference risks

Therearesystemdifferencerisksthatcreate,amongotherthings,uncertaintiesinsovereignbehaviourtowardsprivateentitiesinothercountriesthatareconnectedtopolicyframeworksandtheirstability(seeChapter1).Theseuncertaintiesgiverisetorisksthatareimportanttomanagingrelationshipsinwhichthepartnersareundergoingrapideconomicandsocialchange.Withinthebilateralrelationship,theserisksresultfrominstitutionalandpoliticaldifferencesaswellasinterestdivergencesbetweengovernments,andareembeddedintheinstitutionsandpoliticalandsocialbehaviourofeachcountry.

Systemdifferencerisksanduncertaintiesderivefromdifferenthistories,andfromtheeconomicandinstitutionaltransformationsthatbothsystemsareundergoing.Evenastheprocessofeconomicreformisfurtheradvanced,fundamentaldifferenceswillremainbetweenAustraliaandChinainrelationtopoliticalandlegalinstitutions.TherightofChinaandofAustraliatodetermineandmaintaintheirownpoliticalinstitutions,anddefendtheirnationalsovereignty,isapremiseintheirbilateralrelationship.

TheAustralianandChinesegovernmentsrecognisethatthey‘havedifferenthistories,societiesandpoliticalsystems,aswellasdifferencesofviewonsomeimportantissues’,butbothcountries‘arecommittedtoconstructivelymanagingdifferencesifandwhentheyarise’(DFAT2016a).

Australiaisamulti-partyliberaldemocracy.Chinaisgovernedasaone-partystate.Australiahasafreewheelingmedia.Chinahasamorecontrolledmediaenvironment.TheAustralianpeopleprovideinputtotheirpoliticalsystemthroughregularrepresentativeelections.TheChinesepeopleprovideinputtotheirpoliticalsystemthroughconsultativemechanisms.TheChinesepoliticalandinstitutionalsystemcontinuestochange,withlong-termgoalsforpoliticalreform,butthereisuncertaintyaboutwhenandhowthesegoalswillbedelivered.

Australiaisafederation,underanationalConstitutionoftheCommonwealth.Thefederalgovernmentandstategovernmentsareseparatepoliticalentities,whoseparliamentsareelectedtoberepresentativeofthepeopleinasystemofmulti-partydemocracy.Around100,000Australiansaremembersofpoliticalparties.TheCommonwealthParliamenthasthepowertopasslawssubjecttotheConstitutioninareaswhereitiscompetent.Theprimeministerandotherministersofstatearedrawnfromtheparliamentandaresubjecttoitslaws.Thegovernmentappointsjudges,butthelawisinterpretedindependentlyaccordingtocommonlawtraditions.Stateshavetheirownareasofjurisdiction.Theeconomyislargelyprivate.Whetheradisputeiswithanotherprivatecompany,astateorthefederalgovernment,itissettledaccordingtothiswell-establishedlegalframework.

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ChinahasaunitarypoliticalsystemundertheleadershipoftheChineseCommunistParty.Morethan80millionChinesearemembersoftheChineseCommunistParty.Since2002,ithaswelcomedbusinesspeopleasmembers.ItguidestheworkofChineseleadinginstitutions,includingtheNationalPeople’sCongress,andconsultsthepeoplemorebroadlythroughtheChinesePeople’sPoliticalConsultativeConference(CPPCC).ThegeneralsecretaryofthePartyisalsothepresidentofthePeople’sRepublicofChina.ThestateandPartyoperatewithrespectiveformalconstitutions.Chinaisstrengtheningitssystemoflawsandregulationsatnationalandlocallevels.Whileaverylargeanddynamicprivate-sectoreconomyhasemerged(seeChapter2),publicownershipremainsthefoundationofkeysectorsofthestateeconomy.ChinesecompanylawrequirescompaniestoprovidenecessaryconditionsforPartyestablishments;however,onlyinSOEsdoesacompany’sPartycommitteeplayaformalleadershiproleincompanyaffairs.

BOx 6.4: LAnDBRiDge gROuP AnD THe PORT OF DARWin

UndertherelevantlegaldefinitionsgoverningAustralianforeigninvestment,theLandbridgeGroupisaprivatecompany.Nevertheless,afterthecompanywasawardedaleaseoverthePortofDarwinintheNorthernTerritory,somesecuritycommentatorsraisedalarmsinthemediaaboutLandbridge’ssupposedconnectionstotheChinesegovernment—inparticularthatthecompanyhasaPartyCommittee,andthatitschairmanisanadvisortoandmaybeamemberoftheChineseCommunistParty.

But1.63millionprivatecompaniesinChinahaveCommunistPartycommittees—morethanhalfofallChineseprivatebusinesses—andmillionsofPartymembersworkinChina’sprivatesector(Xinhua2014).ThisisanaturalresultofChina’spoliticalsystem,notevidencethatcompaniesareactingasagentsofthestate.

TheNorthernTerritorygovernmentreceivedA$390millionfromtheproceedsoftheA$506millionleaseawardedtoLandbridge,andLandbridgehascommittedtospendafurtherA$35millionontheportwithinfiveyearsandtoinvestA$200millionovera25-yearperiod.

ThestructureofthesaleofthePortofDarwinmeantthatonlyforeigngovernmentinvestorsrequiredFIRBapproval.ThiswasduetoanexemptionundertheForeignAcquisitionsandTakeoversAct(Cth)1975forassetsalesbystateandterritorygovernments.Privateforeigninvestors,includingtheChineseprivateinvestorLandbridge,didnotrequireapproval.

ToaddressanynationalinterestconcernsregardingtheprivatisationofthePort,theDepartmentofDefencerenegotiatedaDeedofLicencewiththeNorthernTerritorygovernmentfordefenceaccesstothePortforthenext15yearswithanoptiontoextendto25years.ThemainnavaldefencebaseinDarwin,HMASCoonawarra,wasalsoexcludedfromthetransaction.

On18March2016,theTreasurerannouncedanamendmenttotheForeignAcquisitionsandTakeoversRegulation2015,removingtheexemptionforprivateforeigninvestorsacquiringaninterestincriticalinfrastructureassetspurchaseddirectlyfromstateandterritorygovernments.From31March2016,FIRBwillformallyreviewallcriticalinfrastructureassetssoldbystateandterritorygovernments.

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Thesesystemdifferencescansometimesgiverisetomisunderstandingsaswellasbeacauseoffundamentaldifference,buttheyneednotbeanobstacletodeepertradeoreconomicengagement.ChinesebusinessesinvestingoroperatinginAustralianeedtounderstandthepoliticalseparationbetweendifferentlayersofgovernment,andalsobeawarethatinthecontextofrepresentativegovernment,thesupportofpoliticalrepresentativesinteractswithcommunityattitudesandperceptionsratherthandominatingthem.Inaddition,thesupportofelectedrepresentativescannotbeexpectedtofacilitatetheresolutionofdisputesortheconductofbusiness—thatisdeterminedbyindependentregulatorsandthecourts.

InAustralia,wherefundamentalpoliticalquestionsareresolvedbylegalinterpretation,thereisatendencytocategoriseChinesecompaniesas‘state-owned’or‘private’basedonblack-letterprovisionsrelatingtoequity-ownership.TheboundarybetweenChinesepoliticalinstitutions,SOEsandprivatebusinesspeopleisnotalwayswelldefinedorunderstood.SomeChinesecompanies,whichareclearlyprivateaccordingtoAustralianlegaldefinitions,areportrayedasbeingstate-influencedbecauseoffamilyconnectionsorhistoricallinkstotheParty,thestateorthemilitary(Box6.4).

AustraliaandChinacouldfurtherdeveloptheirlegalframeworkstohelpclarifytheseissuesovertime.Thelegalframeworkofmodernmarketeconomies,suchasAustralia,couldprovideusefulassistancetoChina’sownreformcommitmenttoimprovingruleoflaw.ThiscouldhelpreduceuncertaintyforforeigninvestorscomingintoChina,seekingpartnershipswithlocalbusinessesandnegotiatingthelocalregulatoryenvironments(Box6.5).Itisimperativethatbusinessesoperatingineithercountryareabletomakecommercialdecisionsthatrelyonarobustruleoflawratherthanrequiringnon-legalrecoursetopoliticalconnectionsandotherirregularchannelsshouldanybusinessorregulatoryissuesarise.Itisalsoimportantthatbothcountriesallowforopenaccesstoresourcesthataresharedbyallnations,suchassea-lanes,theinternetandspace.

ThedevelopmentofcorporategovernanceandtransparencyintheoperationofChinesecompanies,includingSOEs,canalsohelpinformtheirdealingsinaforeignsetting.AustraliawouldmissanopportunityforpositiveengagementwithChinaifitsformalpolicysettingsdiscriminatedagainstSOEsasamatterofprinciple.AnditcouldmisinterpretChina’sprivatesectorwereittoendorseaviewthatanycompanywithlinkstothegovernmentwasinsomewaycommerciallycontrolledbythestate.Similarly,Chinawillmissanopportunityifitwidelyandunnecessarilydiscriminatesagainstforeigninvestment.

BOx 6.5: sinO gAs in CHinA

SinoGasandEnergyHoldings(SinoGas)isanAustralianstockexchangelistedcompanythatexploresforandproducesnaturalgasintotheChinesemarket.Itscompetitiveadvantageisitsskilledlabourforceandtechnologicalabilitytodrillandextractgasusingadvancedtechniquesatverylowcost.SinoGashasbeenoperatinginChinasince2006andisnowAustralia’slargestenergyinvestorinChinaandoneofonlyasmallnumberofforeignexplorationandproductioncompaniesproducinggascommerciallyintotheChinesemarket.GasproductioncommencedfromitsSanjiaobeiandLinxingProductionSharingContracts(PSCs)inChina’sShanxiprovincein2014.AtotalofapproximatelyUS$310millionhasbeeninvestedinthetwoprojectsbySinoGasanditspartnerssinceinception.ProductionfromitsLinxingcentralgatheringstationcommencedinSeptember

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2015,afterbeingslightlydelayedduetoacentralgovernmentdirectiverequiringsafetyreviewsofallgasoperationscountry-widefollowingthemediasensationoveradeadlyexplosioninTianjin.

AtotalofUS$10.1millionwasreceivedbySinoGas’49percentjointventureforgassoldfromtheLinxingPSCfromDecember2014throughtolateFebruary2016.ProceedsforpilotgassalesfromtheSanjiaobeiPSCofapproximatelyUS$2millionhavebeenmadetoitsPSCpartner,PetroChinaCBM.However,productionattheSanjiaobeiCentralGatheringstationremainssuspendedwhilenegotiationsareunderwayonthefinalallocationofpilotproductionproceedstoSinoGas’jointventure.Thisisexpectedtoberesolvedshortly.

Theanti-corruptioncampaigninChinahascreatedsomeuncertainty,andsloweddealingsbetweenChineseauthorities,SOEsandforeigncompanies.IntheChinesesystem,regulatorymilestonescansometimesrequireamatrixofapprovalsfromdifferentdepartmentsatthelocal,provincialandnationallevels.TheseareissuesthatwouldnaturallybetakenupinanewinvestmentagreementbetweenAustraliaandChinaandmightbuildconfidenceintheinvestmentenvironment.Inthecurrentenvironment,manyoftheseapprovalshavetakenslightlylongerthaninthepastduetotheincreasedscrutinyofdecisionsmadebyregulatoryauthoritiesandSOEs.DelaysonthereceiptofsalesproceedsandregulatoryapprovalshasimpactedSinoGas’shareprice,thoughongoingtechnologytransferaswellasthehigh-levelsupportoftheAustraliangovernmentarehopedtoinsulateSinoGasfromexcessiveprojectdelaysinChina.Notwithstanding,SinoGashasbeenoneofthebetterperformingASXlistedexplorationandproductionstocksoverthepasttwoyears.TheChinaenergysectorremainsanattractivevaluepropositionforforeignfirmsandoperatorsgiventhefavourablefiscalandregulatoryregime.

SinoGasisanAustraliansuccessstoryandthelonger-termprospectsforthecompanyareverybrightbecausetheChinesecentralgovernmentislookingtodoublethegascontributiontoitsenergymixbytheendofthenextFiveYearPlanin2020.Fullproductionfromthecompany’sassetsisexpectedtocommencein2017,andby2021SinoGas’assetswillproduceapproximately3percentofChina’stotaldomesticnaturalgasproduction,makingitasignificantcontributortotheenergyobjectivesofthecountry.

Across-the-boardpoliciesthatdiscriminateagainstforeigncompaniesingeneral,orstate-ownedcompaniesinparticular,runtheriskofconfoundingstrategicintentwithwhatistheunremarkableandunthreateningproductofbasicdifferencesineachcountry’spoliticalinstitutions.WhereeitherAustraliaorChinadoesadoptpoliciestoprotecttheircoresovereigninterests,whetherincriticalinfrastructure,telecommunicationsormedia(astheybothproperlydo),thesepoliciesshouldbetargetedtomitigatetheactualrisksidentified,regardlessofwhetherthethreatcomesfromforeignordomesticactors,andwhethertheyarelegallyprivateorstate-owned.Thisiswhyinstitutionsthatfostermutualunderstanding,transparencyandcommoninterestsarecriticaltoallowingthefullflourishingofthepotentialeconomicrelationshipbetweenAustraliaandChina.

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EnhancingmutualtrustandunderstandingisakeyobjectiveoftheproposedComprehensiveStrategicPartnershipforChange.ThePartnershipwillhelpachievetheseenhancementsandmitigatesystemdifferencerisksthrough:increasingpublicandcommercialcapacitiestounderstandhowthesystemsoftheothercountrywork;morefocusedandmoreusefulstrategicofficialdialogues,forinstanceonregulatorycooperation,riskmanagementandreform;andclosehigh-leveltiesbetweenpoliticalleaderswhocan‘pickupthephone’toreducemisunderstandings.

Reducing risks

MostoftherisksfacingactorswithintheAustralia–Chinaeconomicrelationshiparenormalcommercialrisks,andtheAustralianandChinesegovernmentsshouldproperlyentrustthemanagementoftheseriskstomarketmechanisms,giventhelegalframeworksoftheirrespectivesystems.Therisksofcommercialfailuresandmacroeconomicuncertaintyshouldbeacceptedandoccasionalbusinessfailuresaretobeexpectedandlearnedfrom.Someoftheserisksarebilateralsystemdifferencerisks,whicharestructuralinnatureandcanbemitigatedthroughpoliticaldialogue,publicinstitutionsandbilateralcooperation.Theyoccurbecauseof:differencesininterestsamongAustralianandChinesefirmsintheiroperationsintheothercountry;theentrenchedinterestsofregulatoryactorsanddomesticfirmsintheothercountry,whichmaybemotivatedtolimitforeigncompetitionandpreservemarketsshare;andthewayinstitutionalsystemsandsocialbehaviouraffectbusinessoutcomes.

High-levelpoliticalleadership,buildingonstructuredadvicefromkeyofficialandprivatestakeholders,canusebilateralandinternationalpressuretomakeprogressagainstthesevestedinterestsopposingdomesticreform(Box6.6).Asitisanadvancedeconomy,AustraliaisavaluablepartnerabletoworkatthefrontierofopeningChinesemarketstonewactorsandcreatingpartnershipstoshareexpertiseonmanagingchange.

Inaglobalisedworldeconomy,domesticreformcanbeincentivisedandreinforcedbyinternationalcommitmentstogrowth-promotingeconomicliberalisation.Thisstrategypreservesthesovereigntyofeconomicpolicy,whilehelpingtoovercomeresistancefromentrencheddomesticinterestswhomightotherwisestymiereform.

ThroughtheComprehensiveStrategicPartnershipforChange,bothAustraliaandChinacantakeadvantageofthisstrategytoadvancetheirrespectiveeconomictransformations.ThiscouldbeachievedthroughAustraliaservingasapossibletesting-groundforgradualliberalisationsofChineseservicestrade,investmentandcapitalaccountflows.AustraliaandChinaareasuitablematchbecauseAustraliaistoosmallaneconomytohaveasignificanteffectuponglobalactivitybutitislargeenoughandwelldevelopedenoughtoprovideareliablefeedbackmechanism.

AprimeexampleofsuccesswiththisstrategyisChina’saccessiontotheWTOandAustralia’sapproachtoit.Oneofthekeydriversofglobalgrowthsincethe1970shasbeentheintegrationoftheglobaltradingsystem.Conventionalnotionsofthreedistincteconomicsystems—thecapitalist‘firstworld’,thesocialist‘secondworld’andthedeveloping‘thirdworld’—gavewayinthe1990stotheideaofasingleglobaleconomicsystem,guidedwithinacommonsetofinstitutionsbasedaroundtheWTO,theIMF,themultilateralbanksandotherentitiesthatderivedfromthepostwarBrettonWoodssystem.Economiesthatopenedthemselvestotheglobaleconomygrewfaster—notonlybecausetheirproducersgainedaccesstooverseasmarkets,butalsobecauseinternationalcompetitionplacespressureongovernmentstoreformdomesticeconomies.

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Chinawasalatecomertothisglobaltradingsystem.WhileakeyplankofChina’seconomicreformsafter1978wasopeninguptotheoutsideworld,makingitanexemplarof‘export-ledgrowth’inthe1980s,therewasstillgreatprogressyettobemadeinthemid-1990s.ButChinahadbeeninterestedinjoiningtheglobaltradingregimesinceitfirstrequestedobserverstatusattheWTO’spredecessor—theGeneralAgreementonTariffsandTrade(GATT)secretariat—in1980.Chinajoinedthemulti-fibreagreementthatregulatedglobaltradeintextilesin1984,andinJuly1986ChinarequestedfullstatusasaGATTcontractingparty.

China’sGATTapplicationwasanearlyexampleofclosepracticalcooperationbetweenChinaandAustraliainsupportofbothcountries’economictransformations.AustraliahadbeenencouragingChinatojoinGATTfromlate1985,andprovidedanadvisortoChina’sMinistryofForeignEconomicRelationsandTradefrom1986to1987toassistinpreparingtheapplication.AGATTworkingpartyconsideredChina’sapplicationfrom1987to1996,andwasconcernedaboutmanyChinesepoliciesthatremainedasalegacyoftheplannedeconomy.Theseincludedthen-hightariffbarriers(averagingabove35percent),lackoftransparencyoruniformityincustomsrequirements,theabsenceofopeningupofChina’sfinancialsectortoforeigncompetition,subsidiesforSOEs,aswellasalackofcurrencyconvertibility,labourstandardsandintellectualpropertyrightsenforcement.

BOx 6.6: CHinA’s ACCessiOn TO THe WTO

AttheOsakaAPECSummitin1995,Chinacommittedunilaterallytooneofthelargestsingletradeliberalisations,asbonafidesofitsintentiononthewaytoWTOaccession.TheChinesepremiervisitedtheUnitedStatesfornegotiationsinApril1999,andthepresidentsofbothcountriesmetattheAucklandAPECsummitinSeptemberthatyear.FinalbilateralnegotiationsbetweenthepremierandtheAmericanambassadorinBeijingresultedina250-pageagreementthatpavedthewayforChina’sfullaccession.Allthewhile,AustralianadvisersworkedcloselywithChineseofficialsonthesubstanceandtacticsofachievingWTOmembership(Garnaut2005).

China’saccessiontofullmembershipoftheWTOin2001reducedthetariffbarriersfacingChineseexporters,fuellingaboominwhathadalreadybeenafastgrowingsector.In1980,China’sshareofglobalmanufacturingexportswasjust0.8percent.By2001itwasalready5.2percent.FollowingWTOaccession,China’sshareofglobalmanufacturingexportsgrewby1percentagepointperyear,makingChinathesourceof18percentofworldmanufacturingexportsby2014.Thiswasnotonlybeneficialforconsumersoflow-costChinesemanufacturingproductsworldwide,butalsoaboonforrawmaterialssupplierssuchasAustralia(Andersonetal2014).

JustassignificantasthegrowingmarketforChineseexportswastheexternalanchorthatChina’saccessionprotocolprovidedforChina’sowndomesticreforms.Commitmentstophaseoutgovernmentsubsidiesforloss-makingSOEshardenedthebudgetconstraintinthestatesector,improvingSOEefficiencyandthereforegeneratingsignificantwelfaregainsoverandabovethetradepolicyeffects.Commitmentsontransparency,intellectualproperty,financeandenvironmentalprotectionalsosupportedChina’sdevelopment(BajonaandChu2015).

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AcceptingWTOdisciplinesdidnotmeangoingagainstChina’snationalpolicyinterests.SOEreform,forexample,wasalreadywellunderway,withthousandsofsmallandinefficientSOEsbeingclosedwellbeforeWTOentry(ZhangandFreestone2013).Nevertheless,byworkingtowardsandcommittingtostandardsinaninternationalagreement,theWTOprovidedChina’sleaderswithanexternalanchorwithwhichtoconsolidateexistinggainsandtopushforfuturereforms.

Internationalcommitments,fromthisperspective,arenot‘concessions’thatacountrygivesupinordertosecurebenefitselsewhere,butratherservetosecurethebenefitsthataredeliveredathomefromwin–wincooperationwithinternationalpartnersandinstitutionsthroughwhichallcountriescanthrive(Sachsetal1995).ThisisthephilosophythatunderpinsajointAustralianandChineseeconomictransformation.

WhiledevelopingcountrieswereallowedsomeleewayinmeetingfullGATTobligationsbeforejoining,theUnitedStateswasreluctanttoallowChinatojoineithertheGATTortheWTOuntilalltheseconcernshadbeenaddressed.Indeed,theprotocolsofChina’saccessiontotheWTO(forexampleonexportcontrols)wereinsomerespectsstricterthanthoseapplyingtoexistingmembers(Box6.6).Ratherthanchangepoliciessuddenlyandriskimmensesocialdisruption,Chinacontinueditspolicyofgradualandpragmaticliberalisation.EconomicleadersinChinasawtheopportunitytoprosecuteChina’sdomesticreformagendabyusingWTOrequirementstoforcechangeinsectorsthatresistedopeningtocompetition,andsopledgedreformsintheseareasinexchangeforUSagreement.

managing risk

Alltherisksthatbusinessandcountriesfaceinothermarketsaresusceptibletoameliorationbyarangeofstrategies.Commercialrisk,associatedwithuncertaintyaboutfuturepricesorincomes,canbemanagedbycontractingandexchangehedgingstrategies,andimportantlybyinvestmentintheacquisitionofmarketknowledge(Box6.7).Throughinternationalagreementortreaty,governmentscanprovideprotectionagainstcapriciouspolicybehaviourthatincreaseseconomicrisks.

TheAustralia–Chinarelationshiphasbeenbuiltaroundenshriningmarketprinciplesinthetwocountries’bilateralandglobalapproachtotrade,investmentandfinance,andworkingtoremoveimpedimentstotheoperationofmarketforcessoastoimprovetheefficiencyofcommercialexchangeandthereforeenhancegrowthprospects.

Yetbusinessreliesonaccesstoinformationabout,andanalysisof,theeventsandtrendsthatinfluencetheformationofefficientmarketoutcomes,andnowhereisthismorethecasethaninthediscoveryanddevelopmentofnewandprospectivemarkets.Governmentsareonesourceofinformationandanalysis,butbuildingreliableandindependentcentresofanalysisinuniversitiesandthinktanks,whichcaninformfirmsoftrendsanddevelopmentslikelytoaffectmarketoutcomes,providesanotherimportantsource.TheComprehensiveStrategicPartnershipforChangeshouldencourageinvestmentinnationalcentresofexcellenceinanalysistosupportunderstandingoftheforcesthatwillshapethedevelopmentoftheeconomicrelationshipbetweenAustraliaandChinainitsregionalandglobalsettings.Thatwillensureithasthenecessaryintellectualunderpinningstothrive.

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InAustralia,theANUhousesoneofthestrongestconcentrationsofresearchexpertiseontheChineseeconomyoutsideofChina.EachyearitsChinaEconomyProgram(CEP)publishesapeer-reviewededitedvolumeofinternationalresearchontheChineseeconomy—theChinaUpdateseries—andhostsamajorconferencethatbringstogetherChinese,Australianandinternationalacademicsandpolicymakerstodiscussitsfindings.YeteventheCEPwouldneedtobesignificantlystrengthenedintoatrulynationalendeavour—throughcooperationandresearchcollaborationwithofficialagenciesinAustraliaandChinaaswellasthroughroutinelinkswithothercentresofresearchinAustraliaandinternationally—ifitweretoplayaleadroleinimplementingastrategicresearchagendathatconnectsitsbi-nationaleconomicscholarshipdirectlytothepracticaladvancementoftheeconomictransformationoccurringbetweenthetwocountries.

Theimportantrolethatindependentacademicinterlocutorscanplayinreinforcingthevalidityofmarketapproachesonbothsidesisrevealedinthecommunicationbreakdowns,institutionalconfusionandresultantmistrustthatcharacterisedtheexplosionofthepriceboominironoreexportsfromAustraliatoChinafromaround2007to2012.

TheCEPinAustraliacouldappropriatelyserveasafoundationforanetworkofresearchcapacity,duetoitsexistingworkanditsdeepconnectionstoequivalentChinesecentressuchastheNationalSchoolofDevelopmentatPekingUniversity,RenminUniversity’sNationalAcademyofDevelopmentandStrategy,theChineseAcademyofSocialSciencesandtheCenterforChinaandGlobalization.ProcessessuchasthosesetinmotionbythiscollaborationbetweenCCIEEandEABERcanaddmomentumanddirectiontotheseefforts.

BOx 6.7: DeLiveRing PROsPeRiTy AnD seCuRiTy THROugH THe mARKeT

Intheearly2000s,theglobalmarketforironorehadtoadjusttoalargepositivedemandshockfromChina,whichrequiredenormousamountsofironoretobuildthehousingandinfrastructureneededtosustainrapidlyexpandingurbanisationandindustrialisation.AsinternationalsupplystruggledtokeepupwithsoaringChinesedemand,andhigh-costmarginalproducersinChinaandothercountriesenteredthemarkettofillthesupplygap,thepriceofironorewaspusheduptorecord-highlevelsby2011.

Themagnitudeoftheincreaseinironoreprices,ledsometosuspectthatthe‘BigThree’majorintra-marginalironoresuppliers—RioTintoandBHPBillitoninAustraliaandValeinBrazil—weretakingadvantageofChina’sironoreshortagebyengaginginstrategicsupplieroligopolisticbehaviourtoextractsuper-normalprofits.Naturalconstraintsontheexpansionofironoreproductioncausedashort-runsupplygapfollowingthesurgeinChina’sironoredemand,combinedwithpre-existingmarketconditionsanddelayedpricesignalling.

Theironoremarketadjustedtothedemandshockinacompetitivewayinthelongerrun.Upuntil2009,theglobalironorepricewassetbyabenchmarkpricingsystem,whichinvolveddirectnegotiationsbetweencontractholders—forexampleAustraliansuppliersandChinesebuyers—anddeliveredinternationallycompetitivepricingoutcomes.In2009,thestateChinaIronandSteelAssociation(CISA)intervenedinannualironorepricenegotiationsbythreateningtoboycottBigThreeironoreimportsunlessabelow-marketpricewasagreed.ThisinterventionfailedbecauseChineseimportersweredependent

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onBigThreesupplies,theinterventionwasthereforenotsupportedbythecentralgovernmentorbythesteelbusiness,andthethreatcouldnotbeenforcedbecauseofthecompetitivenatureofthedomesticindustryandtheinternationalmarket.

Thisepisodecreatedunnecessarytensionsinthebilateraleconomicandpoliticalrelationships.Italsoledtothecollapseofthebenchmarkpricingsystem,whichwasreplacedbyaspotmarketpricingsystem.Thischangealteredhowbilateralquasi-rentsfromgeographicclosenessweredistributedbetweenChineseandAustralianironoretraders.Inthefirst21monthsaftertheswitchtothespotmarketpricemechanism,Australianexportersreceived,onaverage,againofaroundUS$288.3millionpermonth,ascomparedtowhattheywouldhavereceivedunderthe2008pricingsystem.Thedivisionofbilateralquasi-rentsisazero-sumscenario,meaningAustralia’sUS$288.3millionaveragegainpermonthmeantthatChina’sironoreimportersfromAustralialostUS$288.3millionpermonth.Forcontext,duringthisperiod,China’ssteelindustrymadeanaverageprofitofUS$1.1billionpermonth(Hurst2016).

TheAustralianandChinesesystemswouldhaveprofitedduringthisearlierphaseofeconomictransformationfromhavingdirectpolicyaccesstoanindependentcentreofeconomicresearchexcellencethatwasdedicatedtofurtheringbilateralrelationsbasedonmarketprinciples.

Policyuncertaintyanditsimpactonbusinessesandwholeeconomiesisneverabsent,evenbetweencountriesthathavethemostfamiliarandinstitutionallysimilarmarketstructures,andevenwhengovernmentshavearangeofmacroeconomicinstrumentsandpolicysettingstocushionagainstunexpectedshocksfromothereconomieswhilepreservingthegainsfromexchange.Thesemacroeconomicinstrumentsnotablyincludeflexibleexchangerates,soundmacroeconomicpolicystrategies,andaccesstoreservesandinternationalsupportfromtheIMFormajoreconomicpartners.

HighvolatilityontheChinesestockmarketandtheslowingheadlinegrowthfiguresaresourcesofuncertainty.Also,someofthepublicreactionstoeconomicnewsfromChinaisnoiseandcouldaffectshort-termdecision-making.Butreasonedcommentarythatisinformedbycloseworkingrelationshipsattheofficiallevelandseriousindependentanalysis—forexample,oftheroleofkeydevelopmentsineachcountrysuchasstockmarketvariabilityormarketdevelopments—areessentialtobalancedandmeasuredresponsestoeventsthatpreventmarketandpolicystakeholdersineachcountryfrombeingdivertedbynon-significantsignalsandmisreadingunderlyingtrends.

Anewandrapidlyexpandingpartnershiprequiresprivateandpublicinvestmentindevelopingknowledge,literacyandunderstandingbothtomaximiseopportunitiesandtoprotectagainstrisks.

An Australia–China Comprehensive strategic Partnership for Change

WhentheAustralianprimeministervisitedChinainApril2013,thetwocountriesannouncedthattheyhadestablisheda‘StrategicPartnership’.TheyagreedtohaveregularmeetingsbetweentheChinesepresidentandtheAustralianprimeministerandtoholdthreehigh-levelannualbilateraldialogues:aLeaders’MeetingbetweentheAustralianprimeministerand

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theChinesepremier;aStrategicEconomicDialoguebetweentheAustraliantreasurerandtradeministerandthechairmanoftheNDRC;andaForeignandStrategicDialoguebetweentheAustralianandChineseforeignministers.InNovember2014,whenChina’spresidentvisitedAustraliaandmetwiththeAustralianprimeminister,bilateraltieswereupgradedtoa‘ComprehensiveStrategicPartnership’.

ThisdiplomaticnomenclatureisnotuniquetoAustralia,butispartofthe‘partnershipdiplomacy’thatisthefoundationofChina’s‘non-alignmentpolicy’ininternationalaffairs.Tobea‘partner’ofChinarequiresalevelofmutualtrust,anabsenceoffundamentaldifferencesonthemajorissuesofterritorialsovereigntysuchasTibet,XinjiangandTaiwan,andanimportancetoChinainstrategic,securityoreconomicissues.Ofthemorethan170countriesthathavediplomaticrelationswithChina,lessthan60are‘partners’.Unlikealliancerelationships,China’spartnershiprelationsareannouncedinjointstatementsratherthanenshrinedintreaties.

China’spartnershipsmostlyfallintofourcategories,whichinorderofascendingimportanceare:cooperativepartnerships;comprehensivecooperativepartnerships;strategicpartnerships;andcomprehensivestrategicpartnerships.Theterm‘comprehensive’indicatesthatacountrycollaborateswithChinaacrossabroadrangeofspheres,includingpolitics,economics,cultureandmilitaryaffairs.Theterm‘strategic’signifiesthatacountryworkswithChinaatahighlevelonissuesofcommoninterestthathaveaglobaldimensionandwhichimpacttheoverallblueprintofeachcountry’sinternationalpolicymaking.Strategicpartnersareconsideredtobereliablecolleaguesandtosharesimilarstrategicobjectivesintransnationalarenas.Countriestendtostartatlowerlevelsandworktheirwayupoveraperiodofmanyyears.

Inthisranking,ChinaalreadyrecognisesthestrategicimportanceofrelationswithAustralia.YetChinahas‘comprehensivestrategicpartnerships’withover20othercountries,includingcountriesthatareseeminglyoffarlesseconomic,politicalandstrategicconsequencetoChina,suchasAlgeriaandPeru.Indeed,certaincountriesofspecialimportanceforChinahavetheirownuniqueclassificationwithinChina’spartnershipdiplomacy.Russiaisa‘comprehensivestrategiccoordinationpartner’.Pakistanisan‘all-weatherstrategiccooperativepartner’.TheIndo-ChinaPeninsulastatesofVietnam,Laos,Cambodia,MyanmarandThailandare‘comprehensivestrategiccooperativepartners’.Germanyisan‘all-aroundstrategicpartner’.TheUnitedKingdomandChinarecentlydeclaredaunique‘globalcomprehensivestrategicpartnershipforthe21stcentury’.Forvariousreasons,neithertheUnitedStatesnorJapanispartofChina’sformal‘partnership’system.

Giventhedevelopmentsintherelationshipanditsprospects,AustraliaandChinashouldnowcontemplateupgradingtheirpartnershiptoaunique‘ComprehensiveStrategicPartnershipforChange’.Thiswouldsendanimportanthigh-levelmessagethatAustraliaandChinaextendtrusttoeachotheraspartnersinaworkingrelationshipthataimsforsubstantialchangetowardssignificantmutuallyagreedgoalsandobjectives.Already,onlymuchlargercountriessuchastheUnitedStates,theUnitedKingdom,RussiaandGermanyhaveanequalorgreaterlevelofregularinteractionwiththeChinesepoliticalleadership.Australia’splacinginChina’spartnershipsystemshowsthatboththeAustralianandChinesepolitiesrecognisehowimportanttheothercountryistotheother.Nowisthetimetoconvertthisbilateralunderstandingandexistingbilateraldialoguesintoclosereconomicandpoliticalcooperation.

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Bilateralpoliticalmeetingsarepartofaprocessofdevelopingunderstandingandtrust,improvingpolicycoordinationandcreatingnormsofconsultationbetweenAustraliaandChina.ThesearecrucialbothtocapitalisingonbilateralpolicyarrangementssuchasChAFTA,andtoestablishingconfidenceinbeingabletocommunicateduringsituationswheretherearedifficultiesintherelationshiporcrisestobemanaged.Importantly,aspartnersforchange,bothAustraliaandChinawillworkacrossarangeofpriorityareasonacommonlanguageforframingandadvancingbilateralrelations,andentrenchedproceduresfornotifyingtheothersideaboutupcomingpolicyannouncementsanddevelopmentsthataffectmutualinterests.Thisensures,asfaraspossible,thatthereare‘nosurprises’.Frequenthigh-levelpoliticalleadershipmeetings,frequentseniorbureaucraticmeetings,anddeeplevelsofworkingrelationshipscharacterisedtherapiddevelopmentofbilateralrelationsinthe1980s,andtheyarethekeytosuccessintherelationshipinallitsdimensionsinthedecadeahead.

TherevitalisingvisitbytheChinesevice-premiertoAustraliainOctober2009setthetoneforthefuturerelationship.Thatvisitfollowedtwodifficultyearsinthebilateralrelationship(AustralianCentreonChinaintheWorld2015):Australia’sthenprimeministerreferencedhumanrightsproblemsinTibetduringaspeechatPekingUniversity;Australia’s2009DefenceWhitePaperignitedcontroversybyconcludingthatChina’smilitarymodernisationcouldbe‘causeforconcern’andwas‘beyondthescopeofwhatwouldberequiredforaconflictoverTaiwan’;Chinalco’sbidforanincreasedstakeinRioTintofellthrough;aRioemployeewasarrestedinChinaonbriberycharges;andaUighurleadervisitedAustralia.YetAustraliaandChinaagreedona‘blueprintforthefurtherdevelopmentofChina–Australiarelations’andthisvisitiswidelycreditedwithlayinganewfoundationforstablebilateraltiesandimprovedpoliticalrelations.Itledtoan‘Australia–ChinaJointStatement’,inwhichbothsidesagreedthat‘strongerpracticalcooperationformutuallybeneficialoutcomesservesthefundamentalinterestsofthetwocountries’,andcommittedto‘sustainandenhancetheirdialogue,engagementandcooperationatalllevels,includingtheseniorleadershiplevel’(AustralianEmbassyChina2009).Thisoutcomeisanexemplarforthefutureofthebilateralrelationship.

AnewpartnershipforchangebetweenAustraliaandChinathatsupportstheeconomictransformationinbothcountriescanonlyworkifinstitutionsandarrangementsarejointlyputinplacetosustainregularengagementandtargetedpolicyinitiativesthatareaheadofthecurveofreform.Theseinstitutionscanaimatentrenchingacultureofcooperationwithintherelationship,bothfromthetop-downthroughpoliticalleadershipandfromthebottom-upthroughofficialandprivateinitiatives,andthroughcombinationsofboth.

AstheAustralianprimeministersaidin2013,‘newarchitecturewillnotdotheworkforusormakehardproblemsinourrelationshipeasy’,but‘whatitwilldoiselevateourexistinghabitsofdialogueandcooperation’(Kenny2013).AustraliaandChinacangivesubstancetotheirComprehensiveStrategicPartnershipandsignalcommitmentbyraisingittoanewanduniquelevel.

ApurelytransactionalapproachtobilateralrelationsisinneitherAustralianorChina’sinterests.Thisisbecause,fromitsmodernbeginnings,theAustralia–Chinarelationshiphasbeenpremisedonbothcountries’ambitionsforreformandchange.Fromtheopeningofdiplomaticrelationstotheprospectswehavelaidoutforthedecadesahead,managingchangeonahugescalehasbeen,andwillcontinuetobe,thepremiseofthesuccessoftherelationship.AsthisReportmakesclear,thisrequireslong-termcommitmentsand

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institutionsthathelptoframecommonprinciplesandreferencepointsforprogressintherelationshipthathelpwiththeprojectofmanagingchange,aroundalltheuncertaintiesandrisksthatareitsinevitableby-product.ThischangewillbringprosperityandsecuritynotonlytoAustraliaandChinabutalsotoourregionandtheworld.

InbuildingnewdiplomaticarchitecturefortheAustralia–Chinarelationship,itisinstructivetoexaminethehistoryofAustralia–Chinacooperation,andparticularlyitshighwatermarkinthe1980s(Garnaut2005).Followingtheestablishmentofdiplomaticrelationsin1972,bilateraltiesflourished,andwiththelaunchofChina’sopeningandreformphasefrom1978thelevelofpoliticalengagementandeconomiccollaborationbetweenthetwocountriesreachedapeakduringthe1980s.

Duringthe1980s,EastAsiawascentraltotheinternationaldimensionofAustralia’sowneconomicreform;atthesametime,Chinawasopeninguptotheworldthroughitsfirstroundofmarketreform.AustralianpoliticalleadersandtheiradvisersdirectedeffortstolinkingAustralia’sdomesticreformprocesstothatoccurringinChina.Thefoundationslaidbyhigh-levelpoliticalvisits,governmentvisits,policydiscussions,exchangesandjointworkinggroupsencouragedgreaterengagementbyprivatebusiness,stateenterpriseandothereconomicactors.

Intheearly1980s,theAustraliangovernmentrecognisedtheenormouspotentialforbilateraleconomicbenefitsifChinacouldgrowitsdomesticeconomyrapidlyandcreatetransitionalinstitutionsthatsecuredforforeignactorsrules-basedaccesstotheChinesemarket.ThiswasseenasanimportantwaytoensurethatChinaexerciseditsgrowingfuturepowerthroughconstructivemultilateraldialogue.

Thebedrockoftherelationshipduringthe1980swasthepersonalinterestofandexceptionalaccessbetweentopleaders.ThisclosenesswasduetotheinitiativeofpreviousAustralianprimeministersandsustainedofficialcommitment.InBeijinginFebruary1984,theChinesepremiersuggested,andtheAustralianprimeministeraccepted,thatthetwocountriesshouldaimtocreatea‘modelrelationship’,onewhereAustralia–Chinarelationsbecameamodelforhowcountrieswithdifferentpoliticalandsocialsystemsandatdifferentlevelsofeconomicdevelopmentcouldinteract.

Duringthistime,Chinaneededtoopenuptotheworld,andAustraliawantedthecredibilitythatcouldcomefromshowingthatitwasactingconsistentlywithitsprescriptionsforChina.Sowhilethe‘modelrelationship’includedtheimportantqualifierthattherewouldbenospecialprivileges—justequalrights,treatmentandaccess—bothsidescommittedtoimplementingallpromisesandcommitmentsmadeunderthemodelrelationship.

Economicrelationswerecentraltothismodelrelationship.AstrategicChinaActionPlanwasdevelopedfollowingdiscussionsbetweentheAustralianprimeministerandtheChinesepremierin1983,andwasagreedinBeijinginFebruary1984.Itcommittedtoadvancingtradeandinvestmentinbothdirections.InAustralia,thePlansetanobjectiveofdoublingthevalueofAustralianexportstoChinawithinfiveyears,andtookintoaccountChina’sdesiretoexpandimportstoAustralia.ThePlan’stargetwasreachedinonlytwoyears.

UnderthePlan,AustraliadecidedtomaximiseitsimpactinChinabyfocusingengagementandgovernmentfollow-throughonasmallnumberofindustrysectorsandChineseprovinces.ThefourkeyexportsectorsforAustraliawere:ironandsteel,non-ferrousmineralsandmetals,woolandgrain.InFebruary1984,AustraliaandChinaestablishedaJointWorking

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GrouponIronandSteel.Similargroupswereformedfornon-ferrousmineralsandmetals,andforwool,andChinaagreedtosoftenitsgrainself-sufficiencytargets.ChinamadeitsfirsttwomajoroverseasinvestmentsinAustralia—abrownfieldinvestmentinthePortlandaluminiumsmelterinVictoriaandariskiergreenfieldinvestmentintheMtChannarironoremineinWesternAustralia.

ThePlansignificantlyreducedcommercialrisksforAustralianenterprisesdealingwithChinabyprovidinghigh-levelpoliticalsupportformajorprojects,establishingworkingrelationshipsandconductingregularvisitswithkeyofficialsintargetareas,obtaininginformationregardingtheprojectandreformprioritiesofprovincialandlocalgovernments,andmakingintroductionsbetweenfirmsandrelevantofficials.

Australiainvestedconsiderableeffortincreatingbusinessandpublicsectorcapacityforanalysingthetrade,investmentandotheropportunitiesintheChinarelationship.Australiandiplomaticofficialsstrivedtounderstandcomplexdecision-makingstructuresandbuilteffectiverelationshipswiththelargenumberofChinesepolicymakerswitheffectivevetopoweroverreforms.TheAustralianEmbassywasabletohelpobtainauthoritativeresponsestomajorAustralianbusinessproposals.AustraliaandChinaworkedtogethercloselyonculturalexchanges,immigrationnormalisationandregionalnuclearnon-proliferation.

Althoughitwasrecognisedtowardstheendofthedecadethat,asChinabecamemorepowerfulanditstieswiththemajorindustrialcountriesexpanded,itwouldbeincreasinglydifficultforAustraliatosustainthestructureofitsrelationshipwithChina,theAustralia–Chinarelationshipcontinuedtohaveaspecialifdiminishedplaceinbothcountries’diplomacy.CompetitionincreasedasothercountriessoughttoparticipateinChina’seconomy.Inflationaryboomsandgrowthcorrectionsinbothcountriesinthelate1980sshiftedattentionfrominternationaltodomesticmarkets,andseveralmajorplayersshelvedtheirbilateralinvestmentplans.ThereformpaceoftheChineseeconomyslowedforavarietyofreasons,creatinguncertaintyforbusiness.

Threedecadeslater,lookingbackatthefoundationsoftheAustralia–Chinaeconomicrelationshipgivesinsightintowhatisneededforfuturesuccessintherelationship.High-levelpoliticalcommitmentisessential,asishigh-levelbureaucraticsupport.Bi-nationalcollaborationonreformandchangeiscritical.Strategicframeworks,suchastheComprehensiveStrategicPartnershipforChange,willbevitaltosettingthepathwayforward.

BothAustraliaandChinaaspiretobeleadersineconomicreformandcansupporteachotherinthiscommonobjective.AnupgradedanduniquebilateralarchitecturealignsbothwiththeAustraliangovernment’scommitmenttoan‘IdeasBoom’underitsNationalInnovationandScienceAgendaandwiththeChinesegovernment’sprioritisationofinnovationinits13thFiveYearPlan.

Thenextphaseofthetwocountries’relationshipneedstobuildonestablishedtrustaroundsharedandcommoninterestsintheireconomicandpoliticalrelationships,managetheuncertaintiesandrisksfromchange,anddevelopdeeper,up-closecommercialandbusinessengagementasthestructureoftheeconomicrelationshipshiftstowardsservicesandconsumers.Itwillflourishallthemoreifbothcountriessucceedincontinuingtonurtureintheirsocietiesacultureofcosmopolitanhumancapitalthatisliterateinthebusiness,societyanddiscourseoftheothercountry.

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Dialogues

Top-levelpoliticalleadershipmeetingssignal,andideallyimprove,theoveralltenoroftheAustralia–Chinarelationship.Theynormallyoccuronlyonceeachyear,althoughthereisscopeforsignificantadditionalcontactonthemarginsofthemanyinternationalleadersandkeyministersmeetingsthatnowexist.

Since2014,AustraliaandChinahaveheldtwoiterationsofanannual1.5-trackdialogueknownastheAustralia–ChinaHigh-LevelDialogue(HLD),whichisarecastingofthe1.5-trackAustralia–ChinaForumheldannuallyfrom2011to2013.Representativesofgovernment,business,academia,thinktanksandnon-profitorganisationsattendfrombothsidesto‘considerthefutureshapeanddirectionoftherelationship’and‘howtodeepenourtiesacrossthebreadthofourcommoninterestandpriorities’(Bishop2015).Engagingadiversityofbilateralstakeholdersinsemi-officialdialoguemechanismsisuseful,buttheHLDisbroadanditsfocusdiffuse,soitdoesnotleadtoconcreteoutcomesorconceptualadvancementsinbilateralrelations.ThisisinkeepingwiththeaimoftheHLDtoenhancemutualunderstandingandprovideaplatformfordevelopingideasfortherelationship,butrealprogressrequiressustainedhigh-levelattentionmarriedtointensivejointworkingarrangementsbetweentherelevantagenciesassociatedwithspecificpolicyissues.

Thegovernmentassistsspecificindustriesinbilateralengagementthroughthecoordinationofsupportacrossrelatedgovernmentdepartments.Forexample,theDepartmentofAgricultureandWaterResourcesadministersanAustralia–ChinaAgriculturalCooperationAgreement(ACACA)fortargetgroupsintheagriculture,fisheriesandforestrysectorsthatarelookingtoenhancecooperationanddeveloplinkageswithChina.ThisagreementoffersopportunitiesforAustralianbusinesspeopletovisitlocationswithinChinaandtomakebusinesscontactsthatmightotherwisenotbepossible.ToenhancethevalueoftheprogramforAustralia,delegatesarerequiredtosharekeylessonsandcontactsfromtheirvisitwiththeirbroaderindustry.

TheAustralia–ChinaCouncil(ACC),establishedbytheAustraliangovernmentin1978withtheSecretariatlocatedwithinDFAT,playsanimportantroleinfosteringbilateralcooperationandpeople-to-peoplerelationsbyactivitiesincludingfundingAustralia–ChinainitiativesthatbroadenandstrengthenAustralia’sengagementwithChina,HongKong,MacauandTaiwanintheACC’spriorityareasofeconomicdiplomacy,education,andartsandculture.TheACChasbeenattheforefrontofestablishingprivatesectorlinkagestosupportAustralianstudiesthroughthecreationoftheFoundationforAustralianStudiesinChina(FASIC),whichsupportstheBHPBillitonChairinAustralianStudiesatPekingUniversity,alongwithanetworkofover30AustralianStudiesCentresinChina.

Theyouthsphereisanotherareainwhichbothsides,oftenwithofficialsupport,haveprogressedthedevelopmentofvaluablebilateraldialoguesandcommunityorganisationsthathelptoconnectyoungAustraliansandChineseacrossdisciplinesandacrosslinguisticdivides.TheAustralia–ChinaYouthAssociation(ACYA)isavolunteerorganisationwhichpromotesbilateralyouthengagementandprovidescommunity,careersandeducationopportunitiesforover5000AustraliaandChinesestudentsandyoungprofessionalsacrossmorethan20chaptersinbothAustraliaandGreaterChina.TheAustralia–ChinaYouthDialogue(ACYD)isamarqueeannualeventthatbringstogetheremergingAustraliaandChineseleadersfromdifferentfieldstoforgeongoingprofessionalnetworksandcollaborations.TheAustralia–ChinaYoungProfessionalsInitiative(ACYPI)isthepremier

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platformforyoungprofessionalsinAustraliaandChinatoengagewiththemostsignificantissuesofthebilateralrelationship.TheAustraliangovernmenthasinvestedinalloftheseinitiatives,andtheirlong-termbenefittothebilateralrelationshipswillbecomemoreapparentastheiralumnibecomethenextgenerationofleadersinAustraliaandChina.

TheAustralia–ChinabusinessdialogueisprimarilydriventhroughtheAustraliaChinaBusinessCouncilinChinaandtheAustralianChambersofCommerceinChina.TheseorganisationsarecommittedtoadvancingbusinessandtradebetweenAustraliaandChinaanddosothroughlobbyinggovernmentstoremovebarrierstobilateralcommerce,providingbusinessintroductionsandnetworksformembersinbothcountries,andmaintainingresearchprogramsthatfeedintoevents,advocacyandpublications.TheAustraliangovernmentalsorunsabiennialAustraliaWeekinChina(AWIC)thatcoincideswithstatevisitstoChinabytheAustralianprimeminister.TheAWICinvolvesafederal-andstate-leaderheadeddelegationofseveralhundredAustralianbusinessesthatparticipateinsector-specificprogramsofseminars,sitevisits,productshowcasesandnetworkingeventswithChinesefirmsandofficials.Theseinitiativesformagoodbasisforcooperation,buttheywouldbeimprovedthroughmorebilateralinvolvementthatcommitsseniorChinesebusinessleaderstoongoingstrategiccooperation.

BOx 6.8: mODeLs OF BiLATeRAL COLLABORATiOn

Somemodelsofproductivebilateralcollaborationinotherareasthatcouldbeemulatedinbusinessandcommercialaffairsinclude:

the Australian Open:In2015,theAustralianOpentennistournament,whichhaslongpositioneditselfstrategicallyasthe‘GrandSlamoftheAsiaPacific’,signeda‘friendshipagreement’withtheShanghaiRolexMasterstoshareresourcesandengageinjointpromotionalactivities.Chinaisagrowingmarketfortennisparticipation,spectatingandsponsorship,andthereisalreadysignificantChineseinterest,attendanceandmarketingattheAustralianOpen.ANZandRolexaremajorsponsorsofbothtournaments,andthefriendshipagreementwillenablestaffexchangeandcombinethetwoevents’platformstopromotebilateraltennistourism.The2016AustralianOpenwas‘launched’inShanghaiinOctober2015.Additionally,theAustralianOpenhaslaunchedaWeChataccount,openedanofficeinHongKong,signedagreementswith12AsiaPacificbroadcasters,andengagedChina’sonlyAustralianOpenchampion,2014women’ssingleswinnerLiNa,asabrandambassador.

the national Library of Australia (nLA):TheNLApartneredwiththeNationalLibraryofChina(NLC)tocompileandcuratethe‘CelestialEmpire:LifeinChina,1644–1911’exhibitionthatshowedexclusivelyattheNLAinCanberrafromJanuarytoMay2016.TheexhibitionfeaturedpreciousartefactsfromChina’slastimperialdynastythatweredisplayedoutsideofChinaforthefirsttime,aswellasrarelyseentreasuresfromtheNLA’sownChinesecollections.Tocomplementtheexhibition,theNLAalsohostedaseriesofacademiclecturesandcommunityeducationalactivitiestoincreasepublicinterestinandunderstandingofChina.TheexhibitionwasalsoexpectedtoboosttourismtotheAustralianCapitalTerritory(ACT).TheNLAreceivedpromotionalsupportfromtheACTgovernment,buildingonpreviouspartnershipsbetweenthetwoentities,onthe15-yearsister-cityrelationshipbetweenCanberraandBeijing,andonanNLA–NLCMoU

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agreedin2012.TheNLAalsoreceivedsupportfromtheAustralia-ChinaCouncilandfromanumberofcorporates,whichwereeitherbuildingrelationshipswithChinaorofChineseoriginandseekingtobuildtheirprofileinAustralia.

the sydney symphony Orchestra (ssO):Billingitselfas‘theleadingculturalambassadorforAustralia’,theSSOsignedaMoUwiththeShanghaiSymphonyOrchestraandtheShanghaiOrchestraAcademyinApril2015.TheMoUformalisesthecommitmentofeachpartytotheirongoingrelationshipsandwillseeregularperformancetoursbetweenthetwocities.TheSSOwillalsoprovidementoringandperformanceopportunitiestoChinesestudentsinSydneyinShanghai.TheSSOalreadyhasMoUswithChina’sNationalCentreforthePerformingArts,Guangzhou’sXinghaiConservatoryofMusicandtheGuangzhouOperaHouse.

Thebusinessrelationshipdoeshaveadedicatedhigh-leveldialoguemechanismintheAustralia–ChinaCEORoundtable,whichhelditsfirstmeetingin2010.TheRoundtablemeetsonthesideofleader-levelstatevisitsanddiscussespossibilitiesfordeepeningbilateraltradeandinvestment.Itisaworthyinitiativebutitmightbeofgreaterservicetobusinessengagementiftherewaseffectiveinter-sessionalpursuitoftargetedagendasforenhancingbusinessrelationshipsandiftherewereasecretariatthatcouldsustainacooperationagendaandprogramofforwardwork.TheAustralia-ChinaSeniorBusinessLeaders’Forum,whichisapurelybusiness-to-businessdialoguealsoprovidesanotherforumforcorporateleaderstoadvancediscussionandpolicyrecommendationsonbilateralchallengesandopportunitiesontheoccasionofAustralia-Chinastatevisits.

Theessenceofabilateralstrategyshouldbetoworktogethertoachievecommonobjectivesratherthanhavingmeetingsfortheirownsake,andsothepositivesentimentandresourcesbehindtheHLDmighthelpfullybedeployedinmoretargetedways.ThiscouldbeachievedbyholdingarangeofHLDs,eachfocusedaroundbringingtogetherbilateralcounterpartsinaparticularareatodeliverspecificoutcomes.AgoodmodelcouldbetheAustralia–JapanPublic–PrivatePolicyDialogue(AJPPPD),aninitiativeoftheAustralia–JapanBusinessCooperationCommittee(AJBCC),whichfocusesspecificallyonpromotingAustralia–JapaninfrastructurecooperationandhasledtosuccessfulinvestmentsbyJapanesefirmsinAustraliansinfrastructureprojects.TheAustralian–AmericanLeadershipDialogue(AALD)alsoorganisesseveraleventseachyearthatfocusondefinedthemes.

AnumberofsuccessfulofficialdialoguesexistbetweenAustraliaandChinathatcouldbeatemplateforthemanysub-componentsofanAustralia–ChinaComprehensiveStrategicPartnershipforChange.TheAustralia–ChinaHumanRightsDialogue,whichwasinitiatedin1997,institutionalisesofficialdiscussionofsensitivepoliticalissuesinastructured,systematicandproductivefashion.Itprovidesamechanismforraisingspecificanddifficultissuesinaquietlyproductiveatmosphere,andseekstoresolveratherthandrawattentiontoproblems.Inadditiontosupportingexistingcommitments,theDialoguecanbeusedtoinformpartiesaboutfuturereform.TheDialoguealsointeractswithandcomplementstheworkandresolutionsofmultilateralhumanrightsorganisations,suchastheUN,andworkswithNGOs.TheDialoguestrengthensmultilateralcommitmentswhileallowingAustraliaandChinatodiscusshumanrightsinacollaborativesettinganddisplayacommitmenttoactionindomesticmedias.Italsohousesotherrelationship-buildinginitiatives.TheHumanRights

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TechnicalCooperationProgram,whichoperatesundertheDialogue,facilitatescollaborationbetweentheAustralianHumanRightsCommissionandpartnerorganisationsinChina,suchastheAll-ChinaWomen’sAssociationandtheBeijingLegalAidOrganisation.

SuchAustralia–ChinacollaborationisanexampleoftargetedcooperationthatdeliversspecificobjectivesthathaveabroadappealacrosstheAustralianandChinesecommunities,andwillthereforecreateamultipliereffectonbroaderbilateralties.Morestrategicallyfocusedplanningofofficialdialogues,andsupportfornon-officialdialogues,willformwell-calibratedpartnershipsbetweenAustraliansandChineseattheforefrontofeconomictransformationsandsocialexchangethatcanbetteradvancebilateralgoalssetatthepoliticalpartnershiplevel.

Aswellasthedirectdifferencesincultural,institutionalandpoliticalsystems,thereareadditionalquestionsofhowgovernancesystemsimpactoncommercialexchangeandwhatprotocolsandarrangementscanbedevelopedtohelpbuildunderstandingandtrustbetweenbothcountries.

AustraliaandChinahaveawiderangeofbilateralmechanismsincludingregularministerialmeetings,politicalexchanges,taxationagreements,disasterreliefcooperationandculturalexchangeprograms.Increasinglytargeted,strategicbilateralengagementinpriorityareasofeconomictransformationwillincreasetrust,shareknowledgeofreformprocessesandimplementpracticalcollaborationsthatfacilitategreatertrade,investmentandfinanciallinkagesinlinewiththedirectionofeachcountry’stransformation.Bilateralbusinesscouncils,professionalassociationsandforumsbuildrelationshipsbetweenbusinessleaderswhileprovidingaplatformforsharingin-countryexpertise.High-levelmeetingsingovernmentandbusinessencourageflowsofpeopleandideas,andcollaborationonpolicyoutcomes.

BilateralpolicyinstitutionssuchastheAustralia–ChinaSEDbringtogethertopministerial-levelpolicymakerstoaddressastrategicagenda.TheinauguralSEDdialogue,heldin2014,focusedoncloserfinancialcooperation,advancingoffshorerenminbimarketdevelopment,andhighlightingareasofpotentialcollaborationduringthetwocountries’G20andAPEChostyears.Thefollowingyear,thedialoguespecificallyaddressedinvestmentopportunitiesinNorthernAustralia,includingdiscussionoftheprospectiveroleoftheAIIB.

Yetthemostproductivebilateralinteractionislikelytobemaintainedwithintreatyframeworksbecausetheseregularisedialogueandobjectives.Forinstance,therehasnotbeenameetingoftheAustralia–ChinaHumanRightsDialogue—whichisnotembeddedinatreaty—inovertwoyears,sincethe15thmeetinginFebruary2014.

ThemostimportantbilateraltreatycurrentlyineffectbetweenAustraliaandChinaisChAFTA.Itlocksinbilateralcommitmentstomarketopeningandsetsadefinitivetimetableforfutureconsultationstofurtherthesereformcommitments,therebycreatingincentivesforcontinuingdialogueandforfindingcooperativesolutionstoopeningupeachother’seconomies.

ThenextstepforAustraliaandChinaistoexpandthiscloserrelationshipbeyondjusttheeconomicrealmthroughembeddingtheComprehensiveStrategicPartnershipforChange.

Ironically,whenChinawasamoreclosedeconomyandsociety,politicalsystemdifferenceswereclearerandengagementthroughtradeandinvestment(involvingdirectlystate-ownedentities)mayseemtohavebeenconductedinamorecertainenvironment,albeitonethatvastlylimitedthepossibilitiesforexchangeandinvestment.AsChinahasbecomeamore

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openandcomplexsociety,thereappeartobemoreuncertaintiesandattendantrisks.Thisisa‘quality’problemassociatedwithgreatlyelevatedopennessandopportunitiesforbusinessaroundthesuccessfulaccretionofChina’seconomicpower.Thiscircumstancerequiresengagement,notretreat,inordertotakeadvantageofthenewopportunitiespresentedbyChina’sincreasedopeningonmanyfronts.

Bridging the distance

Politicalandinstitutionalsystemdifferencescanmakeitdifficultforcountriestodevelopthecertaintyandconfidencenecessarytocommittolong-termpolicyendeavoursandinvestmentprojects.InAustralia,differentsystemsofgovernance,perceptionsofhumanrights,culturalvaluesandregionalsecurityissuesincreasefeelingsofdistancefromChina.InChina,misreadingthehostileattitudesofsomeinAustraliatoinvestmentprojects,lackofknowledgeabouthowdemocraticsystemsworkanddoubtsaboutregionalsecuritystrategiessimilarlycreatesdistance.

AustraliaandChinahaveverydifferentsocialtraditions,systemsofgovernmentandbusinesscultures.Consequently,amostimportantaspectofimprovedbilateralrelationsandthesuccessfulrealisationofaComprehensiveStrategicPartnershipforChangeisdevelopingdeeperrelationshipsbetweenAustralianandChinesepeople—whethertheybepoliticalleaders,departmentalofficials,corporateemployees,orcommunitiesofmigrants,tourists,studentsandcitizens.Initiatingandconsolidatingtheserelationshipsrequiresmutualtrustandadeepunderstandingofhowtheothercountryworks.Improvingthisstockofhuman,socialandculturalcapitalshouldbethegoalof‘Chinaliteracy’fortheAustraliansystemandthegoalof‘Australialiteracy’fortheChinesesystem.Itiscriticaltobeabletounderstandanothercountryonitsownterms—‘seeingoutfromtheinside’aswellas‘lookinginfromtheoutside’(Loubere2016).

Itisonlythroughknowledgeofthepoliticalinstitutions,economicsystemandsocioculturalcircumstancesoftheothercountrythatabilateralstrategicpartnershipcanfulfilitspotential.Thismeansthatmorepeopleonbothsidesmustbeabletospeaktheothercountry’slanguage,understandtheothercountry’sthinkingandcontemporarydebates,andbeabletocontributetothenationallifeoftheothercountry.Thiswillrequiresignificantinvestmentineducation,realignmentofbureaucratic,corporateandnon-profitcareerpaths,andthedeepeningofinteractionsbetweenthepeoplesofAustraliaandChina.

Presently,Australia’sassetsforunderstandingChinaarelesswelldevelopedthantheywillneedtobe.WhileAustraliamayhavebeenhighlyadeptatexportingresourcestoChina,buildingacommensuraterelationshipinmanufacturesandserviceswilldependongreaterChinacapabilities.Whileresourcestradereliesonthe‘hardware’ofextractiontechnologyandtransportationinfrastructure,manufacturingandservicestradeisdependentonthe‘software’ofsales,marketinganddesign.Withoutknowledgeofthetastes,preferences,hopesandfearsofanothersociety,businessesareunabletoeffectivelypositionthemselvestotakeadvantageofthatmarketorefficientlyusemarketingandpromotionalresources.

ThishighlightsthecruxofthemajorproblemthatAustraliafaces:whileitcanprovidemoreChinesepeoplewithhigh-quality,English-languageeducation,itcannotsimplyassumealinearrateofprogressinotherareasofAustralia’sservicesindustrieswithoutaddressingAustralia’scapacitytodevelopservicesexpertise.Therehavebeenconstantcallsfrom

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withinthebusiness,policy,academicandeducationsectorsforAustraliatoincreaseits‘Chinaliteracy’—aconcepttypicallydescribedastheknowledgeandskillsnecessaryto‘understand’Chinaandnavigatecross-culturalsocialandprofessionalinteractions.

TheAustraliaintheAsianCenturyWhitePaper(2012)andbodiesasdiverseasAsialink,theAustralianIndustryGroup,theAustralianPublicServiceCommissionandtheBusinessCouncilofAustraliahavearguedthatthereisan‘absenceorunderdevelopmentofcriticalindividualandorganisationalcapabilities’onAsia.MoreAustralianstudentsarestudyingChinesetodaythaneverbefore,butmostareofChineseheritage.AuthoritativereportstellusthatChineseclassesare‘overwhelminglyamatterofChineseteachingChinesetoChinese’(AsiaEducationFoundation2008).Excludingfirstlanguageandheritagespeakers,moreYear12studentsstudyLatinthanChineseasasecondlanguage.Arecentreportestimatesthattherearelessthan150Australiansofnon-ChineseheritagewhocanspeakChinesefluently(Orton2016).ItwouldbesensibletoresurrectandproperlyfundtherecommendationoftheAsianCenturyWhitePapertoprovideAustralianschoolstudentswithcontinuousaccesstopriorityAsianlanguagesthroughouttheireducation.

ItisdifficulttoimaginehowAustraliacanfullygraspChinaopportunitiesintheservicessectorwithouteitherencouragingthetargetedimmigrationofskilledChinese,withoutspeakingChinese,withoutunderstandingChinesesocietyandwithoutknowingtheChineseregulatoryenvironment.AndtheneedofservicesfirmsforChina(andAsia)literacywillonlygrow(BCG2012).LogisticscompanyLinfoxnotesthatit‘facesthechallengesofrunningalarge,complexorganisationinmultiplegeographiesandcultures…12,000ofLinfox’s19,200employeesarenowinAsia(only13areexpatriates)and20differentlanguagesarespokenacrossthefirm’(BCG2012).AllAustralianfirmsneedtheservicescapacitytofacechallengessimilartothoseofLinfox.

One,oftenunderexploredpartofthisproblem,comesdowntobusiness.IfbusinesswantsaworkforcewithChinaskills(or‘Chinaliteracy’),businessneedstocreateamarketforthisworkforce.Itisestimatedthat,theresourcessectoraside,AustraliacouldliftitseconomicperformancewithAsiabyuptoA$275billionoverthenext10yearsbyimprovingAsiacapabilities(Asialink2012).TheAustralianDepartmentofIndustry,InnovationandSciencehasmandatedAsialinkBusinessasAustralia’sNationalCentreforAsiaCapability,tosupportAustralianorganisationstodeveloptheknowledgeandnetworksneededtoengagewithAsianmarkets,includingChina.IthasmadeprogresstowardscultivatingamoreChinacapableworkforcethroughinitiativessuchastheChinaCountryStarterPacktofillthegapinChinainformationavailabletoAustralianbusinessesandtrainingover5000professionalsacrossthecountryannually.

Eventoday,veryfewmanagersinAustraliahavedevelopedthetime-consumingspecialistlanguage,culturalandanalyticalskillsthatarenecessarytobeChina-literate.Anothershifthastocomeinhowgraduatesarerecruitedattheentry-levelofbusinessandpublicservice.VeryfewjobsaskforspecialistChina-literateskills,focusinginsteadon‘generalist’skills.ButthehighertheproportionofChina-literateseniorleaders,themorelikelybusinesses(orpolicyagencies)willperformaboveexpectations.Withthisinmind,AustralianeedstothinkabouthowtobestusetheChinaskillsthatitalreadypossesses.Forexample,astartingpointwouldbetoprovideyoungAustraliansinindustry,governmentandotherprofessionalcareerswithpathwaysthatallowthemtomaintainandimprovetheirChinaskills.

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Chinaliteracyisnotdeterminedeithersolelyorevennecessarilyatallbyone’slevelofChinese-languageproficiency.PerhapsevenmoreimportantlywithintheranksofcorporateleadershipisanunderstandingofhowtodobusinessinChina,wherepersonalnetworksandinfluenceiskeytobuildingtrustwithpotentialpartners.AformerAustralianambassadortoChinahasopinedthatthemostimportantaspectofChina-literacyforAustralianbusinessesisinvestinghigh-leveltimeandeffortinmaintainingrelationshipswithcommercialpartnersandgovernmentofficialsthroughvisitingChinaandthroughinvitingChinesepartnerstospendtimeinAustralia,aswellasputtingseriousresourcesintotrainingandretainingappropriatebiculturaltalent(Raby2011).

Itistrue,ofcourse,thatAustralianandChinesefirmsoperateamarketforChinaliteracy,andthiscanbeassumedtobeworking—thesebusinesseswillstructuretheirhiringandmanagementpracticesasneededtoattractthenecessarytalent.ButtheambitionsofAustralianandChinesecompaniesinthisareaareconstrainedbythesupplyofbiculturalandbilingualworkersthatemergefromeacheducationsystem.ItisinrelationtopublicinstitutionssuchasschoolsthatgovernmentshavearoletoplayininvestmentinChina-literacyandAustralia-literacyasapublicgood.

AnassetthatappearsunderutilisedisthelanguageandculturalskillsofmanypeopleofChinesedescentlivinginAustralia.Of22millionAustralianscountedinthe2011Census,closetoonemillionhadsomeformofChineseancestry.AustralianswithChineseheritagecomprise4percentofthetotalpopulationand44percentoftheAsianAustralianpopulation,withSydneyandMelbournethemajorcentresofconcentrationofChineseAustralians.Since2011,mainlandChinahasbeenthelargestsourceofpermanentmigrantstoAustralia,andtherearenow319,000AustralianresidentswhowereborninmainlandChina—thethird-largestforeign-bornethnicgroup—aswellas75,000borninHongKong,25,000borninTaiwanand2000borninMacau.MandarinChineseisthesecond-most-spokenlanguageinAustraliaafterEnglish.YetChineseandotherAsianAustraliansareunderrepresentedinprofessionalandleadershippositions—AustraliansofAsianancestrycompriseonly1.7percentofparliamentarians,3percentofcompanyexecutivesand3.8percentofpublicserviceleaders.Theanalysisatthispointsuggeststheremightbea‘bambooceiling’thatneedstobebrokenifAustraliaistocallitselfAsia-literate(Soutphommasane2014).

Thereisalsounderdeveloped‘Australia-literacy’inChina.Australiahasitsowninstitutional,legal,political,socialandculturalsystemthathastobeunderstoodinordertobenavigatedbyforeigncommercialentities.WhileChina’sforeignlinguisticcapabilitiesandinternationaltradeintegrationaremoreextensivethanAustralia’s,manyChineseentitiesareunfamiliarwithhowtodobusinessinrelationtoAustralia’sdemocraticpoliticalsystem,regulatory,labour,environmentalandeconomicpolicies,aswellasitssocialnormsandpractices.ThismeansthattherearegreatopportunitiesforAustralianfinancial,legalandbusinessservice-providerstoworkproductivelywithChineseenterprisestradingandinvestinginAustralia.ChinesebusinessandgovernmentalsoneedtorecognisethebenefitofinvestingatalllevelsinunderstandinguniqueAustraliancharacteristics.Forexample,Australians’discomfortwiththeideaofalargerChineseeconomicpresenceinAustraliawillbeamelioratedbytheeffortsofChineseinvestorsthatareAustralia-andcommunity-literate.

Whileindividualsandevengroupsmayinvestinseriousbiculturalliteracy,AustraliaandChinacannotbeexpectedtobecomeproductivelyliterateineachother’ssocietywithouthigh-levelpoliticaladvocacyandencouragement.TheComprehensiveStrategicPartnership

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forChangeshouldcreateaproperlyresourcedbi-nationalcommissionthatwould,amongitslargergoals,assistinpromotinginstitutionalexchangesacrossschooling,university,businessandgovernmentthatarelinkedtoastrategicagendaforincentivisingimprovementstobiculturalliteracyandbusinesscapabilities.

Theseperceptionsarerevealedinvariousmeasuresofdistancebetweenthecountriesandinpollingdatathatsuggesthowclosecountriesfeeltowardseachother.Thesedatarevealvariationsovertime,buttheyshowthatAustralianshaveahighdegreeofrespectforChina’sachievementsandstatus,andthatChinesehaveawarmregardforAustralia’sopennessandroleintheregion.Despitesystemdifferences,AustraliaandChinahaveahistoryofhigh-level,strategiccooperationandoutstandingachievementinpolicycooperation,fromtheearlyopeningoftheresourcetradethroughtoChina’saccessiontotheWTO,therecentnegotiationofChAFTAandtheirclosecooperationinG20affairs.

BOx 6.9: RegiOnAL seCuRiTy AnD THe AusTRALiA–CHinA ReLATiOnsHiP

Bothcountrieshaveacoreinterestinasecureregionthatprovidesastablefoundationforadvancinginternationalcommerceandincreasingprosperity.Bothcountriesrecognisetheneedfortheregionalordertocontinuetoadaptandevolvetoensurethis,inawaythatrespectsandupholdsthesecurityandinfluenceofallcountriesintheregion.

AustraliahasreliedontheUnitedStatesforitsdefencesincethewartimeagreementsof1942andhasmaintainedaformalmilitaryalliancewiththeUnitedStatessincetheAustralia,NewZealandandUnitedStatesSecurityTreaty(ANZUS)wassignedin1951.ThemilitaryalliancebetweenAustraliaandtheUnitedStatesincludesamutualsecuritycommitment.Italsoincludesintelligencesharingarrangements.Therehasbeenalongstanding,bipartisancommitmentinAustralianpoliticstothisarrangement,ithaswidepublicsupportanditisunlikelytochange.ThisalliancerelationshipdoesnotprecludecooperationwithChinainareasofsharedinterest.

Whilepoliticalandsecurityrelationscansometimescutacrosseconomicinterests,thefoundationofaComprehensiveStrategicPartnershipforChangeisthelong-termnationalinterestsofbothcountries.AcurrentsecurityissueofprominenceintheregionisconflictingterritorialclaimsmadeintheSouthChinaSeaandtheEastChinaSea.ThisReporthasnoroleinweighinguptheseclaimsortheirresolution,butitisinthesharedeconomicinterestsofallpartiestoseethesettlementofanydisputesamicablyandtoensurethattheregionremainsopentotrade.

IntandemwiththetechnicaladvancesanddevelopmentofChina’seconomy,itsPeople’sLiberationArmy(PLA)hasinvestedinaprogramofmilitarydevelopmentandmodernisation.Recentinvestmentsinaircraftcarriers,submarines,long-rangemissilesandanemerging‘bluewater’navyhaveincreasedChina’scapabilitiesandabilitytoinfluencetheregionandbeyond.Eveninthecontextofa‘peacefulrise’,itistobeexpectedthatChinawilltakestepstoprotectitsownaccesstoglobaltrade,andtocontributetothesecurityofitscitizensandinvestmentsabroad.

China’semergenceasaregionalmilitarypowercreatesapotentialstrategicrivalfortheUnitedStatesintheregion.Undercertaincontingenciesinvolvingmilitaryconflict,Australia’salliancecommitmentsmightbeinvoked.Australiahasalreadyincreasedthenumberof

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USforcesrotatingthroughAustraliaaspartoftheAmerican‘RebalancetoAsia’strategy.TheAustraliangovernmentbelievesthat‘anydisruptiontokeyregionalsea-lanesandtoAustralia’sabilitytotradewouldhaveafundamentalimpactonournation’(Hurley2014).

ButAustralia’salliancewiththeUnitedStatesdoesnotprecludesecuritycooperationwithChina.AustraliahastheclosestdefencerelationshipwithChinaofanyoftheUnitedStates’English-speakingallies.InDecember2015,Australiahostedthe18throundoftheofficialAustralia–ChinaDefenceStrategicDialogueinCanberra.Thisremarkablerecordofdialogueonmilitarymattersisakeyassetfornavigatingnotonlybilateraldefencerelationsbutalso,potentially,thefutureofregionalsecurity.

RegularbilateralexchangestakeplacebetweentheAustralianDefenceForceandthePLA,includinghigh-levelofficervisits,navalshipvisits,strategicpolicyforums,humanitarianreliefdrills,culturalexchangesandanoverarchingAustralia–ChinaDefenceEngagementPlan.InJuly2014,PLANavyvesselsoperatedunderAustraliancommandduringUS-led‘RimofthePacific’navaldrills,andAustraliahostsanannualUS–China–AustraliatrilateralmilitaryexerciseinNorthernAustraliacalledExerciseKowari.TheAustraliangovernmentiscommittedtocontinuingthedevelopmentofitsdefencerelationswithChina.AustraliaandChinacoulddemonstratetheirrespectivecommitmentstotransparentregionalsecuritycooperationbystrengtheningbilateralintegrationoftheirglobalpeacekeepinganddisasterreliefforces.

AustraliaandChinacanbuildonthisfoundationofcooperationbyworkingwithotherregionalcountriesinexistingforumsliketheASEANDefenceMinisters’MeetingPlusandtheEastAsianSummitaswellasinnewmultilateralpolicydialoguesonregionalsecurityissues.

TheComprehensiveStrategicPartnershipforChangerecognisesthatregionalpoliticsareundergoingenormouschange.Thischangeneedstooccurinapeacefulandprogressivemannerwherenoonecountrydominatesanother,andallstates,largeandsmall,areabletoexpresstheirviewsandcontributetocommonsecurityobjectives.AustraliaandChinacanplayvitalrolesinleadingregionaldialogueandbrokeringsecurity,withtheirpartnershipasavehicleforpromotingregionalsecurityinitiatives(AustralianCentreonChinaintheWorld2015).

managing uncertainties

LearninghowtomaketheAustralianandChinesesystemsworktogetherintheprocessofenormouschangeandreformiscrucialtothevitalityoftheAustralia–Chinarelationship.ThedifferentnaturesoftheAustralianandChinesesystemsimpactoneconomicuncertaintyandriskdirectly;theyplayintohowthetwocountriesconducttheirpoliticalanddiplomaticrelations,andtheseaffairsultimatelyaffectthedepthoftheireconomicrelations(Box6.9).Theprinciplesandunderstandingsthatbothcountriesarticulate,andareguidedby,inmanagingthesedifferenceshavebeen,andremain,centraltothesuccessoftheirrelationship.ThatiswhythedevelopmentoftheirComprehensiveStrategicPartnershipforChangeisimportantastheoverarchingframeworkfortherelationship.

Changeinthepoliticalandglobalorderhighlightsthespecialimportanceofclarityineachcountry’sapproachtoregionalsecurityaffairs.(ThisissueisdiscussedindetailinChapter7.)Australia’salliancerelationshipwiththeUnitedStatesandChina’sunderstandingofthat

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relationshipprovidesafoundationfortheirownpursuitofcloserbilateralsecurityandmilitaryexchanges.Givingprioritytothedevelopmentofthesetiesacrossawiderrangeoftraditionalandnon-traditionalareasofsecuritymustbeanactivepartoftheagendaoftheComprehensiveStrategicPartnershipforChangeandwillserveindirectlytoreduceeconomicrisk.

Moreimportantly,thefoundationsoftrust(Box6.10)thatAustraliaandChinaalreadybringtotheireconomicrelationship,providesabaseforthemtoworkwiththeirpartnersintheregion,suchasJapan,theASEANcountries,SouthKoreaandIndiatotakeinitiativestowardsaddressingissuesofcommonconcernthathavethepotentialtocontributesignificantlytoenhancingregionaleconomicandpoliticalsecurity(seeChapter7).

BOx 6.10: BuiLDing POLiCy TRusT

TheelevationoftheAustralia–ChinabilateralrelationshiptoaComprehensiveStrategicPartnershipforChangerequiresahighleveloftrustbetweenthetwogovernments.ThePartnershipprovidesabaseforexpandingcommongroundforcooperationatthesametimeasmanagingrisks,includingpolicyandsystemdifferencerisks.Thefoundationsofahighleveloftrustresidewithofficialsofbothcountries—intheirprofessionalcapabilities,theirin-depthknowledgeofeachother’ssystemsandtheirbeingculturallysavvy.Thesecapabilitiesandfamiliaritiesareessentialtogoodjudgmentaboutpolicyintention,confidenceinengagementandavoidinginadvertentlyharmfulactions.

AustraliaandChinahavealreadycomealongwayinlayingthefoundationforconfidenthigh-levelgovernment-to-governmentengagement,withmanystepsalreadytakenbybothgovernmentsandcentraleconomicagenciesinestablishingstronginstitutionalandofficial-to-officiallinks.OneexampleistherelationshipbetweentheAustralianTreasuryandChina’sNDRC.Australia’swasthefirstTreasuryofaWesterncountrytosetupanofficewithintheirBeijingEmbassy,in1993.TheAustralianTreasurerandtheNDRCChairmansignedaMoUin2008,whichprovidedtheinstitutionalframeworktoguidethedevelopmentoftheagency-to-agencyrelationshipinfollowingyears.TheNDRCChairmanandtheTreasurerhavesincemetannuallyatMacroeconomicDialoguestodiscussglobaldevelopmentsaswellasmacroeconomicpoliciesandreformchallengesineachcountry.OfficialsofthetwoagencieshavepaidfrequentvisitsandengagedonarangeofmacroeconomicandstructuralreformpolicyissuesofdirectrelevancetothepolicyagendasinChinaandAustralia.TheAustralianTreasuryhasorganisedanannualseminarseriesconductedbyTreasuryofficialsinChina,directedtodevelopinganunderstandingofAustralia’seconomyandofAustraliansocialandeconomicpolicythatisofrelevancetoChina’sreformpolicies.

RecognisingtheimportanceofChinatoAustralia’sprosperityaswellasthecomplexanddynamicchangetakingplaceintheAustralianeconomy,Australia’scentraleconomicagencies,includingtheAustralianTreasury,theRBA,PM&CandDFAT,haveinvestedindevelopingskillsandcapacityforbetterunderstandingtheChineseeconomyanddevelopingamoreeffectivepolicyengagementwithChina.AstrongmotivationforthisendeavouristhatimprovedChinaknowledge,skillsandcapacitywillenhanceChinapolicyandthebenefitsfromtherelationshipforbothcountries.

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Thesebeginningsprovidethefoundationfortheengagementthatwillbeneededtomanageanddevelopamoresophisticatedrelationshipoverthecomingdecade.TheproposedAustralia–China(Ao–Zhong)Commission,throughitspromotionofhigh-levelexchanges,canassistinthis.Existinginstitutionallinksdemonstrate,however,thatcentraleconomicagenciesinbothcountriescanprofitablyexpandtheirties.ThisReport,whichhasenjoyedtheblessingofboththeAustralianandChinesegovernments,isanexampleofeffectiveworkingcooperationatthehighestlevelbetweenthetwocountries.ThecommitmentbytheAustralianTreasurytosupportafollow-upproject,toenhanceAustralianunderstandingofChina’seconomicpolicyandengagementwithChinesepolicymakers,isafurtherusefulstepinthisdirection.

Policy and institutional innovation

Inalltheseareas,thereisneedforinnovationininstitutionalmechanismsthatwillfacilitatefamiliarityandunderstandingofmotivationsandintentionsatthehighestlevelsofpolicymaking,cooperationattheworkinglevelinpolicydevelopmentbetweengovernments,andinvestmentinthehumancapitalandcollaborativepolicyinfrastructureonbothsides.

ThereisabroadandvastarrayofexchangesthatoccurwithintheAustralia–Chinarelationship.Theyspanacademia,thearts,business,culture,defence,economics,politics,scienceandsecurity.Strengtheningandencouragingtheseexchangeswillbevitaltosuccesswiththerelationshipinthecomingdecades.

TheComprehensiveStrategicPartnershipforChangecanprovideanoverarchingframeworkforlong-term,high-levelengagementthatbringsthecountriescloserbyworkingtogethertoadvancearticulatedstrategicobjectivesacrossallaspectsoftherelationship.ItwouldenabletheAustralia–Chinarelationshiptobecomeamodelofhowcountrieswithdifferentpoliticalandsocialsystemsandatdifferentlevelsofdevelopmentcancollaboratetoenhancecollectivewelfare.ProgresswithdeepeningtheComprehensiveStrategicPartnershipforChangewouldbuildstrongerholisticnetworksbetweentheAustralianandChinesesystems,ratherthanonlydisparatesectors,andthiswillinturnforgebilateralpartnershipsdirectedatrealisingparticularopportunitiesandmanagingspecificrisks.

ThefutureoftheAustralia–Chinarelationshipisbestguaranteedthroughstronginstitutionalarrangementsandthroughanentrenchedcultureofcooperationbetweenthetwocountries.TheAustralianandChineseleadershipscanencourageandpromotearangeofofficial,political,businessandcommunityinitiativesinbothcountriestodefineandfulfilthepotentialofanenhancedComprehensiveStrategicPartnershipforChange.

TheAustralia–ChinaComprehensiveStrategicPartnershipforChangewould:

• underlinebothcountries’commitmenttomutualtrust;

• institutionalisetheirdialoguesonstrategicobjectivesandworkprogramsoneconomicreformsandpolicychange;

• buildbi-nationalcapacitytosupporttheneweconomicengagement;and

• laythebasisfordeeperpoliticalcooperation.

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ThePartnershipwillentrenchdeeperandbroaderdialoguesandcooperationacrosstherelevantministriesanddepartments.Itwillbeservedbyjointworkinggroupsonreformdrawnfromthenationalgovernment,stateandprovincialofficials,business,themilitary,researchleaders,academiaandthebroadercommunity.Itwillfosterjointtrainingandthedevelopmentoflong-termworkingassociationsinkeyareasbetweentheofficialsofbothcountries.Itwilldevelopjointprotocolsforworkingtogetheronbilateral,regionalandglobalconcerns.

Australia–china (Ao–Zhong) commission

Beyondhigh-levelofficialandsemi-officialexchanges,amajorbi-nationalefforttoupgradethebreadthanddepthofexchangesisneededtosupportthedevelopmentoftheComprehensiveStrategicPartnershipforChange.ThiseffortneedstomatchthecharacteranddepthofexchangesthatAustraliahaswithothermajorpartners,suchastheUnitedStates.Amodel,onwhichAustraliaandChinacouldbuildandextend,istheAustralian–AmericanFulbrightCommission,whichisanon-profitorganisationthatwasfoundedbyatreatybetweenAustraliaandtheUnitedStates.CorefundingofanewAustralia–China(Ao–Zhong)Commissionshouldcomefrombothnationalgovernmentsequally.ButtheCommissionshouldalsobeopentoapprovingandmanagingprogramssponsoredbystategovernmentagencies,business,academicinstitutionsandpersonalbequests,aswellasbybothnationalgovernments.TheCommissionwouldbeindependentlygovernedbypersonsofstandinginbothcommunitiesandprotectthedevelopmentofexchangesagainstparticularinfluenceorfavour(DrysdaleandZhang2016).

TheFulbrightCommissioncoordinateseducationalpartnershipsandfundsacademicscholarshipswithafocusondeveloping‘long-lasting,productivebilateralrelations,partnershipsandconnectionsbetweenAustraliaandtheUS’(Australian–AmericanFulbrightCommission2016).However,atrulycomprehensiveandstrategicAustralia–Chinacollaborationframeworkwouldextendbeyondeducationalcooperationbyalsoadvancingandfindingsynergiesbetweenpolitical,official,subnational,businessandculturalexchangesandpartnerships.

TheCommissionwouldfurthermutualunderstandingthrougheducationalandculturalexchangebetweenthetwocountries.AcrucialpartofthisprogramwillbethedevelopmentofdeepnetworksbetweenAustralianandChinesepeopleacrossallareasoftherelationshipthroughthepoolingofsignificantprivateresourcesintoapublicframework.Itsimportancecouldbesymbolisedbythetwoheadsofgovernmentservingasdualhonourarypatrons.Itwouldhavethreemainpurposes.

First,theCommissionwouldfosterhigh-qualityresearchandacademicexchange.Thegoalofthiscooperationwouldbetoincreasethebi-nationalhumancapitalacrossAustralianandChinesesociety,whichwillcreatedeeperpoolsoftalentfromwhichtodrivethebilateralrelationship.Apartfromscientificandresearchexchange,theCommissioncouldsupportleadershipincreatingcollaborativeexcellenceinlanguageandculturaleducationinprimary,secondaryandtertiaryeducationsystemsthroughimprovedfundingmodels,curriculumdesign,teachertrainingandattitudinalchange.ThiswouldbuildintoaversionoftheAustralian–AmericanFulbrightCommissions’modelofpublicandprivatelysponsoredpostgraduate,postdoctoral,early-careerresearcherandsenioracademicexchanges,withafocusonbuildinglong-termpartnershipsforresearch,mentorship,scientificinnovationandentrepreneurialcommercialisation.TheCommissionwouldalsoleverageexistingofficial

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initiativessuchasAustralia’sNewColomboPlanandtheChineseGovernmentScholarships,andprivateinitiativessuchastheBHPBillitonAustralia–ChinaScholarshipsandtheWestpacAsianExchangeScholarships.

Second,theCommissionwouldfosterpolicyexchanges.Thegoalofthiscooperationwouldbetoproduceacadreofpoliticalandgovernmentleadersinbothcountrieswhoarefamiliarwiththepolicymakingdynamicsoftheothercountryandhavedeeppersonalnetworkswiththeirbilateralcounterparts.ThereispositiveexperiencewiththisthroughtheprogramsthatcurrentlyfacilitateexchangeswithChina’sOrganisationDepartmentthroughtheAustraliaandNewZealandSchoolofGovernment,andthroughtheANU’sexchangeswiththeCentralPartySchool.Thedeeperpolicylinkagesthatwouldresultwillsustaingreaterdialogueandmoreproductivebilateralinitiatives.TheCommissioncanbuildonexistingprogramssuchastheNationalParliamentaryFellowshipsProgramandtheNationalGovernmentFellowshipstofacilitateanextensiveprogramofprofessionalsecondmentsandresearchfellowshipsforAustralianandChinesepublicservantsandpolicymakerstoeitherreceivetrainingintheregulatoryworkingsoftheothersystemortoworkontargetedbilateralpriorityissueswithintheelitepolicy-shapinginstitutionsandwiththepolicythoughtleadersoftheothercountry.Thiswouldformabilateralbridgeheadbetweenpolicymakinginstitutionsandintellectualcommunities.

Third,theCommissionwouldfosterbusinessandeconomicexchange.ThegoalofthiscooperationwouldbetopropelstrategiccollaborationoneconomicreformprioritiesthatwillhelpAustraliaandChinatomanagetheirrespectivetransformations.ThiswillbesupportedbytheforwardworkagendaofthisReporttoundertakeacomprehensiveanalysisofAustraliaandChina’seconomicpolicymakingstructuresacrossallsectorsandinvestigatehowAustraliaandChinashouldthereforebestrelatetoeachotheracrossbusiness,governmentandsociety.ThisprojectwillbecollaborativeandservetounderpinAustralianandChineseeconomicengagementforthenextdecade.ThisresearchwillbecometheplatformforestablishingtheCommissionandcollaborationonsimilarinstitutionsindifferentcountries.

Acrossallofthesesectors,theCommissionwouldserveasanoverarchingframeworkthatallowspublicandprivateactorsinAustraliaandChinatoinvesttheirresourcesincreatinglarge-scalenationalprogramsofexchangeforbuildingtalentinthepursuitofspecificorgeneralbi-nationaloutcomes.

TheCommissionandtheoverallComprehensiveStrategicPartnershipforChangeareinitiativesonwhichjointworkcanbeginimmediatelyfortimelyimplementationbybothsides.Theprocessofplanning,negotiating,launchingandadministeringthesearrangements,andtheproductivebilateralengagementsandchangesthattheyachieve,willlaythegroundworkforAustraliaandChinatoupgradetheir‘model’relationshipoverthelonger-termintoabilateraltreatyframework.Thisframeworkwillcementpoliticalcommitmenttotherelationship,institutionalisebilateralcooperationandperpetuateeconomicreformpartnerships.

Thecommonthemeofbilateralcollaborationacrossallsectorsshouldbeworkingtogetheronjointinitiativeswithspecificobjectivesandpurposestowardsoutcomesthatareaprioritytobothsides.Mobilisedthroughthejointcommitmentofbothgovernments,anexpandingnetworkofcollaborationwillconstituteatrulystrategicpartnershipforchange.Thispartnershipneedstobefoundedondeeperpolicycollaborationatalllevelsindevelopingthenewbilateralrelationship,definingjointinterestsintheregionaleconomy,andstrengtheningtheglobaleconomicsystemonthebasisofinclusionandconsensus.

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CHAPTER7Australia and china in regional economic diplomacy

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Key messAges

AustraliaandChinafacenewchallengesinAsiaandthePacificasaresultofthechangingstructureofregionalandglobaleconomicpower.TheeconomicandpoliticalriseofChinaischangingtheregionalaswellastheglobalorder.Regionaleconomicinterdependencenowincludesawidergroupofeconomies,includingIndia,andawiderrangeofissueareas.TheestablishedregionalinstitutionsandarrangementsinEastAsiaandacrossthePacificdonotencompassalleconomiesandwerenotsetuptodealwiththeinteractionbetweeneconomicandpolitical-securityaffairs,andtherearegapsincoveragewithinthearchitectureforeconomicandpolitical-securitycooperation.ThesechallengesrequireAustraliaandChinatoplayanactiveroleinforginganewconsensusaroundtheprinciplesthatwillguidefutureregionalcooperation.Overthepastthreedecades,Australia’sandChina’seconomicintegrationintotheregionalandglobaleconomyhasoccurredwithinaframeworkthathasbeeninclusive,hasavoidedarrangementsthatweakentheglobalsystemandhasledpoliticalcooperation.Thetwocountriescannowdirecttheirbilateralrelationshiptowardthesecommonregionalandglobalobjectives.

AustraliaandChinashouldworkwithotherpartnersinAsiaandthePacificto:

• Connectandextendexistingregionalarrangements,suchasAPECandtheEAS,sotheycanprovideaplatformtoaddressthenewprioritiesinregionalcooperation.

• Initiatehigh-levelpoliticaldialogueoncross-cuttingissuesthatrequireclosecooperation,includingtheenvironment,energytransformationandregionalinfrastructureinvestment.

• MobiliseacoalitiontodefinethepathforwardinforgingtheTPPandRCEPintoaFreeTradeAreaoftheAsiaPacific(FTAAP)thatstrengthenstheWTOandtheglobaleconomicsystem.ConsolidationoftheTPPandRCEPmaynotbeapracticalobjectiveinthemediumtermbutfindingwaystomakeboththeTPPandRCEPinclusiveandcomplementaryis.

• Seektoestablishacommonframeworkforinfrastructureinvestmentandfundingintheregion.Currentlymanyplayersareactingindependentlyandatcross-purposes.Ministersandseniorofficialscanmeettodiscusspriorities,strategiesandmutualinterestsininfrastructuredeliverytofurtherregionalconnectivity.SucharegionalforummightinvolvetheAIIB,ADB,WorldBank,country-specificinstitutionsandrecipientregionalgroupingssuchasASEAN.

• Useambitiousbilateralinitiativestoprogressregionalandglobalarrangements.ChinacouldusetheinvestmentchapterinChAFTAtopushforahigherqualityinvestmentchapterinRCEPandsetthebenchmarkforotherbilateralinvestmenttreaties.AustraliaandChinacanpioneerservicessectoropening,capitalisingonAustralia’spotentialroleasatestinggroundforwiderdomesticandregionalliberalisation.

• Initiateadialogueonthearticulationofacommon,plurilateralsetofprinciplestogovernforeigninvestment—bothforfacilitatinginvestmentbeforeitismadeandthetreatmentofinvestmentonceithasbeenimplemented.

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• Leveragethebilateralrelationshiptobuildcooperationinthirdcountriesinareassuchasaidanddevelopmentandinfrastructureandconnectivity.

• Furtherenhancebilateralsecuritytiesasanimportantstepincreatingeffectiveworkingrelationshipsonsecurityissuesamongallcountriesintheregion,therebystrengtheningthefoundationforpoliticalconfidenceandregionaleconomicprosperity.

ChinaandAustraliaarebothintegratedintotheregionalandglobaleconomy,andtheirbilateralrelationshipisnestedinahighlyintegratedEastAsianregion.Chinaisthecentreofregionalsupplychainsanditstradeandinvestmentexpansionhavebeenthedrivingforcesofitsrapiddevelopmentandindustrialisation.Goingforward,regionaltradeandinvestmentliberalisationandintegrationwillcontinuetobekeydriversofChina’sfutureeconomicdevelopmentandreform.TheshareofEastAsiainAustralia’stradeisoneofthehighestofanycountryintheworld,with66percentofAustralia’stradetakingplacewithinEastAsia(Figure7.1).Moreover,AustraliaisastableandsecuresupplierofenergyandrawmaterialstoChinaandtherestofNortheastAsia.

EastAsiaisoneofthemosteconomicallyintegratedregionsintheworld—onparwithEuropebyanumberofimportantmeasures.Economiccooperationhasledpoliticalcooperation,andregionaleconomicintegrationhasbeenmarket-ledratherthaninstitution-led.AsAsianeconomieshaveliberalisedandopeneduptoregionalandglobaltrade,institutionshavebeencreatedtohelpmanageandsecurethesethickeninganddeepeningeconomicrelationships.AsiancountriesopenedtheireconomiestointernationalcompetitionwithintheglobalinstitutionalframeworksanddidsobecausetheyhadgrowingconfidenceintheglobaltradingsystemandtheglobaleconomicordercreatedafterWorldWarIIaroundtheBrettonWoodsinstitutions.

AustraliaandChinahavealsoactivelyengagedinregionalcooperationandinstitution-buildingasawaytopromoteeconomicdevelopmentandreformathome,andtofostercloserpoliticalcooperationinthewiderAsianregion.TherelationshipbetweenAustraliaandChinahasdevelopedinthecontextofdeepeningregionaleconomicintegration,andstrengtheningthebilateralrelationshipservestofosterbroaderregionalcooperation.Forbothcountries,economiccooperationhasunderpinnedregionaleconomicdiplomacyandinstitution-buildingprocessesinAsia.Regionalpoliticalandsecuritycooperation,ontheotherhand,hasbeenpiecemealandlesscomprehensive,butincludesnotableachievements,suchascooperativeeffortsontheCambodianpeacesettlementandtheUnitedNationsTransitionalAdministrationinEastTimor.

ThediversitywithintheAsiaPacificregion—withcountrieshavingdifferenteconomicandpoliticalsystems,andbeingatdifferentstagesofdevelopment—demandsacollaborativeapproachtoregionalism.Regionalcooperationhasoccurredonavoluntarybasiswhereagreementswerebasedonforgingconsensusandorderedaroundpositive-sumeconomicinterests.Importantly,thepoliticalandsecurityrelationshipshavebeenunderpinnedbytheUSallianceframeworkcreatedafterWorldWarII,andUSrapprochementwithChinasince1972.

TheinstitutionsthathavefurtheredregionalcooperationinAsiaandthePacific,includingAPEC,ASEANanditsPlusThreeandPlusSixprocesses(includingthesubsidiaryChiangMaiInitiative),havedonesolargelyonthebasisofnon-bindingcommitmentsandwithoutthecessionofsovereigntytoanysupranationalregionalauthority.Theestablishmentof

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CHAPtER 7: Australia and China in regional economic diplomacy

theseinstitutionswascharacterisedbyevolution,flexibility,consensusandvoluntaryparticipation,becauseofthedifferencesinpoliticalandinstitutionalsystemsintheeconomiesaroundwhichtheyhavebeenbuilt.Theyhaveservedtobuildpoliticaltrustandcooperationamongcountriesacrossaregioninwhichpreviouslytherehadbeenasubstantialdeficitinmechanismsthroughwhichthatcouldbedone.Thismodelofcooperationconstitutesanimportantinstitutionalinnovationthathasprovedvaluableinothertheatres,suchasintheglobalG20forum,whichhasasimilarmodusoperandi.

Asianregionalismhasthereforenotproceededattheexpenseof,orinamannerthatundermines,globalinstitutions.Onthecontrary,ithassoughttocomplementandreinforceglobalinstitutions.ThatremainsanoverarchingobjectiveforbothAustraliaandChinaintheirapproachtoregionalcooperation.Theprincipleofopenregionalism—thatis,regionalcooperationandintegrationthatisopentotherestoftheworldandwhichreducesbarrierstoallstatesinanon-discriminatoryfashion—onwhichAsiaPacificeconomiccooperationwasbuilt,hasensuredthatregionalcooperationhasstrengthened,ratherthandetractedfrom,globalcooperation.

Butthingsarechanging.TherapidpaceofeconomicgrowthandintegrationinAsiaisbringingaboutamorecomplexandmultipolarorder,andthrowingupneweconomicandpolitical-securitychallenges.AnewregionalconsensusisneededtoensurethattheprinciplesuponwhichAsia’seconomiccooperationwasbuilt—openregionalism,consensus-drivencooperationandstablerelationsbetweenthegreatpowers—arenoteroded.AustraliaandChinaarewellplacedtoworktogethertoforgethisnewconsensusbecausetheyhavesuccessfullyworkedtogetherinthepasttofosterregionaleconomiccooperationonthesesameprinciples.

ThischapterdescribesAustraliaandChina’sjointinterestsinregionaleconomicdiplomacyandsomeoftheprinciplesthathaveservedtheirpastcooperationwell.ItreviewsthechangestothestructureoftheregionalandglobaleconomythathavealreadyoccurredasaconsequenceoftheriseofChinaandtherestofAsia,andoutlinessomefuturetrends.Thechapterthenexamineswhethercurrentinstitutionalarrangementsareadequateundercircumstancesinwhichthestructureofregionalandglobaleconomicweighthaschangedsignificantly,anddiscussestheareasthataremostinneedofchange.ThechapterconcludesbyidentifyingcommoninterestsandgoalsforChinaandAustraliainregionaleconomicdiplomacy.

Australia and China’s joint interests in regional economic diplomacy

AustraliaandChinashareanumberofcommoninterestsintheirpursuitofregionaleconomicdiplomacy:

• usingregionaleconomicframeworkstostrengthenandreformtheirdomesticeconomies;

• promotinganopentradingenvironmentinAsiathatsupportstheglobaleconomicorder;and

• usingregionaleconomicinstitutionstobuildstrongerframeworksforpoliticalandsecuritycooperationinAsia.

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TheseinterestshaveunderpinnedAustralia’sandChina’sapproachtoregionaleconomicdiplomacyoverthepastthreedecades.AustraliaandChinahaveasuccessfulrecordofworkingtogetherinbuildingthefoundationsforAsia’sregionaleconomiccooperation.

FollowingWorldWarII,AustraliabuiltsteadilyitsengagementwithAsiaandreduceditseconomicdependenceonBritain.Australia’sMenziesgovernmentsignedamomentousbilateraltradeagreementwithJapanin1957,andrenegotiateditstraditionalpreferentialtieswiththeUnitedKingdomastheformationoftheEuropeanCommonMarketloomed.Thissteadydiplomaticshiftwasacceleratedwiththereformsofthe1980s,whichreorientedAustralia’seconomicandforeigndiplomacytowardsAsia.Australiasoughttocapitaliseonthelarge-scaleeconomicgrowthandstructuralchangestakingplaceinAsiaandtheirpotentialeconomicbenefitstoAustralia.TherewasrecognitionthatunlessAustraliaremoveditsprotectionisttradebarriersandundertookmajordomesticeconomicreform,itwouldnotenjoythebenefitsofAsia’seconomicascendancyandriskedbeingleftbehindbyrisingAsianpowers.TradeliberalisationthusbecameakeypolicystrategyandwasviewednotonlyasawaytounleashAustralia’sdomesticeconomicpotential,butalsoasawaytounderpinAustralia’sengagementwithAsia.

In1989,theAustraliangovernmentproposedanewmechanism—APEC—topromoteregionalobjectivesintheGATTUruguayRoundandtofosterlongruneconomicdevelopmentcooperation.APECwasdesignedtofostertradeliberalisationandeconomicreforminAsiaandtobolstertheglobaltradeliberalisationagendaoftheUruguayRound.But,importantly,APECalsoservedAustralia’sgoalofpullingtogetherthetwohalvesofAsiaandthePacific—EastAsiaandNorthAmerica—inacooperativeendeavour.ThisgoalwasdrivenbythealignmentofAustralianandEastAsianinterestsinimprovingaccessforlabour-intensiveandothermanufacturesinNorthAmericanandotherinternationalmarkets,andimprovingAustralia’sowndirectengagementwiththeEastAsianeconomies.APECwasthereforeexplicitlydesignedtolinkthecountriesoftheWesternPacific(includingAustraliaandNewZealand)andEastAsiawiththoseofNorthAmerica,viacommonmultilateraleconomicopeningstrategies.

Crucially,thisperiodofreformcoincidedwithChina’sowneffortstoreformandopenitseconomyandtodeepenitseconomicanddiplomaticengagementwithAsia.Afterthreedecadesoflimitedtradeandothereconomicinterdependence,theintroductionofDengXiaoping’s‘reformandopening’policiesin1978pavedthewayforgreaterChineseengagementwithregionaleconomies.AustraliasoughttoharnessthesechangestakingplaceinChinabyinvolvingtheChineseleadershipinthedevelopmentofideasaboutAsiaPacificeconomiccooperation.EconomistandformersecretaryoftheAustralianDepartmentofTrade,SirJohnCrawford,ledamissiontoChinain1980totalkaboutChina’sparticipationininformalprocessesofregionalcooperation.In1986,China,ChineseTaipeiandHongKongwere,atAustralia’sinitiative,invitedtojointhetripartitePacificEconomicCooperationCouncil(atitsVancouvermeetingofthatyear).AustraliaalsoattemptedtoengageChinainthefirstforeignandeconomicministers’meetinginCanberrain1989,althoughtheTiananmenIncidentearlierthatyearmadethispoliticallyimpossible.In1991,ChinajoinedtheAPECmeetinginSeoul,andin1993,China’sthenpresidentJiangZeminattendedthefirstAPECLeaders’SummitinSeattle.

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APECprovidesChinawithanimportantchannelforparticipatingintheprocessofinternationaleconomicgovernanceandregionaleconomicintegration,aswellaspromotingitsowndomesticpolicyagenda(ChinaAPECDevelopmentCouncil2009).LikeAustraliabeforeit,theChinesegovernmentusedparticipationinAPECandtheregionaltradeliberalisationagendatopushpoliticallysensitivetariffreductionandeconomicreformsathome.AtAPEC’sOsakasummitin1995,Chinaannouncedreductionsintariffson4900items,andwithinayearthesimpleaveragetariffratewasreducedfrom36percentto23percent.ByOctober1997,Chinahadreduceditssimpleaveragetariffrateevenfurther,to17percent.APEC’sagendacloselycoincidedwiththeglobalagenda,anditwasinthiscontextthatChinaundertooktheliberalisationandeconomicreformsnecessaryforitsaccessiontotheGATT/WTO.ButChina’sunilateraltradeliberalisationeffortsandactiveparticipationalsohelpedtobringmomentumtoAPEC,andbroughteconomicgainstoChinaanditstradingpartners,suchasAustralia.

Afterlayingthefoundationsforregionaleconomiccooperationinthe1980s,the1997–1998Asianfinancialcrisisrevealedthebenefitsbutalsothelimitationsofexistingregionaleconomicframeworks.Australia’seconomicsystemandinstitutionsallowedittobenefitfromeconomicintegrationwithAsiawhileprotectingagainstmuchofthepotentialfinancialvolatility.Thefloatingexchangerate,forexample,waskeytoAustraliaavoidingrecessionoranyseveredownturnduringtheAsianfinancialcrisis.Theexchangerateactedasashockabsorberasexchangeratemovementsprotectedagainstvolatilityinthedomesticeconomy.InChina’scase,theAsianfinancialcrisisdeepeneditsunderstandingofthebenefitsofregionaleconomiccooperation.Thecontagion-likespreadofthefinancialcrisisaroundtheregiondemonstratedthatregionaleconomieswerenowdeeplyinterconnected,andthatinthiseraofglobalisation,statescouldnotactaloneintryingtoprotectagainsteconomicvulnerability.Chinareceivedinternationalaccoladesforresistingpressuretodevalueitscurrency—thusavoidingbeggar-thy-neighbourexchangeratecompetition—andforprovidingaidpackagesandlow-interestloanstoitscrisis-affectedneighbours.TheAsianfinancialcrisisincreasedChina’sconfidenceinitsabilitytoplayaconstructiveleadershiproleintheregion,butalsodemonstratedthelimitationsofexistingregionalandglobaleconomicmechanismssuchasAPEC,theWorldBankandtheIMF.

TheAsianfinancialcrisisthereforespurredgreaterregionaleffortstodevelopnewEastAsianeconomicarrangements,suchasASEANPlusThree(includingChina,JapanandSouthKorea)andtheChiangMaiInitiative(CMI).Atatimewhenglobalfinancialarrangementswereperceivedtohavefailedtheregion,thesenewEastAsianarrangementssoughttostrengthenanddeepenEastAsianregionaleconomicandfinancialcooperationaswellasregionalregulatorycapacity.BolsteredbyitsleadershiproleduringtheAsianfinancialcrisis,Chinaplayedanimportantroleinthisregionalcooperationprocess,joiningtheASEANPlusThreegroupandsubsequentEastAsianeconomicarrangementswithenthusiasm.Chinaunilaterallyliberalisedmanyofitskeysectors,includingagriculture,therebyopeningitsmarketstoSoutheastAsianexports.In2002,ChinainitiatedaframeworkagreementfortheChina–ASEANFreeTradeAgreement.China’scommitmenttofurtheropeningup,anditswillingnesstosignuptotherulesandnormsoftheglobaltradingsystemthroughaccessiontotheWTOin2001,gavetradingpartnersconfidenceinthedirectionofChinesereforms.UnilateraltradeliberalisationalsocreatedsignificantgoodwillbetweenChinaanditssmallerSoutheastAsianneighbours.EveninNortheastAsia,wherepoliticalandsecurityrelationshipswaxedandwaned,tradeandeconomicexchangegrewrapidly.

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Beyondeconomicbenefits,AustraliaandChinahavealsoviewedregionaleconomicdiplomacyasawayofbuildingstrongerpoliticalandsecuritycooperationinAsia.Thelegacyofcolonialism,ColdWardivision,andunresolvedhistoricaltensionsbetweenJapananditsneighbourshadstymiedinstitution-buildingprocessesinAsiasincetheendofWorldWarII.AlthoughASEANhadbeenestablishedinSoutheastAsiain1967,thewiderAsiaPacificregionremainedinstitutionallyunderdeveloped.Theregionwascomprisedofstateswithverydifferentpoliticalsystems,aswellasmanynewlyindependentstatesthatwerefiercelyprotectiveofanyperceivedthreatstotheirsovereignty.Indeed,thesefactorshadledASEAN,theregion’smostsignificantexistinginstitution,todevelopparticularpracticesofconsensus,flexibility,non-interferenceininternalaffairsandnon-bindingresolutions,asawayofreassuringpostcolonialstates’anxietiesaboutinternationalinstitution-building.

Giventheseobstacles,theAustralianandChinesegovernmentshavebothobservedthevalueofeconomiccooperationasanon-threateningwayforregionalstatestodevelophabitsofdialogueandcooperation,andtheASEANapproachtoinstitution-buildingasawaytofostertrustandultimatelypoliticalcooperationintheregion.Inaddition,participatinginAPECprovidedavaluablewayforBeijingtoreassureregionalneighboursofitspeacefulrise,andtohelpbuildastableregionalenvironmentthatwouldbeconducivetoChina’sfutureeconomicgrowth(Zhang2014;Zhongetal2014).ChinawasencouragedbythewayinwhichAustralia,JapanandtheSoutheastAsianstatesusedregionaleconomicinstitutionsasawaytoenmeshChinaintoaregionalwebofrelationships,andtodemonstratethebenefitsofregionalcooperation.Chinapubliclyacknowledgedthesebenefitsin1997whenits15thPartyCongressofficiallydeclaredthat‘multilateralism’wasaguidingChinesepolicyprinciple(Harris2000).

Asia’s economic integration

China,AustraliaandthewiderAsiaPacificregionhavebenefitedgreatlyfromthestunninglevelsofregionaleconomicintegrationthathavebeenachievedsincethelate1980s.Despitethecomparativelylowerdensityofitsmultilateraleconomicinstitutions,ascomparedwithEuropeforexample,Asianowenjoyshighlevelsoftradeinterdependenceinresourcesandintermediategoods,andhighlevelsofexportsoffinalgoods.Bymanymeasures,EastAsiaisthemosteconomicallyintegratedregionintheworld,ledbyitsextensiveproductionnetworks(ArmstrongandDrysdale2011).

TheongoingsuccessofAsia’seconomicintegrationiscriticallyimportanttoAustraliaandChina’sprosperity.TradewithEastAsiaaccountsfor66percentofAustralia’stotaltrade(Figure7.1).ThismakesAustraliathemostEastAsian-orientedtradingnationintheworld.Justunder46percentofAustralia’stradeiswithNortheastAsia(ASEAN’s‘PlusThree’countries),higherthananyothermajorEastAsiancountry.AustraliaalsohasthehighesttradedependencewithASEAN,at15percent,oftheothernon-ASEANeconomiesintheASEANPlusSixarrangement(NewZealand,India,China,JapanandSouthKorea).IndonesiaandMalaysiaalsohaveover60percentoftheirtotaltradewithintheASEANPlusSixgrouping,withoveraquarteroftheirtradewithintheASEANgrouping.InChina’scase,justunder27percentofChina’stradeiswiththerestofEastAsia.TheChina–ASEANfreetradeareaisnowtheworld’slargestfreetradeareacomprisedsolelyofdevelopingcountries,withtradeofUS$480billionin2014andtotalmutualinvestmentreachingmorethanUS$150billion.By2020,China–ASEANtradeisexpectedtoreachUS$1trillion(Zhong2015).

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Figure 7.1: Asia Pacific economies’ share of trade with east Asia, 2014

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ASEAN+6 ASEAN+3 ASEAN

Source:UNComtradeandauthors’calculations.

ChinaisatthecentreofregionalsupplychainsandhasbeenahubforEastAsiantradewiththerestoftheworld.InthepastitplayedamajorroleintheassemblyofmanufacturedgoodsthatwouldbeexportedtoNorthAmericaandEurope,butthevalue-addedinChinaduringtheproductionprocesshasalreadystartedtoincreaserapidlyandChinaisbecomingamuchlargerconsumerofthosefinalgoods(seeChapter2).ChinaisnowfocusedonfurtherliberalisingregionaltradeandinvestmentaswellasstrengtheningregionalconnectivityandintegrationasawaytoenhancetheinternationalcompetitivenessoftheChineseeconomy,andtograduallybuildaglobal,high-standardsfreetradearea.ChinaisalsothelargesttradingnationgloballyanditsvasttraderelationshipswithNorthAmerica,Europeandtherestoftheworldmeanthatitisakeyglobaltrader.

shared principles

ThesuccessofAsia’sregionaleconomicdiplomacyandtheachievementofdeepeconomicintegrationhasbeenunderpinnedbythreecoreprinciples:openregionalisminsupportofglobalframeworks;consensus-drivencooperation;andstablerelationsbetweenAsia’sgreatpowers.

Open regionalism in support of global frameworks

Regionaleconomicintegrationhasbeenopenandhasdevelopedinsupportofglobalframeworks.Asia’seconomicsuccessesoutlinedabovehavebeenachievedbecauseAsia’seconomicarrangementshavegenerallybeenoutward-lookingratherthaninward-looking.Thatis,theyhaveworkedtostrengthenratherthansubstituteglobaleconomicarrangementssuchastheGATTandWTO.Astradingnations,AsiaPacificregionaleconomieshavelearnedthattheirowneconomicprosperityreliesonopenengagementwithNorthAmerica,Europeandotherpartsoftheglobe.

Openregionalism—regionaleconomicintegrationthatisnotattheexpenseofeconomiesoutsideoftheregionandissupportiveoftheglobaltradingsystem—canbeseenmostprominentlyinAPECandASEAN.AttheAPECsummitinBogor,Indonesiain1994member

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economiesagreedtothe‘Bogorgoals’.ThesewereasetofambitioustargetsthataimedtoachievefreeandopentradeandinvestmentintheAsiaPacific,by2010forindustrialisedeconomiesandby2020fordevelopingeconomies.TheBogorgoalsencouragedmembereconomiestoundertakeunilateralliberalisation—thatis,notpreferentialorbetweenmembersonly—andthereforepromotedfreeandopentradewiththerestoftheworld,ratherthanjustamongAPECmembers.

MuchofAsia’sregionalcooperation—economicallyandgeopolitically—isorderedaroundtheASEANgrouping,whichhasalsopursuedopenregionalism.ThisisbecausemostofASEAN’smajoreconomicpartnershavealwaysbeenoutsideofSoutheastAsia—includingChina,Japan,Australia,theUnitedStatesandtheEuropeanUnion.ForASEANtohavepursuedinward-lookingarrangements—thatis,liberalisationattheexpenseofthesemajoreconomicpartners—wouldnothavebeenpoliticallyoreconomicallysensible.ThisapproachisrecognisedinthedesignoftheASEANFreeTradeArea(AFTA),whichwaslaunchedin1992.AFTAinitiallypursuedpreferentialliberalisationbyonlyremovingborderbarrierstogoodstradedwithintheASEANzone.However,fromtheoutsettherewasanagreementthatthesepreferenceswouldbeextendedtoallexternaltradingpartnersaswell,andthusmultilateralised,whenitbecamepoliticallyfeasibletodosoineachdomesticpolity.

MorerecentlytheASEANregionhasbeenpursuinganambitiousASEANEconomicCommunity(AEC),whichwasestablishedinNovember2015.TheaimoftheAECisto‘transformASEANintoasinglemarketandproductionbase,ahighlycompetitiveeconomicregion,aregionofequitableeconomicdevelopment,andaregionfullyintegratedintotheglobaleconomy’by2020(ASEAN2008).TheAECwouldallowthefreeflowofgoods,services,investmentandskilledlabour,andthefreermovementofcapitalacrosstheregion.BecauseintegrationintotheglobaleconomyisoneofthefourpillarsoftheAEC,integrationintheASEANregionwillnotdiverttradeorcommerceawayfromnon-memberstowardstheASEANgrouping.ThegoalisambitiousbutwouldhelpmoveASEANtowardsasinglemarketandproductionbasethatfurtherstheopportunitiesandeconomicengagementofChina,AustraliaandotherneighboursintheAsiaPacific.

consensus-driven cooperation

ConsensualprocesseshavedrivenAsia’seconomicintegration.Consensushasbeencriticalforachievingcooperationamongagroupofstateswithdiversepoliticalsystemsandlevelsofeconomicdevelopment.ConsensushasalsoencouragedthecooperationofAsia’smanypostcolonialstates,whichhadlittleornopriorexperienceofmultilateralismbeforeWorldWarII,andwhichhavethereforealwaysbeenstronglyattachedtotheprotectionofstatesovereignty.Butthisapproachtoregionalandinternationaldiplomacyhasenduringvalue.Consensus-formingstrategiesreassuresmallpowersthatlargepowerswilltaketheirviewsintoconsiderationinadoptingpolicypositionsandthattheywillnotdominateinstitutions;theyalsoreassurelargepowersthatsmallercountrieswillnotbandtogetheragainstthem.Thisconsensus-buildingapproachhasencouragedAsia’sdiversemixofstatestoparticipateinregionalinstitutions,evenattimeswhentheyhavebeenuncomfortablewiththemembership,structure,approachesortheissue-focusofaparticularinstitution.

Thoughoftencriticisedforbeingprocess-driven(ratherthanoutcome-driven)‘talkshops’,theTrack1.5andTrack2dialogues,meetingsandotherprocessesthathaveaccompaniedthecreationofinstitutionssuchasAPECandtheASEANPlusprocesseshavebeencrucialinshapingsharedregionalunderstandingsabouttheimportanceoftradeandinvestment

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liberalisation,economicreformandmultilateraleconomiccooperation.Inparticular,Asia’sregionalinstitutionshaveactedasforumsforbuildingcriticalconsensusonthreeissues:first,thatopeninguptotradeandinvestmentbenefitsone’sowneconomy;second,thatthesebenefitsarecompoundedifopeningupoccursinconcertwithothercountries;andthird,thatopeningupwithoutdiscriminatingbetweentradingpartnersisthebestmodeofstrengtheningeconomicrelationships.AchievingconsensusontheseissuesunderpinnedAsia’srapidexpansionintradeandinvestmentinthe1990s,liftedtheincomesofAsiaPacificeconomies,andensuredthateconomicrelationshipsdeepenedevenintheabsenceofstrongpoliticalrelationships.ThatAsiahasbeenabletoachievetheselevelsofregionalcooperationandeconomicintegrationisbecauseinstitutionalarrangementshaveevolvedthroughconsensualprocesses,haveprotectedstatesovereignty,havebeenvoluntaryandhaveallowedadiversegroupofstatestomakenon-bindingcommitmentsthatareappropriatetotheirlevelsofeconomicdevelopment.

BOx 7.1: AsiA PACiFiC RegiOnAL iniTiATives AnD THe gLOBAL sysTem

WhenAPECwascreatedin1989,disadvantagetonon-membereconomieswouldhavebeeninconsistentwiththeimportanceofeconomiclinksbetweenmembereconomiesandthoseoutsidethegrouping.APECcooperationwasfoundedontheprincipleofaligningAsiaPacifictradestandardswithglobalstandards,andresultedinextendingandstrengtheningtheglobalGATTprocess.APEChastakeninitiativestothegloballevel.

In1996,APECinitiatednegotiationsonanInformationTechnologyAgreement(ITA)intheWTO,andtheagreementwasconcludedinDecemberthatyear.TheITApreventedcountriesfromintroducingtradebarriersforwhatwerethenrelativelynewformsoftradeininformationandcommunicationstechnology(ICT)goodsandservices.ByrequiringcountriestoapplyzerotariffsandotherbarrierstonewlyemergingICTgoodsandservices,theITAencouragedrapidexpansioninthetradeofthesenewtechnologies.Thisinturnmadepossibletheproliferationofsupplychainsintheelectronicsindustry,whichhavefundamentallychangedthewayinwhichcountries’internationalbusinessisintegrated,andwhichhavedeepenedeconomicinterdependenceacrossAsia.Supplychainsrelyonlogisticsdrivenbyrapidcommunicationsandtechnology,andtheproliferationofsupplychainshasbeencriticalintransformingChinaintothe‘factoryoftheworld’.WithouttheITA’sagreementonzerotariffsfornewlyemergingICTtrade,supplychainswouldnothavedevelopedsoreadilyastheydid.

Morerecently,theITA‘model’hasbeenemulatedfortradeinenvironmentalgoods.In2012,APECnegotiatedtheEnvironmentalGoodsAgreement(EGA),whichremovestariffsontradeongoodssuchasequipmentforairpollutioncontrolandwastewatermanagement.TheglobalmarketforthesenewenvironmentalgoodsandtechnologiesisexpectedtoexpandtoaroundUS$3trillionby2020(DFAT2015a).BuildingonAPEC’sregionalagreement,negotiationsonanEGAweresubsequentlylaunchedonaplurilateralbasis(thatis,withmanybutnotallmembersparticipating)intheWTOin2014.

TheCMI,whichwascreatedin2000inthewakeoftheAsianfinancialcrisis,representsanothercaseinwhichregionalcooperationhassoughttostrengthen—notdivertfrom—globalfinancialarrangementssuchastheIMF.TheCMIendorsesglobal,market-basedprinciplesoffinancialcooperation,andonlypermitsasmallpercentageofitsfundstobereleasedtoailingeconomieswithoutIMFapproval.

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Notallregionalarrangements,processesorinstitutionalinnovationshavebeentheproductofconsensus,butthosethathavehadsuccess,buy-inandownershipbycountriesintheregionhavedonesothroughaprocessofbuildingconsensus.Forexample,theformationofAPECwasaninitiativetakenbyAustraliaandJapan,buttheideaofAPECrequiredmuchsocialisationamongotherAsiaPacificeconomiesbeforeitcouldbeintroducedandaccepted.APEChassubsequentlyevolvedandhasbeenshapedovertimebyitsmembers.TheADB(Box7.2)isanotherexampleofthewayinwhichconsensushasunderpinnedAsia’sapproachtoregionaleconomiccooperationandinstitution-building.Ultimately,exampleslikeAPECandtheADBdemonstratethateconomicinstitutionsandotherregionalarrangementshavehadtoevolveanddevelopthroughconsensualprocesses.Itisoftenassumedthatastatic‘rules-basedorder’wascreatedin1945andhasremainedunchangedsincethattime.Thatisnotthecase.Asneweconomicissuesanddemandshavearisenintheregion,newinstitutions,norms,rulesandregionalarrangementshaveevolvedthroughprocessesofconsensus,communicationandsocialisation.

BOx 7.2: COnsensus AnD THe CReATiOn OF THe AsiAn DeveLOPmenT BAnK

TheprincipleofconsensushasbeenacriticalelementunderpinningtheevolutionofrulesandnormsinAsia.OnekeyexampleistheADB,whichwascreatedin1966.TheADBwascreatedonthebackofJapan’srisingeconomicpower.JapanwasdissatisfiedwithitslackofrepresentationinglobalinstitutionssuchastheWorldBankandInternationalBankforReconstructionandDevelopment(IBRD),whichweredominatedbytheinterestsofcountriesinEuropeandNorthAmerica.JapanalsoviewedtheADBasawayofachievinggreaterinternationalpoliticalpower,andofmaintainingitsexport-ledeconomicgrowthstrategy.ThoughfellowAsianstatessupportedJapan’sdevelopmentalagenda,theywerealsofearfulthattheADBwouldbecomeaplatformforJapaneseregionaldominance.Atthesametime,theUnitedStateswaswaryofJapan’sdevelopment-stateapproachtoeconomicdevelopment.

Thus,althoughJapanhasalwayscontributedthelargestshareofcapitaltotheADB,andholdsthelargestnumberofofficialpositions—includingthatofBankpresident—JapanhasnotdominatedtheADB.Instead,sincethe1980sinparticular,thealmostequalvotingsharesheldbytheUnitedStatesandEuropehavebalancedJapan’svotingshare.Thishasrequiredmemberstatestoengageinaconsensus-buildingprocesstodeterminetheBank’sprinciplesonprocurement,lendingpracticesandissuefocus.Forexample,theUnitedStates’preferenceforprivatecapitalandmarket-basedeconomicdevelopmenthasalwaysbeenbalancedbyJapaneseandEastAsianpreferencesformorestate-activistapproachestoeconomicdevelopment.Sinceitscreation,theADBhascontinuedtoevolveasamultilateraldevelopmentfinancinginstitution.

stable relations between Asia’s great powers

TheachievementofdeepeconomicintegrationinAsiahasbeenunderpinnedbystable,peacefulrelationsamongAsia’sgreatpowers.ThemostimportantoftheserelationshipsisthatbetweentheUnitedStatesandChina.US–Chinarapprochementin1972transformedtherelationshipbetweenthesetwocountriesinwaysthatwereofgreatbenefitnotonlytotheUnitedStatesandChinabutalsotothewiderregion.Since1972,ChinaandtheUnited

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Stateshavedevelopeddeepdiplomatictiesandhighlevelsofeconomicengagement,andhaverecognisedthatstablebilateralrelationsaretheonlywaytoensureapeacefulAsianregion.Moreover,theleadershiproleplayedbytheUnitedStateshasbeenofgreatvaluetobothAustraliaandChina.TheUnitedStateshasplayedaleadingroleincreatingandunderwritingtheglobaleconomicandfinancialsystem,andhasstronglyencouragedChina’sintegrationwithinthatsystem.TheUnitedStates’diplomaticandmilitarypresenceinAsiahasalsoservedasanimportant‘backstop’,whichhasencouragedregionalstates—manyofwhomhaveadversarialpoliticalandsecurityrelationships—tofeelsecureenoughtopursueeconomiccooperationandinstitution-building.ThesearrangementshavebeenhelpfulinanumberofwaystoAsiannationsinthepast,includingthosethatarenotUnitedStatesalliancepartners,suchasChina.

Alongsidebilateralcooperationbetweentheregion’sgreatpowers,Asia’seconomicandotherinstitutionshavealsoservedasimportantvenuesfortrust-building,dialogueandsocialisationaroundregionalnormsofbehaviour.Thisisdue,inpart,tothe‘ASEAN-way’principlesofconsensus,non-intervention,sovereigntyandnon-bindingresolutionsonwhichtheyarebuilt.TheseprincipleshavebeencriticallyimportantinenmeshinggreatpowerssuchastheUnitedStatesandChinaintoregionalmultilateralprocesses.Theseinstitutionshaveneverreplacedtheneedfordirectnegotiationsbetweenthegreatpowersthemselves.Buttheseinstitutionshaveprovidedimportantoccasionsforbringingthegreatpowerstogetherinframeworksrespectfulofwiderinterests.Theyhavealsoprovidedopportunitiesforgreatpowerstoholdoff-the-record,informalmeetingsonthesidelinesofpublicsummits,andhaveimpelledthegreatpowerstolistentotheconcernsofsmallerstatesintheregion.

Changing structure of regional and global economic power

Forthepastthreedecades,Asiahasbeenaremarkablypeacefulandprosperousregion.Asia’speaceandeconomicvibrancyhasbeenunderpinnedby:theUnitedStates-ledeconomic,politicalandsecurityordercreatedattheendofWorldWarII,China’sacceptanceofthatordersince1972,andbytheeffortsofChina,Australiaandotherstofosterregionaleconomiccooperationsincethe1980s.Butthisexistingorderisnowunderstrain—partlybecauseofitssuccessandthedramaticeconomicriseofChinaandotherregionalstates.

Thelatterhalfofthe20thcenturysawtherapidindustrialisationandriseoftheJapaneseeconomyinthe1960sthroughtothe1980s,withthenewlyindustrialisedeconomies(NIEs)ofSingapore,SouthKorea,TaiwanandHongKongfollowinginthe1980sand1990s.ThemajorforceofgrowthintheglobaleconomysincetheturnofthecenturyhasbeenChina,withanaveragegrowthrateof10percentperyearoverthe30yearssincereformandopeningin1978(Figure7.2).ThegrowthratesoftheeconomiesofJapan,ChinaandtheNIEshaveslowedastheyhavebecomelargerandmorematureeconomieswithhigherpercapitaincomes.India’seconomicdevelopmentandtheriseofotherSoutheastAsianeconomiessuchasVietnam,MyanmarandIndonesiaarealreadyshowingpromiseasthenextdrivingforceofgrowthinAsiaandtheglobaleconomy.

China’seconomyhasalreadygrowntobeaslargeasthatoftheUnitedStatesinpurchasingpowerparity(PPP)terms(seeChapter1,Figure1.6).ForwardprojectionsoncurrenttrendswithconservativeassumptionswillseeChinaovertaketheUnitedStatesasthelargesteconomyintheworldinnominalmarketexchangeratetermsbytheendofthe2020s,withmanyprojectingthistohappenearlierinthatdecade.

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ThegrowthofChina’simportanceintheworldeconomyhasoccurredveryrapidly.ThisswiftchangeiscreatingsomeuncertaintyabouthowtomanagethenewresponsibilitiesandchallengesposedbytheriseofChinaandotherregionaleconomies(Zhang2015).ThereisariskthatsomeoftheresponsestothesequickchangescouldunravelthesharedprinciplesthathaveunderpinnedAsia’seconomicachievementstodate.

threats to open regionalism

First,therearegrowingchallengestomaintainingtheprimacyofopenregionalisminAsia.Inthepast,Asia’sdeepeconomicintegrationwasbuiltonthebasisoftheMostFavouredNation(MFN)principle,whichextendstradeandothereconomicbenefitstoallstates,regardlessofwhethertheyaremembersoftheagreementornot.Now,wearewitnessingtheproliferationofexclusive,preferentialtradeagreements(PTAs)inAsia,whichserveonlytodeepeneconomictiesbetweenPTAmembercountries.Someoftheproposedmultinationalpreferentialagreements—suchastheTrans-PacificPartnership(TPP)agreementandRegionalComprehensiveEconomicPartnership(RCEP)—areparticularlylargeandcomprehensive.Whiletheselargeandcomprehensivepreferentialagreementsoffermorebenefitstotheirmembersthannarrowerbilateralagreements,theyalsohavethepotentialtoimposemoreadverseeffectsonnon-membereconomies.Thiscanbeavoided.Agreementsandarrangementsthatarepreferentialandexclusivecanbemademoreinclusiveovertime,justastheAFTAwas,andcreativewayscanbefoundtoextendbenefitstonon-members.HowtonegatesomeoftheadverseconsequencesofnewregionalagreementssuchastheTPPandRCEPisdiscussedlaterinthechapter.

Figure 7.2: Waves of regional and global economic growth

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Source:AustraliaintheAsianCenturyWhitePaper2012andauthors’calculations.

threats to consensus-driven cooperation

Second,therearegrowingthreatstoAsia’sconsensus-basedapproachtoregionalcooperation.Ascross-bordereconomicissueshavebecomeincreasinglycomplex,andhavebeguntoaffectawiderrangeofinterestsandcountries,ithasbecomemoreandmoredifficulttoachieveconsensus-basedregionalcooperationamonglargergroupsof

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countries.Attimes,theprincipleofconsensushasalsobeenusedandabusedasawayforcountriestoavoidmakingprogressonreform.Inthesecircumstances,smaller‘coalitionsofthewilling’havebeenformedtoachievefasterprogressonissuesincludingtradeandinvestmentliberalisation.Forexample,withtheDohaRoundoftradeliberalisationstalled,somecountrieshaveresortedtobilateralorplurilateralagreementsinordertoopenupmarketaccess.Similarly,inareassuchasinvestmentliberalisation,wherethereisnoexistingglobalorregionalregime,smallgroupsofcountrieshavebegunworkingtogethertoprogressbilateraldealsorregionalagreements.Thereisnothinginherentlywrongwithsmallergroupsofcountriesworkingtogethertointroducenewarrangements.Indeed,thepresenceofcoalitionsofthewillingisawell-establishedpracticeinAsia.APEC,forexample,hashistoricallyusedtheapproachof‘pathfinderinitiatives’toachieveprogress;theseallowsomemembereconomiestoworktogetherinestablishingnewcooperativearrangements,whicharethencommunicatedtootherAPECmemberswhoareencouragedtoparticipatewhentheyareready.Inorderfortheseinitiativestosucceedingainingacceptancebynon-participants,however,itisimportantthattheybecommunicatedtransparentlytoothercountriessoastoavoidsurprises,andtobedevelopedinamannerthatdoesnotdisadvantageothercountries.

threats to stable relations between the great powers

Finally,theexistingeconomic,politicalandsecurityorderinAsiaisunderstrainbecauseoftheeconomicriseofChinaandothersintheregion.Thetransitiontoamoremultipolarorderisinevitable,butthechallengefacingtheregionishowtomanagethatordertransitionpeacefully.China’svasttrade,financial,demographic,environmentalandmilitaryfootprintgivesitagrowingandlegitimateinterestinplayingalargerregionalandglobalrole.Atthesametime,whilemajorshiftsintheregionaldistributionofwealthandpowermakecomparableshiftsintheregionalstrategicorderinevitable,AustraliaandotherregionalstatesverymuchpreferthattheUnitedStatesretainsastrongandstabilisingroleinwhateverneworderemerges.ThegoalmustbetoreconfigureanewregionalorderthatenablesaleadingroleforboththeUnitedStatesandChina.ThisnewregionalordermustalsoallowspaceforotherestablishedpowerssuchasJapan,andforrisingpowerssuchasIndiaandIndonesia.Anynewregionalordermustensurethatsmallerandmiddlepowers,suchasAustralia,SouthKoreaandSoutheastAsiancountries,continuetofeelsecureandabletoparticipatewithindependentvoices.

Managingthisordertransitionwillnotbeeasy.Anditwilllargelybeajobforthegreatpowersthemselves.Nevertheless,Asia’smiddlepowersstillhaveavitalroletoplay.TheyshouldcontinuetouseAsiaPacificinstitutionstohelpmanagetheorderlytransition,playingapositiveroleinpromotingcooperativeregionalinitiativesandmoderatinggreatpowerrivalry.Thereisaneedtoensurethatcurrentregionalinstitutionsandarrangementsaresuitableformanagingeconomicintegration,structuralchangeandpoliticalcooperationasAsia’sorderchanges.FrequentdialoguebetweentheUnitedStatesandChinaiscriticallyimportant,anditisimperativethatthisdialoguetakesplaceroutinelyandwithinframeworksthatinvolveinterestsandissuesbeyondtheUS–Chinabilateralrelationship.TherearetworegularmeetingsayearbetweenthepresidentofChinaandthepresidentoftheUnitedStateswithinaframeworkthatincludesothercountries:theAPECsummitandtheG20summit.Whilethereareotheroccasionsforbilateralmeetings,includingstatevisitsandmeetingsoftheUNGeneralAssembly,forexample,theAPECandG20summitsallowforUS–Chinacooperationinthecontextofbroaderregionalandglobalcooperation.Thoseoccasionsshouldbemadeasproductiveaspossibleforbuildingconsensustowardseffectinggradualandpeacefulordertransition.

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AustraliaandChinashouldseektoenhancetheirbilateralsecuritytiesasanimportantelementthatcontributestobuildingeffectiveworkingrelationshipsonsecurityissuesamongallcountriesintheregion.Closerbilateralsecuritytieswillhelptostrengthenthefoundationsofpoliticalconfidenceonwhichregionaleconomicprosperitycancontinuetogrow.AustraliaiscommittedtoitslongstandingalliancewiththeUnitedStates,butthisdoesnotprecludesecuritycooperationwithChina.Thedevelopmentofcloserbilateralsecuritycooperationonarangeoftraditionalandnon-traditionalsecurityissueswillbeanimportantelementinelevatingtheAustralia–ChinarelationshiptoaComprehensiveStrategicPartnershipforChangeandindeepeningstrategictrustbetweenthetwocountries.ThechangingregionalordermakesitincreasinglyimportantforChinaandAustraliatoclearlyunderstandeachother’sapproachtoregionalpoliticalandsecurityaffairs.AparticularareainwhichthereisscopeforexpandingdialoguethatwillcontributetothisunderstandingisrelatedtoChina’sevolvingthinkingaboutitsmaritimeeconomy,inwhichbothcountrieshavedirectmutualinterests.

moving forward with common interests

TheeconomicandpoliticalriseofChinaandotherregionaleconomiesischangingtheAsianorderandbringingaboutneweconomicandpolitical-securitychallenges.Basedontheirsuccessfulhistoryinjointlybuildingregionaleconomiccooperation,AustraliaandChinaarewellplacedtoworktogethertoforgeanewconsensusaroundtheprinciplesthatwillguidefutureregionalcooperation.

AustraliaandChinacandirecttheirbilateralrelationshiptowardcommonregionalinterestsinanumberofpracticalways.Jointcooperationwiththirdcountriescanbenefitfromcomplementarycomparativeadvantagesandcanadvancebroaderregionalcooperation.Thereisscopeforworkingtogether—givenAustralia’sexpertise,regionalinterestsandconnectionstotheUnitedStates—onChineseglobalgovernanceinitiativessuchastheAIIB.Therearealreadyareas,suchasindevelopmentcooperationinthePacific,whereAustraliaandChinaactivelyworktogether.Thesecooperativeendeavoursshouldbeextendedsothatprogressindevelopmentcooperation,infrastructureinvestmentandotherinitiativescanhelptodeepenprogressattheregionallevel.

AsChina’seconomyundertakesitshugestructuraltransformation,manyopportunitieswillbeopenedupinlabour-intensivemanufacturingandthesectorsthatChinatransitionsoutof.India,therestofSouthAsiaandmuchofSoutheastAsiacanemulateChinaandNortheastAsia’seconomicsuccess,realisetheircomparativeadvantageandtransitionintolow-costmanufacturing.RealisingtheseopportunitiesinSouthandSoutheastAsiawillassistinChina’sowntransition.AndChina’sregionalinfrastructureandconnectivityinitiativescanplayamajorrolealongsideexportingChina’sover-capacity,surplussavingsandexpertise.

ThelargestopportunityliesinIndia.Indiacanrealiseits‘MakeinIndia’economicreformagendathroughliberalisinglabourlaws,improvinginfrastructureinvestmentandfinancing,openingtoforeigninvestment,andpursuingregionaleconomicintegration.RegionalcooperationthatfacilitatesamoreopenanddynamicexternalenvironmentwillhelpIndiaandothereconomiesundertakesuchdifficultreforms.SuccessfulreformsinIndiawillleverageitsabundantandgrowinglow-costlabourresourcestoexploitacomparativeadvantageinlabour-intensivemanufacturesandservices.AustraliaandChinahaveastronginterest,andcanplayanactiverole,insupportingIndia’seconomicgrowthambitions.

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strengthening and connecting existing institutions

Asiaisnowhometoacomplexweb,or‘variablegeometry’,ofregionaleconomic,politicalandsecurityinstitutionswithdiversemembershipsandfunctions.EconomicinterdependenceinAsiaandacrossthePacificincludesawidergroupofeconomies,suchasIndia.Inrealitythereisnosingleregionalinstitutionthatcurrentlyaddressesalloftheregion’seconomic,politicalandsecurityissues.

Theestablishedregionalinstitutions,arrangementsandgroupingsinEastAsiaandacrossthePacificdonotencompassalleconomiesandwerenotsetuptodealwiththeinteractionbetweeneconomicandpoliticalaffairs,andtherearegapsincoveragewithinthearchitectureforeconomicandpoliticalcooperation(Figure7.3).

APECremainstheregion’sprimaryvenuefordiscussionofeconomicissues,andhasaparticularfocusontradeandinvestmentliberalisation.ItistheprimaryinstitutionforUSengagementonregionaleconomicaffairs,andtheAPECSummithasprovedtobeanimportantvenueforleaderstodiscusswin-wineconomicissuesandpromoteeconomiccooperationinitiatives.TheroutineworkdoneamongcountriesattheofficiallevelofAPEChasalsoservedtobridgeunderstandingbetweenmembers,todeepencooperationandtoleadtooutcomesthathavebenefitedmembersandnon-membersalike(Box7.1).Thenetworkofofficials,theworkprogram,andtheleaders’meetinghasmeantthatmembereconomiesfeelownershipoftheprocessandtheinstitution.YettherearemajorgapsinAPEC’smembership.AsFigure7.3shows,whileAPEC’smembershipisbroad,thereareanumberofregionaleconomies—includingIndia,Cambodia,LaosandMyanmar—whoarenotAPECmembers.APEC’sdiversemembershipofeconomies,ratherthanstates,makesitaninappropriateplatformfordiscussingEastAsia’spoliticalandsecuritychallenges.WhileinformalmeetingsonpoliticalandsecurityissuestakeplacebetweenleadersonthesidelinesofAPEC,theseissuesarenotonthemainagenda.

Figure 7.3: AseAn, APeC, eAs and ARF membership compared

ARF

EAS

ASEAN+6

ASEAN+3

ASEAN Brunei

Papua New Guinea

New Zealand Australia

India

South Korea

China Japan

Myanmar Laos

Cambodia Thailand

Philippines Indonesia Vietnam

Singapore

Malaysia

Pakistan

North Korea Mongolia

European Union

Bangladesh Canada

Russia United States

Hong Kong Chinese Taipei

Peru Mexico

Chile

Sri Lanka

Timor-Leste

APEC

Source:Authors’schema.

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TheASEANRegionalForum(ARF),createdin1994,hasfocusedmoreonregionalsecurityissues.Itisalargeanddiverseorganisation,involving27participants,includingtheEU.Thoughithasbeenausefulplatformforregionalstatestogettoknowoneanother,andtoparticipateinconfidence-buildingmeasures,theARF’ssizeandthediversecharacterofitsparticipantshasmadeitverydifficulttoachievesubstantialprogressonregionalsecuritydisputes.

TheEastAsiaSummit(EAS)wascreatedin2005andisanotherASEAN-ledinstitution.TheEASemergedoutofproposals,intheearly1990s,tocreateanEastAsianEconomicCaucus.TheAsianfinancialcrisisthenpromptedASEANcountriestoworkwiththeir‘PlusThree’NortheastAsianneighbours—China,JapanandSouthKorea—tobuildanEastAsianeconomiccommunity.WithJapaneagertobroadenitsmembership,India,AustraliaandNewZealandsubsequentlybecamefoundingmembersoftheEASin2005.In2011,membershipoftheEASwasfurtherexpandedtoincludeRussiaandtheUnitedStates.ThisexpansioninmembershiphasalsochangedthecharacteroftheEASfrombeinganorganisationpredominantlyfocusedoneconomicissues,toonewherepoliticalandsecurityissueshavecometodominatetheagenda.IncomparisonwithAPEC,theEAShasneverenjoyedthesamedensenetworkofinstitutionalisedofficialactivityamongitsmembers.Givenitsshiftawayfromeconomicissuesinrecentyears,thereisariskthatmuchoftheEASagendawillbecomedominatedbycountries’politicaldeclarationsratherthaninstitutionalisedcooperation.EAS’mainassetisthatitsagendadoesencompasssecurityissues,andthatitsmembershipincludesallofthemajorpowersinAsiaandthePacific,includingIndia.

Theseinstitutionsandarrangementshaveservedtheregionwelltothispoint,butinquitedifferentways.AsrelativeeconomicandpoliticalpowershiftsintheAsiaPacificandglobally,thereisapressingneedtoconnectandextendexistingregionalarrangementssothatthereisareadyplatformtoaddressnewprioritiesinregionalcooperation.Regionalcooperationhastobuildonandmovebeyondthecoreeconomicagenda.Thewebofeconomic,politicalandsecurityinstitutionsinAsiamustnowbebetterlinkedtoaddressthegapsinmembershipandfunction.TheflexibilityofAsianregionalarrangementsallowsopportunitiestoconnectexistingarrangementsinwaysthatallowthemtoaddressthesenewchallengesandopportunities.

Attheregionallevel,oneoptionwouldbetostrengthentheconnectionbetweentheannualAPECEconomicLeaders’MeetingandtheEastAsiaSummit.Thesetwomeetingsarenowheldback-to-backinNovemberinordertoallowtheUSpresidenttotraveltoAsiaonceayear.Currently,leadersmovefromonehostcountrytotheotheranddiscussdifferentagendaswithdifferentmemberships.ThismeansthatthereisadistinctcontrastinthenatureofthediscussionsatAPECandtheEAS.TheChineseheadofstatedoesnotcurrentlyattendEASmeetings.TheAPEChostandASEANChair(whichhoststheEAS)couldworktogethertoensurethatAPEC’seconomiccooperationagendafeedsintotheEAS’politicalandsecurityagenda,withoutdilutingtheissuefocusofeach.ThiscouldbefacilitatedviajointmeetingsbetweentheAPECandEAS‘troikas’(thatis,theprevious,currentandfutureAPEChostsandASEANChairs)inadvanceoftheannualLeaders’MeetingandSummit.

AnotherwayofstrengtheningtheconnectionbetweenregionalinstitutionalarrangementsmightbetoreachouttoinviteIndiaandotherASEANstatestojointheAPECprocess—notnecessarilyasformalmembersinitiallybutratherasparticipants.TheAPEChosthastherighttoinvitegovernmentleadersfromnon-APECmembereconomiestoattendtheannualLeaders’Meeting.BuildingontheinitiativetakenbyChinawhenithostedAPECin2014,futureAPEChostscouldinviteIndia,Cambodia,LaosandMyanmar—thatis,thosecountrieswhoaremembersoftheEASbutnotAPEC—toattendtheAPECLeaders’Meeting.TheAPEC

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EconomicLeaders’MeetingwillnextbeheldinEastAsiain2017whenVietnamhostsAPEC.In2017,therefore,thereisanimportantopportunityforVietnamtoinviteIndia,Cambodia,LaosandMyanmartoattendAPEC.LeaderscouldthentraveltothePhilippines(whichwillbetheASEANChairin2017)fortheEastAsiaSummit.FindingcreativesolutionstohaveallASEANmembersjoinAPECmeetingswillmakeiteasiertomoreeffectivelyconnecttheseregionalprocesses.EastAsiaandthetrans-PacificrelationshipshavebenefitedgreatlyfromASEANcentralityandthereisgoodreasontopreserveandstrengthenASEANasthefulcrumofregionalcooperation.Australia,ChinaandtherestoftheregionhaveastakeinthesuccessoftheASEANEconomicCommunityandaunifiedandintegratedASEANmakesbroaderAsiancooperationeasier.

Important,cross-cuttingissuesthatrequireclosecooperationsuchasenergyandenvironmentaltransformationshouldbethefocusofhigh-levelpolicydialogueledbyacoalitionofinterestedpowersintheregionandcarriedacrossdifferentforums.Theseissuescutacrossenergysecurity,climatechange,andpoliticalandeconomiccooperation.Theseareissuesthataffectallstatesintheregion,andcanbeadvancedbyleader-levelagreementamongallofthemajorregionalplayers.Theenergytransitionfromfossilfuelstorenewableswillbringnewopportunitiesandchallengesthathavelargetransnationalspillovers.Focusingonanissuesuchasenergytransformationcouldliftthelevelofcooperationbetweencountries,giveregionalarrangementsnewimpetusandprovideaframeworkforcloserpoliticalcooperation.ThisisanissuethataffectsChinaandAustraliaacutely,butalsoaffectsJapan,theUnitedStates,India,Indonesiaandeveryothercountryintheregion,whethertheyareenergyproducers,consumersorboth.Thereiscurrentlynoregionalforumortheatreinwhichenergyissuesareprominentlyontheagenda,butasmallcoalitionofcountriesincludingAustraliaandChinacouldinitiateadialogueinoneormoreoftheestablishedregionalplatformsandcarrypolicydevelopmentforwardacrossalltheseforums.

Atthegloballevel,AustraliaandChinahaveasharedinterestinfeedingregionalinterestsandinitiativesintoglobalarrangements.TheAsianmembersoftheG20—Australia,China,Japan,India,IndonesiaandSouthKorea—andthePacificmembersoftheG20—Canada,MexicoandtheUnitedStates—areallleadersinthevariousAsiaPacificregionalforums.AbetterconnectionbetweentheregionalforumsandtheG20atthegloballevelwillhelptoshapetheG20agenda,toimplementG20outcomesthroughregionalinstitutionsandtobuildconfidenceamongcountriesthatarenotmembersoftheG20initsinclusivenessandcredibility.TheAsianG20membersarethemostimportanteconomiesintheregion,andindividuallyandcollectivelytheyrepresentimportantvoicesinglobalaffairs.Theyalreadyexerciseameasureofinfluenceglobally,andcanrepresenttheinterestsandviewsthatareexpressedinregionalforumsthatoperatethroughaprocessofconsensus.

RegionalinstitutionssuchastheChiangMaiInitiativeMulilateralization(CMIM)andtheASEANPlusThreeMacroeconomicResearchOffice(AMRO)surveillanceunitcanacttostrengthenandreinforcetheglobalfinancialsafetynetandglobalsurveillance.AlthoughthecurrencyswapsinCMIMhaveyettobedrawnon—evenduringtheglobalfinancialcrisis—CMIMandAMROcanbuildtrustandcapacityandplayanimportantroleaspartofthebroaderglobalfinancialsafetynetintheeventofafuturefinancialcrisis(seeChapter8).ThesenewAsianarrangementsmarkasignificantstepforwardinAsianfinancialandmonetarycooperation.Tobetrulyeffective,theyneedtobecoordinatedwiththeIMF.Asia,lefttoitsowndevices,wouldfinditdifficulttomobilisetheresourcesorimposetheconditionsonneighbouringcountriesneededtomanagefinancialcrises.AstrengthenedAMROthat

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coordinateswiththeIMFwillhelpregionalfinancialsurveillance.AustraliaisnotpartytoCMIMorAMRObecausetheyemergedfromASEANPlusThree,butAustraliahasaninterestinhelpingtobuildAMRO’scapacityandplayingasupportingrolewithinCMIM.Morebroadly,theAustralia–Chinabilateralrelationshipshouldincludedialogueandcooperationonissuesthatcanfeedintoandshapethoseregionalforumsandarrangementsinwhichonlyonecountryisamember,suchasCMIM.ThereshouldbecreativewaystohaveAustraliabecomeadefactopartnerinAMRO.ItisinAustralia’sinteresttohelpstrengthenthecoordinationbetweentheIMFandregionalfinancialarrangements(seeChapter8).

TheinstitutionsandarrangementsthathaveservedChina,AustraliaandAsiawellinthepastmustevolvetoreflectnewregionalrealitiesandinterests.Thereislittleappetiteintheregiontocreateentirelynewinstitutions,butexistinginstitutionscouldbere-energisedandtheirconnectionsstrengthened.Andregionaleffortsshouldbeconcentratedonimportantcross-cuttingissuessuchasenergytransformation.AustraliaandChinacanworktogetherwithregionalpartnerstoreformandstrengthentheseexistinginstitutionsandarrangements.

moving towards inclusive regional agreements

TheAsiaPacificregionhasseenaplethoraofbilateralandregionaltradeagreementssignedsincetheearly2000s.ButnoneoftheregionalorplurilateralagreementssignedtodatehavebeenasconsequentialorlargeinmembershipastheTPP,RCEPortheTransatlanticTradeandInvestmentPartnership(TTIP).Theseregionaleconomicagreementsaimtomakemajorprogressontradeandinvestmentliberalisationwheretheglobalsystemhasstalled,andtofurthercross-bordercommerceandexchangeinnewareasofimportancetobusiness,insomecasesbycreatingnewinternationalrules.

RegionalagreementscandeepenregionalandglobaleconomicintegrationandmakeprogresswheretheWTOhasbeenunableto,andintheprocessstrengthenprospectsforprogressatthegloballevel.Yettherearerisksthattheseagreementscanharmnon-members,andthatdifferentagreementswithdifferentmembershipscanbecomeavenuesforcompetitiverule-making,thusfragmentingregionalandglobaleconomicintegration.Thereisstronginterestinavoidingoramelioratingtheseadverseconsequencesinordertobuildaninclusive,globaleconomicsystem.

The12-memberTPPincludesAustralia,theUnitedStates,Japan,Canada,Mexico,Vietnam,Brunei,Singapore,Malaysia,NewZealand,ChileandPeru.LargeAsianeconomiessuchasChina,IndonesiaandIndiaareyettojoin.GiventhestandardsthattheTPPappliesandthefactthatnewmemberswillberequiredtonegotiatebilateralagreementswithallothermembersandberatifiedbyUSCongress,itisunlikelythatChinawillbeabletojointheTPPinthenearfuture.However,theTPPdoesprovidesomecountry-specificcarve-outsandspecialanddifferentialtreatmentfordevelopingmembersregardingtheirtransitionperiods.

ComparedtotheTPP,RCEPcoversabroaderrangeofcountrieswithmorevariedlevelsofeconomicdevelopment.ASEAN’saimisforRCEPtoconsolidateandharmonisetheexistingASEANPlusOneFTAswithChina,SouthKorea,Japan,IndiaandAustralia–NewZealand.TheseFTAsvaryconsiderablyintermsoftheirscope,comprehensivenessandmarketaccesscommitments.RCEPisexpectedtobecharacterisedbyasetofcommonrules,butwithflexibilityfordevelopingcountriestocommittocertainstandardsinreasonabletimeframes,andmarketaccesscommitmentsbyindividualcountriesthattakeaccountoftheirlevelofeconomicdevelopment.

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Figure 7.4: AseAn, RCeP, TPP and possible FTAAP membership

FTAAP

Papua New Guinea Russia

Hong Kong Chinese Taipei

TPP

RCEP

ASEAN Brunei

New Zealand Australia

India

Japan

Myanmar Laos

Cambodia Thailand

Philippines Indonesia

Vietnam

Singapore Malaysia

South Korea China

Canada United States

Peru Mexico

Chile


AustraliaispartytoboththeTPPandRCEPandhasaroletoplaywithotherpartners,suchasJapan,indialogue,capacitybuildingandexperiencesharingtobridgethegapbetweenmembersandnon-members.Thisbridge-buildingroleisvitalbecauseAustralia,JapanandothershaveanumberofimportanttradingpartnersthatarenotmembersofboththeTPPandRCEP.TheTPPandRCEPagreementsshouldbeusedtodeepenmarket-basedeconomicinterdependenceandanybarriersagainstnon-membersshouldbewatereddown.Theagreementsneedtobe‘living’agreementsthatchangewithcircumstancesandgiveallmembersavoice.Thecriteriaforaccessiontotheseagreementswillalsobeparticularlyimportantifthebenefitsoftheseagreementsaretobeexpandedbeyondtheoriginalsignatories.

TheTPPandRCEPshouldnotbecomecompetingblocsbutinsteadneedtobemadecomplementary.RCEPdoesnotincludetheUnitedStatesandtheTPPdoesnotincludeChina.ThesearrangementsshouldbedirectedtoenhanceeconomicintegrationinAsiawithoutfragmentingeconomiclinkageswithintheregionorbetweentheregionandtherestoftheworld.

TheTPPandRCEPwillservetheirpurposeonlyiftheyareusedtofosterdomesticeconomicreformagendas.ChinahasbeenhighlysuccessfulinitsstrategyofusingmembershipofexternalorganisationsliketheWTOtoleverageandentrenchmajordomesticreforms.Chinanowhasanopportunitytopursueanewroundofreformsviaexternalengagement,includingfinancialsectorandinvestmentreform,reformofSOEs,lockinginimprovedenvironmentalandlabourstandards,andfurthermodernisingitseconomy.ButtheprospectofachievinganyofthesereformsviatheTPPwillbelongtermratherthanshortterm,particularlybecauseChinaisnotamemberoftheTPPandtherewillbemanyhurdlesfornewmemberstojoiningtheTPP,anditisnotclearwhenaccessionmightbecomepossibleforChina.Moreimportantly,thosereformsandcommitmentsthatChinawillhavetomakeinordertojointheTPPwillhavetobestructuredinawaythatisconsistentwithChina’sdomesticreformgoals.ThemajorchallengeforChina,butmorebroadlyfortheTPP,willbewhethertheTPPisabletocreateanexternalenvironmentforChinaandothernon-membersthatisconducivetotheir

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pursuitofdomesticreforms.Anexclusivesetofarrangementsintheregionthatmakestheexternalenvironmentmoredifficultforfurtheropeningupofeconomiesandimplementingofdomesticeconomicreformsneedstobeavoided.

TheRCEPprocess,ontheotherhand,showsmuchmoreimmediatepromisethroughChina’sparticipationinnegotiatingtheopeningupofborderstotradeandinvestment.China’sWTOaccessionexperiencedemonstrateshowinterestscanaligntocreatewin–wincommitmentsvianegotiation.Itishardertonegotiatedomesticreformexternally.Reformismoresustainableifitisimplementedwithexternalsupportintheformofagreeingtomutuallybeneficialgoals,capacitybuildingandexperiencesharing,andbygivingcountriesspacetofindthebestreformpathfortheirowncircumstancesandinstitutions.Soratherthanexternallymandatingreforms,internationalagreementscanworktoprovideexternalimpetusforongoingdomesticeconomicandregulatoryreformprocesses.

TheRCEPagreementhasthepotentialtocreateanenvironmentforbothmembersandnon-membersthatisconducivetoopeningupofmarketsandtheprosecutionofdomesticreforms.ThereistheopportunitytocreateanagreementthatextendstheprinciplesandmodesofcooperationofASEAN,especiallytheAEC,toabroadergroupingthatincludesmajor-economyneighbourssuchasChina,JapanandIndia,aswellasadvanced-economyneighbourssuchasAustralia,SouthKoreaandNewZealand.ByRCEP’ssettingbindinggoalsandallowingsomecountriestoreachthosegoalsinthemostsuitablewayforthemovertime,withcapacitybuildingandexperiencesharingalongtheway,thebroaderEastAsianregionwillmoveclosertoasinglemarketandproductionbase.

MuchbroaderanddeeperintegrationwouldoccurwiththeEastAsianeconomiesthroughRCEPadoptingthefourpillarsoftheAEC—asinglemarketandproductionbase,acompetitiveeconomicregion,equitableeconomicdevelopmentandintegrationintotheglobaleconomy—andcommittingtomajorliberalisation.Thiswillinvolvecommitmentstocomprehensivefreeingoftradeingoods,servicesandinvestmentandwithaframeworkforeconomiccooperation.Recognisingthatasuccessfulagreementwillrequireanongoingprocess,membersshouldcommittoambitiousbindinggoalsfordeliveryby2025,withbuilt-ininstitutionssuchasworkinggroupsforongoingimplementation.

RCEPhasrealpotentialtoavoidoverlyprescriptiveoutcomes,byprovidingcountry-specificmarketaccesscommitmentsandsettingsomeagreedrulesanddirectionsforfuturework.AswiththeexperienceofASEAN,multilateralisingpreferences—sothatbenefitsareextendedtonon-members—overtimewillbeimportanttoavoidanexclusivemembershipthattruncateseconomicintegrationacrossthePacificorwiththerestoftheworld.WhetherRCEPultimatelyresultsinopenregionalismdependsonthemodeofcooperation,theendgoalsandhowthosearepursued.

RCEPcountriesalreadyaccountforalargershareoftheglobaleconomythandotheTPPcountriesanditsmembersalsoincludeafastergrowinggroupofcountries,ledbyIndiaandChina.RCEPisdiverse,withsomeoftheleastdevelopedcountriesintheregionsuchasCambodia,LaosandMyanmar,whicharenotAPECorTPPmembers.TheGDPoftheRCEPgrouping—onconservativeprojections—couldbeclosetodoubletheTPP’ssizein15years(Figure7.5).

PursuinganambitiousRCEPagreementalongsidetheTPPwillbeimportantforfurtheringeconomicintegration,andAustraliaandChinahavearoletoplayinsettinghighstandardsinthisprocess.Indoingso,AustraliaandChinacanusethebestfeaturesofChAFTA—

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includingtheliberalisationofservicesandinvestmentaccess—tosetthebenchmarksforRCEP.StronginitialliberalisationandcommitmentsforphasedliberalisationininvestmentbyChinaandotherswouldhelptodevelopcompetitiveliberalisationbetweenRCEPandtheTPP.ItwouldalsoensurethatafutureUS–ChinaBITcouldincorporatethebestfeaturesofboththeTPPandRCEP,takingaccountoftheinterestsofthewholeregionratherthanjustbilateralinterests.Thisapproachwouldhelptoachieveconvergencebetweenthetworegionalagreements,therebyaddressingthebiggestproblemtheycurrentlyface:namely,thattheUnitedStatesandChinaarenotpartytobothagreements.

EarlyconsolidationoftheTPPandRCEPisanunrealisticobjective.Thetrackrecordofconsolidatingsmallerbilateralagreementshasnotbeengoodandhastendedtoleadtothecreationofadditionallayersratherthanconsolidation.Thelonger-termconvergenceoftheTPPandRCEP,however,canbepursued.Apracticalwayforwardwouldbetomobiliseacoalitionofthewillingtoworktogetherindefiningthepathforwardinlinkingthesetworegionalagreements.Australia,asamemberofbothagreements,hasacrucialroletoplay,butChinaandothersthatarepartyonlytooneagreementarealsoimportantforfindingcreativewaystobridgethegapsbetweentheTPPandRCEP.

Figure 7.5: gDP projections of RCeP and TPP groups, 1980–2050, at purchasing power parity

0

20

40

60

80

100

120

1980

19

85

1990

19

95

2000

20

05

2010

20

15

2020

20

25

2030

US$

Tri

llio

n (2

012

PP

P)

RCEP TPP

Note:IMFprojectionsto2020followedbyprojectionsbasedonanestimateofpotentiallabourproductivityforcountriescurrentlyintransitiongiveninstitutionalqualitymeasuredbytheWorldEconomicForum’sGlobalCompetitivenessIndex.Source:HubbardandSharma2016.

ArelatedinitiativeistheefforttodeveloptheFreeTradeAreaoftheAsiaPacific(FTAAP),whichwasputbackontheregionalagendain2014whenChinahostedAPEC(APEC2014a).TheFTAAPbuildsontheongoingregionalundertakingsoftheASEANPlusThree,TPPandRCEPandaimstofurtherAPEC’sregionaleconomicintegrationagenda.Consistentwiththeprinciplesofeconomiccooperationthathaveservedtheregionsowelluntilnow,APECleadershaveagreedthattheFTAAPshouldsupportandcomplementthemultilateraltradingsystem,worktohelpachievetheBogorgoals,andbepursuedwithastep-by-step,consensus-basedapproach.Itwouldalsoneedtobeahigh-quality,‘nextgeneration’agreementandruninparallelto—notaspartof—theAPECprocesssothatnon-bindingvoluntarycooperationcanbepreservedinAPEC.

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TheprinciplesthathaveservedEastAsiaanditstrans-PacificcooperationsowellinthepastshouldguidetheformationandarchitectureoftheFTAAPsothatitstrengthenstheWTOandtheglobaleconomicsystem.RecognitionoftheimportanceofASEANcentralityandextendingthebestfeaturesoftheAECwillbeimportantinachievingahigh-qualityagreementthatmovestheregiontowardsasinglemarketintheAsiaPacific.BuildingonthesharedprinciplesthathaveunderpinnedAsia’seconomicintegrationtodate,itisalsoimportanttoensurewherepossiblethatregionalagreementsdonotunderminetheglobalmultilateralsystembyadverselyaffectingnon-members.

BOx 7.3: BuiLDing A muLTiLATeRAL Regime FOR gOveRning FOReign DiReCT invesTmenT

TheglobaltradingsystemhasbeenintegralforChina’sintegrationintotheglobaleconomyandregionalarrangementssuchasAPEChavehelpedinthis.Asinvestmentflowshavebecomemoreimportantintheregion,thelackofaregionalorglobalinvestmentregimeisemergingasasignificantgapinthemultilateralarchitecture.Chineseoutwarddirectinvestmentisalreadylargeandwillonlybecomemoreimportantregionallyandglobally.AustraliaisamajorrecipientofChineseinvestment,andbothcountrieshavearoletoplayindevelopingarrangementsattheregionalandgloballevelsthathelpwiththemanagementofforeigninvestmentandfurtherregionaleconomicintegration.

Currently,thelackofaregionalorglobalregimeforinvestmenthasledtoamixofbothunilateralpolicies(mostlyonthepartofrecipientcountries)andbilateralpolicies,usinginvestmenttreatiesandeconomicagreementsthathavevaryingprovisionsandprotections.AustraliaandChinahaveaninterestininitiatingdialoguearoundthearticulationofacommonsetofprinciplestogovernforeigninvestment—bothforfacilitatingpre-establishmentforeigninvestment(beforeitentersacountry)andthenationaltreatmentofpost-establishmentforeigninvestment.ThismightbeginwiththeimplementationofChAFTA(seeChapter4).AustraliaandChinacanalsocarrytheirworkonaninvestmentagreementundertheaegisofChAFTAintotheRCEPnegotiations.Withoutregionalguidingprinciples,thereisariskthatagreementsbetweenlargecountries—suchastheUnitedStates–ChinaBilateralInvestmentTreaty(BIT)—willbecomethedefaulttemplateforthosebetweenallstatesintheregion.Itisimportantthattheinterestsofsmallercountriesarerepresentedinthesediscussionssothatoutcomesareintheinterestsofallinvestorsandrecipients.

Promoting infrastructure investment as multilateral regional goods

PromotinginfrastructurefundingandinvestmentisaparticularpriorityinAsiaandthePacific.TheWorldBankhasestimatedthateachadditional10percentofglobalinvestmentininfrastructureincreasesglobalGDPgrowthbyonepercentagepoint.Giventhemodestandunevengrowthintheglobaleconomy,increasinginfrastructureinvestmentisimportantformanycountries.Inparticular,thereisgreatdemandforinfrastructureinvestmentwithintheregion.TheADBhasestimatedthatAsiawillneedUS$8trillioninnationalinfrastructureandUS$290billionininfrastructureconnectingeconomiesby2020(ADB2009).MeetingthatUS$8trilliondeficitinregionalinfrastructuredemandby2020iscriticaltothecontinuing

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growthanddevelopmentofregionaleconomies.Yet,asiswidelyrecognised,therearecurrentlyanumberofconstraintsoninfrastructureinvestment.ThescaleoffundingthroughthemultilateraldevelopmentbankssuchastheWorldBankandtheADB,whicharesmallrelativetothesizeofdemand,hasshrunkinrecentyears.Indeed,sincethe1990s,someoftheexistingmultilateralbanks,suchastheWorldBank,haveincreasinglyfocusedonfunding‘social’projectsinareassuchaseducation,health,environmentandurbandevelopment,ratherthanfundinginvestmentinroads,railways,portsandotherinfrastructureprojects.Moreover,theAPECConnectivityBlueprint(2015–2025)releasedatthe2014APECSummitrecognisesthatthequalityanddistributionofinfrastructureintheregionremainsuneven,andthatmanycountrieslackfinancialsupportforinfrastructurefunding.ThereisclearscopeforintermediatingAsiansavingsandfacilitatinggreaterprivatesectorfinancingtocopewiththehugeshortfallinregionalinfrastructureinvestment.

China’slaunchoftheAIIBisanimportantmomentintheemergenceofChinaasacontributortoregionalandglobalpublicgoods(Lin2015).ChinaalreadyhasanumberofexistingavenuesthroughwhichitfinancesinfrastructureprojectsinAsia,includingtheChinaDevelopmentBank,itsnewOBORinitiative,theSilkRoadFundandtraditionalbilateralfinancing.Throughtheseavenues,ChinaseekstostrengthenAsianconnectivityandeconomicintegrationthroughinvestmentinroad,rail,shipping,aviation,telecommunications,powerandenergypipelineinfrastructure.ButtheAIIBrepresentssomethingnew.IndevelopingtheAIIB,Chinahasvoluntarilycommitteditsresourcestoamultilateralbodywithformalgovernancestructuresandwithexternaloversight.WhilethismultilateralapproachnecessarilylimitsChina’sfreedomofaction,itoffersmanyadvantagestoChinaandthewiderregion.

First,multilateralisingfinancingdecisionscaninsulateChinafrombilateralpoliticaltensions.Withcompetitionamongrecipientsforlargeinfrastructureinvestmentprojects,investmentdeployedthroughmultilateralprocessesarelesslikelytobecomepoliticised.Whencommercialdecisionstakeplaceonaunilateralorbilateralbasis,theyruntheriskofbeingsecond-guessed,orbeingviewedasconnectedtounrelateddisputesordisagreements.

Second,itisinChina’sdirectinteresttoensurethattheAIIBmeetsallthestandardsofamultilateralinstitution.TheAIIBisunderintensescrutinyandtheinternationaltoleranceformisstepswillbelow.WhileChinaoriginallyformedtheconceptoftheAIIB,itsgovernancearrangementshavebeenshapedbyitsmanyfoundingmembers,andshouldensurethattheAIIBmeetsalltheaccountabilityandtransparencystandardsofothermultilateraldevelopmentbanksandhasanappropriatelyskilledinternationalworkforce.ThedownsideofbuildinginthoseprocessesandproceduresisthatitmaytakelongerthanChinaandrecipientcountriesmaywishfortheAIIBtobecomeasignificantplayerintheregion.ButChinawillbenefitsignificantlybecausethereisnoquestionthattheAIIBtrulyisamultilateralinstitutionandnotonecontrolledbyChina.ThisdoesnotmeanthattheAIIBneedstomirroralloftheproceduresoftheexistingmultilateraldevelopmentbanks.Onthecontrary,theAIIBshouldseektobemoreeffectiveandefficientthantheothermultilateraldevelopmentbanks.Indoingso,thisdemonstratesthatChinacanmakeaneffectivecontributiontoprovidingglobalpublicgoodsandactivelyleadamultilateralorganisation.Moreover,theareasoftheAIIB’soperationswheretimeandcareshouldbetaken—suchasrigorouscreditassessments,carefulprojectselection,carefulattentiontoenvironmentalandsocialissuesandstrongaccountingandtransparencyarrangements—areoneswhereChinacanlearnfromtheexperienceofothers.Assuch,thereareanumberofindirectbenefitsthatChinacangainfromthecarefulestablishmentoftheAIIB.

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TheOBORinitiativeaimstoconnectAsia,theMiddleEast,EuropeandAfrica.ItisaboldplanbyChinathatcouldgreatlyfacilitateinfrastructureconnectivityandeconomicintegrationwithinandacrossregionsandsub-regions(StateCouncilofthePeople’sRepublicofChina2015).China’ssurplussavingsandinfrastructuredevelopmentexpertisecanbemobilisedforthebenefitofthedevelopmentofothercountriesthatlackcapitalandinfrastructuredevelopmentexpertise.ItcanalsoeasesomeoftheovercapacityissuesinChinawhileexpandingtradeandcommerceforChineseandothercompanies.AsthesuccessofthisChineseinitiativerequiresactiveinvolvementofothercountriesbasedontheirowninterests,theOBORinitiativecanalsoprovideaplatformforcooperationbetweendevelopedanddevelopingeconomies(Zhang2016b).AustraliaisactivelydevelopingtheNorthernAustraliaregionandhasstronginterestinbeingpartoftheOBORinitiative.BeyondthebilateralinterestinAIIBandOBOR,bothAustraliaandChinahaveaninterestinregionalinfrastructurebuildingandconnectivitythatwouldbemademoreeffectivethroughbilateralandregionalcooperation.

Ultimately,China’scontributionsviatheAIIBandOBORformanimportantplankinAsia’swiderconnectivityagenda.China’sneighbourhoodinSoutheastAsiahasawell-developedASEANMasterPlanforConnectivity(AMPC).TheAMPCisaregionalplanfortransportandinstitutionalconnectivitydesignedtobringcountriesclosertooneanother,andtofacilitatebetteraccesstotrade,investment,tourismandpeople-to-peopleexchanges.TheAIIBandtheAMPCsharesimilargoals.China’scapitalandexpertiseinbuildinginfrastructureisalreadyhighlysoughtafterinSoutheastAsiaandelsewhere—Chinese-developedports,high-speedrailandmajorinfrastructureprojectssuchastheTrans-AsianRailwayNetworkandAsianHighwayNetworkhaveearnedChinaanimpressivereputation.WorkingalongsidetheAMPCwillhelpChinatoprioritiseinvestmentandembedcooperationamongrecipientcountries.Forinstance,roadsandrailnetworkswillconnectcountrieswithsharedborders,whileasystemofshortseashippingwilllinkmaritimeSoutheastAsiawithportsforroll-onroll-offvessels.

TheAIIBrepresentsanimportantstepinChina’sprovisionofregionalandglobalpublicgoods.AsuccessfulAIIBwillmeanChinesefunds,expertiseandleadershipcanbeleveragedtosupportdemandforinfrastructureinvestmentinAsiaandbeyond.ItisintheinterestsofAustraliaandthewiderregiontoseetheAIIBsucceed.

ButtheAIIBisnottheonlyimportantinfrastructureinvestmentinstitutionoperatinginAsia.TheADB,WorldBank,andunilaterallendersanddonorsareallimportantforinfrastructuredevelopmentinAsia.Apositivedevelopmentisthatinitsinitialoperations,theAIIBisfocusingonco-financingarrangementswiththeADBandtheWorldBank.However,thereisadangerthatsomeoftheplayersmayactindependentlyandattimesatcross-purposes.Itwouldbeproductivetoensureacommonunderstandingandcoherencetotheinfrastructureinvestmentnetworkintheregion.Therewouldbevalueinministersandseniorofficialsfromthecountriesintheregionregularlydiscussingpriorities,strategiesandmutualinterestsininfrastructuredeliverytofurtherregionalconnectivity.Regionalinfrastructurefundingandinvestmentisclearlyacross-cuttingissuethatwouldbebestservedbyhigh-levelpoliticaldialogue.WhileASEANhastheAMPCforadvancingconnectivityamongitsmembers,AustraliaandChinacouldinitiateabroaderdialogueinvolvingregionalcountries,regionalandmultilateraldevelopmentbanks,internationalfinancialinstitutionsandrecipientregionalgroupingssuchasASEAN.Movingtowardsestablishingacommonframeworkforinfrastructureinvestmentandfundingintheregionwouldbeamajorcontribution.Existingarrangementsshouldbeusedcreativelyandnon-exclusivelytofosteranimportantdialogueofthiskind.

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Australia, China and the next decade of regional cooperation

AustraliaandChinahaveenjoyedgrowingprosperityasadirectresultofthedomesticeconomicreformsandregionaleconomicintegrationinitiativestheyhavejointlypursuedoverthepastthreedecades.ButlargechangesarenowunderwayinAsiaduetothechangingstructureofregionalandglobaleconomicpower.Closecooperationandcommunicationisrequiredinordertoavoidmisunderstandingsanddisputes,tonarrowdifferences,andtomaintainandbuildtrustamongcountriesintheregion.Theshifttowardsamorecomplexandmultipolarorderhasalreadycreatednewtensionsandhasbeguntoerodesomeoftheregion’ssharedprinciples.ThemajorchallengesnowfacingAsia’sregionaleconomyrequireinnovativesolutions.

AustraliaandChinashareacommoninterestinforginganewconsensusonthesharedprinciplesofcooperationthatcanbringfurthereconomicinterdependence,buildpoliticalcooperationandmaintainstablerelationsbetweentheregion’sgreatpowers.

Theregionalandglobaleconomicsystemsarechangedasaresultofwhatlargeeconomiesdobythemselvestomanagetheirinteractionswithothereconomiesandpolities.Butifwearetoachieveapeacefultransitiontoamoremultipolarworld,thesechangesmusttakeplacethroughcollectiveconsensusamongallthecountriesthatareaffected.ThischapterhasidentifiedanumberofareasinwhichcollaborationbetweenChina,Australiaandtheirpartnersinregionaleconomicdiplomacywillbeofspecialimportanceinthecomingdecades.

Practicalprogresscanbemadeinstrengthening,extendingandbetterconnectingtheestablishedregionaleconomiccooperationarrangements,suchasAPEC,theASEANPlusframeworksandtheEAS,andinsecuringaframeworkforpoliticalconfidenceandsecuritywithinwhicheconomicprosperitycanbeattained.AstartingpointwillbetobetterconnectthecooperationanddialogueoneconomicissuesthattakesplaceinAPECandtheASEANPlusprocesseswiththecooperationanddialogueonpolitical-securityissuesdiscussedwithintheEAS.Important,cross-cuttingissuesthatrequireclosecooperation,suchasenergyandenvironmentaltransformationaswellasregionalinfrastructurefundingandinvestment,shouldbethefocusofdialogueledbythemajorpowersintheregionandcarriedacrossdifferentforums.

AustraliaandChinahaveastrong,sharedinterestinmobilisingacoalitionfordefiningthepathforwardinforgingtheTTPandRCEPtogethertowardsaFTAAPthatstrengthenstheWTOandtheglobaleconomicsystem.TheChAFTAagreementcansetbenchmarksthatwillhelpwithambitiousandhigh-qualityoutcomesintheRCEPagreement,especiallyintheinvestmentchapter.AustraliaandChinacanpioneerservicessectoropening,capitalisingonAustralia’spotentialroleasagoodtestinggroundforliberalisation.ChinacanuseChAFTAasatestinggroundforahighqualityUS–ChinaBIT.

Asia’sfutureeconomicgrowthandintegrationisincreasinglydependentoninvestmentincriticalinfrastructure.AustraliaandChinawillbothbenefitiftheregionisbetterconnectedthroughsea,roadandrailnetworksandotherconnectivityprojects.TheAIIBisanimportantnewchanneltofundingAsia’sinfrastructureneeds.Startingahigh-leveldialogueamongalltheactorsintheregion—bothfundersandrecipients—aimedtowardsestablishingacommonframeworkforinfrastructurefundingandinvestmentwouldreducecosts,bringbetterunderstandingandhelpimproveconnectivity.

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CHAPTER8collaboration in the global system

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Key messAges

AustraliaandChinabothbenefitfromstrongglobalinstitutionsthatareinclusive,rules-basedandpromoteopenandefficientinternationalmarkets.AneffectiveglobalgovernanceframeworkwillbecriticaltothesuccessofChina’seconomictransitionandtheresilienceoftheglobaleconomy.Butmanyoftheseinstitutionswerecreateddecadesagoanddonotreflectcurrentrealitiesoftheglobaleconomy.Australia,Chinaandotherpartnerscaneffectincrementalchangeinreformingglobalgovernance.

AustraliaandChinahavepowerfulinterestsinentrenchingtheG20asthepreeminentforumforglobaleconomicgovernance.WithouttheG20,Australiamaybeexcludedfromasmalleralternativegrouping(suchasa‘G10’)which,dominatedbydevelopedratherthanemergingeconomies,wouldalsoseeChinawithlessvoiceinglobalrule-setting.AustraliaandChinashouldactivelyusetheG20,ensureitsagendaisinclusiveandtargeted,ensurecontinuitybyprioritisingitsmulti-year‘two-in-five’growthagenda,anddeepenitsworkonglobalgovernancereform.Mostimportantly,deficienciesintheglobalfinancialsafetynetcreatesystemicrisksthatthreatenthetrading,financialandproductionnetworksthatareintegraltotheAustralianandChineseeconomies.

• AustraliaandChinacollaboratewithintheG20onglobalfinancialsafetynetissuesonfourkeyfronts:thenextstageofIMFreform,implementingarrangementstomaketheIMFandregionalfinancingarrangementsmorecohesive,renegotiatingbilateralloansandstrengtheningdomesticmacroeconomicframeworks.

• Inthenearterm,Chinashouldworktobuild-uptheanalyticalcapacityoftheASEANPlusThreeMacroeconomicResearchOfficeandstrengtheninstitutionalcollaborationbetweenregionalinitiativesandtheIMF.Inthelongerterm,AustraliaandChinashouldencourageG20discussionsonthenextstageofIMFquotareform,assumealeadingroleinrenegotiatingbilateralloansbetweenG20countriesandtheIMF,andfocustheG20growthagendaonimprovingmacro-financialresilienceofallcountries.

AustraliaandChinabenefitmorefrommultilateraltradeliberalisationthanfromplurilateralorbilateralinitiatives.Butincreasedfragmentationisswellingbusinesscosts,reducingtradeflowsandweakeningproductionnetworks.

• AustraliaandChinashouldleadagreaterG20focusonthemultilateraltradingsystemandinitiateapragmatic,incrementalprocessonWTOreformanddefineapathwayforRCEPandotherarrangementsliketheTPPtoraisethestandardofregionalagreementsandstrengthentheWTO.TheyshouldalsoencouragetheuseoftheG20growthstrategiestoachieveambitiouscommitmentsundertheTradeFacilitationAgreement.

AustraliaandChinacantakeotherimportantstepstoprogresscollaboration.

• AustraliaandChinashouldinitiateastep-by-stepprocesstowardsamultilateralframeworkforinvestment,aswellasincreasingandstreamliningmultilateralfundingforinvestmentininfrastructure.AustraliaandChinashouldcollaborateintheG20towardsinstitutingmorestructuredcooperationbetweentheAIIB,theBRICSNewDevelopmentBankandexistingmultilateraldevelopmentbanks.

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• BothcountriesshouldworkwithintheG20topromoteglobalenergygovernancereformthataddressesthesubstantialgapsinexistingframeworksandinstitutionsliketheInternationalEnergyAgency.

• AustraliaandChinashoulddeveloptheirpartnershipwithintheglobalresponsetoclimatechange.Thiscooperationcandrawonavarietyofexistingforumsfordialogueattheofficialandpoliticallevels,includingministerial-levelconsultationsandacademiccollaborations.

Theglobaleconomicsystemhasmanydimensions:trade,finance,energy,development,security,climateandmanymore.Ensuringthatmarketsareopen,inclusiveandgovernedbyapredictableandstablesetofrulesandnormsiscriticaltotheirsuccessfulfunctioning.AustraliaandChinawillbothbeactivebeneficiariesofgoodoutcomesinallofthesedimensions.

Thesystemofrules,normsandinstitutionsthatgoverntheinteractionsbetweencountries,inallofthesedimensions,iscollectivelyreferredtoasthe‘architectureofglobaleconomicgovernance’.Thisarchitectureisbecomingmorefragmented.IntheaftermathofWorldWarII,theglobalgovernancesystemconsistedoflargemultilateralinstitutionsliketheUnitedNations,IMFandWorldBank.Today,itismorediversifiedacrossmultilateral,regionalandbilaterallayers.Thisfragmentationhaschallengedtheabilityofglobalpolicymakerstorespondadequatelytotheneedsoftheinternationalcommunity.

Thearchitectureofglobaleconomicgovernanceisnowinneedofreform.Thechangingstructureoftheglobaleconomyandtheriseofemergingmarketeconomies,particularlyChina,havepresentedimmenseopportunitiesfortheworldbuthavealsopresentedchallengesforglobalgovernance.Globalinstitutionsthathaveservedtheinternationalcommunitywellhavenotkeptupwiththesetransitions.Theyareinneedofreformandthegapsthathaveemergedinglobaleconomicgovernanceneedtobefilled.

TheG20isnowtheworld’sprimaryvehicleforsuchareformofglobaleconomicgovernance.ItisvitalthattheG20’sstatusasthe‘globalsteeringcommittee’isentrenched.TheG20istheonlyforuminwhichitispossibletodetermine,andremake,theprioritiesoftheinstitutions,forumsandorganisationsthattogethermakeupthearchitectureofglobaleconomicgovernance.Inaddition,theG20istheonlyforuminwhichadvancedandemergingeconomiescancooperateinthisgovernancereformonanequalfooting.

MakingsurethatthishappensissomethingthatisparticularlyimportantforbothAustraliaandChina.ThedeclineoftheG20wouldrepresentasubstantialriskforAustralia,giventhatAustraliaismuchmorelikelytobeexcludedfromthesmallerad-hocgroupingsofgreatpowerswhichwouldlikelythenemerge.AsforChina,thesesmallerad-hocgroupingsmightwellbedominatedbyadvancedeconomies,andChina’sinputinthemwouldbeaffordedlessweight.Asaconsequence,therewouldbelessinternationalbalanceintheglobalprocessofeconomicrule-setting.

AustraliaandChinaareinapositiontocooperate,inimportantways,inensuringthatthisobjectiveisachieved.Actingtogether,AustraliaandChinashouldensurethattheG20agendaremainsinclusiveandthatitsmembersworkcollaborativelyonglobaleconomicissuesina

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CHAPtER 8: Collaboration in the global system

waythatresonatesacrossthefullmembershipoftheG20andbeyond.Inparticular,AustraliaandChinacanpromotetheG20byactivelyusingitasaforuminwhichmajorglobalissuesareraisedandnegotiated,insteadofthatbeingdoneinanad-hocwayinotherglobalorregionalbodies.

TherearefivekeyareasofglobalpolicymakinginwhichAustraliaandChinashareaninterestinstrengtheningtheG20’sleadership.

ThefirstpriorityareaforAustraliaandChinaistoensurecontinuityintheG20agendabymaintainingitscorefocusongrowthandstrengtheningtherecoveryfromtheglobalfinancialcrisisof2007–2008.Itisnearlyadecadesincethiscrisisstruck,andyettheglobalrecoveryisstillnotcomplete.TheG20isinapositiontomakeadifferencetothestrengthofthisrecovery:the‘two-in-five’agendathatAustraliainitiatedwhenitheldtheG20presidencyin2014hasputitinapositiontodojustthis.Thisagenda,agreedattheG20Leaders’SummitinBrisbaneinNovember2014,isaprocessinwhichG20membersundertooktocarryoutpolicieswhich—whentakentogether—wouldensurethatglobalGDPis2percenthigherbytheyear2018thanitwouldotherwisehavebeen.Thisagreementwasasignificantachievement,butthefollow-throughsinceBrisbanethenhasbeenpatchy.Chinacanstrengthenthisfollow-throughbyreinvigoratingtheG20MutualAssessmentProcess(G20MAP).Thetwo-in-fiveprocesscouldalsoplayanimportantpartinaresurrectionoftheG20’sleadershiproleininternationalcooperationonmacroeconomicpolicies.ThiswasarolethattheG20heldin2008–2009duringtheglobalfinancialcrisis;itisimportantthatittakesthisroleagain.TheG20’sabilitytotakealeadinstrengtheningtheglobalrecoverywillalsobehelpedbyitsabilitytopromoteinfrastructureinvestmentworldwide.Thisagendaitemisdiscussedinmoredetailbelow.

ThesecondpriorityareaforAustraliaandChinaistoensuretheadequacyoftheglobalfinancialsafetynet.Therearebiggaps.Itistoosmallandtoofragmented.Thisreducesitscoverage,consistencyandresponsiveness.AustraliaandChinahaveacommoninterestinastrong,inclusiveandresponsiveglobalfinancialsafetynet,centredonarepresentativeIMFandwithstrongcooperationamongthemajoreconomies.AustraliaandChinashouldusetheirinfluenceintheG20,IMFandregionalarrangementstofocusonfivekeyissues:thenextstageofIMFquotareform;thenecessity,atbothglobalandregionallevels,ofcountriesbeingabletoobtainliquidityfinancingasnecessary,includingtheurgentneedforChinatogainaccesstothegroupofcountriesthatareabletoobtainverylargecurrencyswaps;theimplementationofarrangementstomaketheIMFandregionalfinancingarrangements,suchastheChiangMaiInitiativeMultilateralization(CMIM),morecohesive;renegotiatingbilateralloansbetweenG20countriesandtheIMF;andusingtheG20growthstrategiesandpeerreviewprocesstoboosteffortsonstrengtheningdomesticmacroeconomicframeworkstoimproveresilience.

Thethirdpriorityareaistrade.AustraliaandChinabenefitmostfromtradeliberalisationwhenitismultilateralratherthanbilateralorplurilateral.AustraliaandChinashouldworktosupportthecohesivenessoftheglobaltradingsystembyencouragingtheG20torefocusonthemultilateraltradingsystemratherthanonregionalorbilateralalternatives.ThisshouldincludeafocusonwhatincrementalandpragmaticstepscouldbetakenonWTOreform.AustraliaandChinashoulduseregionalarrangements,suchasRCEP,toraisethestandardforcohesiveregionalagreements,pushingforbettercollaborationbetweentheWTOandregionalagreementsandbydeliveringambitiouscommitmentsundertheTradeFacilitationAgreementbygivingthestructuralreformsundertheG20growthstrategiesastrongertradefocus.

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Thefourthpriorityareaisinvestment.ThereisscopeforAustraliaandChinatosupporttheG20inconsolidatingtheworkoftheWTO,G20,OECD,UNCTADandothersonaprocesstowardsamultilateralframeworkforinvestment.Thereisalsospecificscopeforgreatermultilateralcooperationoninfrastructureinvestment.AustraliaandChinashouldpromoteinfrastructureinvestmentintheG20asacross-cuttingthemetobringG20countriestogethertotakeactiononmultiplefronts,includinggrowth,macroeconomicmanagement,development,trade,energyandclimatechange.ThereisscopeforbettercooperationandsynergiesbetweentheAIIB,theBRICSNewDevelopmentBankandexistingmultilateraldevelopmentbanks.TheG20shouldcontinuetosupportdevelopmentbanksinoptimisingtheirresourcesbyleveragingprivate-sectorfinance.SuccessinthisareawillclearlybehelpfulintakingforwardtheG20’sagendaofpromotingasustainedworldwiderecoveryfromtheglobalfinancialcrisis.

ThefifthandfinalkeyareaforcollaborationbetweenAustraliaandChinaconcernsenergytransformationandclimatechange.Theglobalenergygovernancearchitecturehasfailedtokeepupwithsignificantchangesinglobalenergymarketsandtheglobaleconomy,andneedstobereformed.AustraliaandChinashouldsupportthepositivemomentumintheG20onglobalenergygovernancereforminbuildingandadaptingexistingorganisationsandensuringthattheyworktogethereffectively.CloselyrelatedtotheneedforenergycollaborationisthefactthatAustraliaandChinabothhaveavitalinterestinsupportingastrongglobalresponsetoclimatechange.China’seconomicandclimatechangestrategyisincreasinglygearedtowardslow-carbongrowth.Australiahasthepotentialtobecomeanexporteroflow-carbonenergy,whichcouldsupplyChina.AustraliaandChinashouldworktogetheronbothclimatechangeandenergystrategies.Thisshouldinvolvegovernment,industryandtheresearchcommunity.Anexistingresearch-basedcollaborationmodelcouldbescaleduptoaninternationalinitiative.

Australia and China within the global system

ThefoundationsoftheeconomicpartnershipbetweenAustraliaandChinaaremultilateralandglobalincharacter.TherearemanyareasinwhichcollaborationbetweenChina,AustraliaandtheirpartnersinglobalaffairswillbecomeincreasinglyimportantbecauseChina’sroleintheglobaleconomyisgrowing.Althoughparticipationinsomeglobalorregionalinstitutionsisuniquetojustoneofthetwocountries,AustraliaandChinahavemoreincommonthannotgiventhenatureoftheireconomictiesandtheirlocationintheworld.

AustralianandChineseleaders,ministersandseniorofficialshaveagreaterrangeofopportunitiesforregularengagementnowthaneverbefore.Figure8.1givesasnapshotofhowAustraliaandChinaengageinglobalgovernance—theinstitutionstheyhaveincommonandthosetheydonot.

Figure8.1providesseveralimportantinsights.First,itshowsthescaleofmultilateralcooperationbetweenAustraliaandChina.TheleadersofbothcountriescometogetheratleastfourtimesayearattheG20,APEC,EastAsiaSummitandUnitedNations.ThefinanceministersofbothcountriesmeetaroundfivetimesayearjustfortheG20,aswellasseparateregularmeetingsforAPEC,ASEAN,theIMFandtheWorldBank.CentralbankgovernorsmeetregularlyattheBankforInternationalSettlements,G20andAPEC.Foreachoftheseinstitutionsandforums,hundredsofAustralianandChineseofficialsareengagingonanalmostcontinualbasisinsupportoftheirministersandleaders.

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Second,Figure8.1illustratesthebreadthofissuesonwhichAustraliaandChinacooperatethroughmultilateralinstitutionsandforums.Today,almosteverydomesticpolicyissuehasaninternationaldimension,andmostinternationalissuescanhavesignificantdomesticconsequences.Asaresult,theagendasofinternationalinstitutionsandforumshaveincreasedexponentiallyovertime,coveringabroadrangeofissuesfromtrade,finance,development,tax,financialregulationandmacroeconomicpoliciestoissueslikesecurity,humanrights,climatechange,theenvironmentandreformingtheglobalgovernancearchitectureitself.

Third,AustraliaandChinahavemoreincommonintheseaffairsthannot.TheinstitutionsinwhichAustraliaandChinacooperatearemoreinfluentialandsystemicallyimportantthantheinstitutionsuniquetojustoneofthecountries.Theseprocesseshavehelpeddevelopextensivepersonalnetworksofleaders,ministersandofficials,aswellasrepresentativesfrombusiness,labour,academiaandcivilsociety.

Finally,Figure8.1highlightsthelargenumberofregionalinstitutionsinwhichAustraliaandChinacooperate,someofwhichcompetedirectlyorindirectlywithexistingglobalinstitutions.TheonlymajorglobalinstitutionsinwhichAustraliaandChinadonotbothparticipatearetheUnitedNationsSecurityCouncil(whichexcludesAustralia),andtheOECDandrelatedInternationalEnergyAgency(whichexcludeChina,althoughChinaparticipatesinbothinstitutionsthroughanassociatestatus).

Figure 8.1: Australia and China in the global governance architecture

China only Australia only Both China and Australia

• UNSecurityCouncil

• NewDevelopmentBank(formerlytheBRICSDevelopmentBank)

• ChiangMai

• Brazil-Russia-India-China-SouthAfrica

• OneBelt,OneRoadInitiative

• Trans-PacificPartnership

• AsianDevelopmentBank

• InternationalEnergyAgency

• PacificIslandsForum

• OECD

• ANZUStreaty

• CommonwealthHeadsofGovernmentMeeting

• G20

• ASEAN+6

• UNGeneralAssembly

• EastAsiaSummit

• APEC

• IMF

• WTO

• WorldBank

• RegionalComprehensiveEconomicPartnership

• InternationalEnergyForum

• AsianInfrastructureInvestmentBank

• BankofInternationalSettlements


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the Australia–china relationship and sustaining international cooperation

TheAustralia-Chinarelationshipisofgeopoliticalsignificance,bothforeconomicreasonsandforreasonsofpoliticaleconomy.ThisisdespitethedisparitybetweenChinaandAustraliaintermsofeconomicandpoliticalweight.ItisthisfactthatmakesAustralia–Chinacooperationparticularlyimportant,bothinrelationtostrengtheningtheG20’sroleinglobaleconomicgovernanceandinrelationtothefivekeyareasofglobalpolicymakingdiscussedabove.

ThegeopoliticalsignificanceoftheAustralia–ChinaeconomicrelationshipstemsfromAustralia’sroleasamajorsupplierofprimarycommodityinputstotheChineseindustrialsystem,andtheemergingfutureofbilateralservicestrade,directinvestmentandeconomicpartnership.Prosperityinthetwoeconomiesgoestogether.Suchprosperityisvitalfortheworldeconomy.

WhileitseconomyiscloselylinkedtoChina,andtoAsiamoregenerally,Australia’sstrategicandpoliticalalliancewiththeUnitedStateshasbeenconfirmedasparamountbysuccessiveAustraliangovernments.AustraliahasastrongincentivetoavoidconflictbetweenitseconomicpartnersanditsUSalliance.Australia’sabilitytosteersuchamiddlepathisgreatlyhelpedbyitslonghistoryofengagementwithglobaleconomicinstitutionssuchastheIMF,WorldBank,WTOandUNagencies.FormanyyearsAustraliahasplayedanimportantrolebothinthegovernanceoftheseinstitutionsandinthedeterminationoftheirpolicystances.Australia’sabilitytokeeptheAustralia–Chinarelationshipwithinsuchabroadmultilateralframework,whileatthesametimebuildingonthebilateralrelationship,givesAustraliatheabilitytomakeasignificantcontributiontothetaskofaddressingglobalchallengesanddisputes.SuchacontributionbyAustraliamighthelptheworldtoavoidthecounterproductiveandunnecessaryfragmentationofrelationships,somethingthatwillhurtbothcountries.

Onmanyissues,themosteffectivewayforAustraliaandChinatoengagebilaterallywillbetoworktogetherwithinmultilateralframeworksandtodevelopcoalitionsoflike-mindedcountriesthatcanattractbroadersupportforaction.CollaborationbetweenAustraliaandChinaisitselfsymbolicofthesortofglobalcoalitionsthatneedtobebuilt—thosethatformacrossthedividesofadvancedandemergingeconomies.Thefocusofcoalition-buildingeffortsshouldbeonbothprocessandcontent.

Onprocess,AustraliaandChinahaveacommoninterestinensuringthattheglobalandregionalrules,normsandinstitutionsthatgoverninteractionsbetweencountriesareeffective,inclusiveandcomprehensive.ThisReporthasalreadyarguedthattheG20istheprimaryvehicleforachievingthis.Thischapterwillillustratesomeofthechallengesfacingglobalgovernancemechanisms,andwillidentifythecommoninterestswhichAustraliaandChinahaveinworkingwiththeirpartnersintheG20inaddressingthesechallenges.

Oncontent,AustraliaandChinashouldworkwithintheseglobalframeworkstopromotethecommonglobalintereststhatthetwocountriesshareinrelationtoparticularareas.ThisReporthasalreadymentionedfiveoftheseonwhichthischapterwillfocus:fosteringglobalmacroeconomicpolicycooperation;strengtheningtheglobalfinancialsafetynet;strengtheningthemultilateraltradingsystem;fosteringbetterglobalcoordinationofinfrastructureinvestment;andaddressingglobalenergypolicyandclimatechange.

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strains on the global governance architecture

AttheendofWorldWarII,countriessetaboutbuildinganewglobalordertogoverntheinteractionsbetweencountriesandpromotepeace,stabilityandgrowth.Thisglobalarchitecturehasservedtheglobalcommunitywell.IthasprovidedaframeworkwithinwhichAustraliaandChinahavebeenabletopursuetheirnationaleconomicandpoliticalgoals.Itscoredesignremainsimportanttoservingthoseobjectivesconsistentlywiththeinterestsofothercountries.Althoughithasbeenrelativelyresilientuptothispoint,anumberofrelatedforcesarenowstrainingthisarchitectureanditwillneedtobereformedifitistobeaseffectiveinthefutureasithasbeeninthepast.

Onesuchforceisglobalisation.Emergingeconomiesnowconstitutealargeshareoftheglobaleconomy(Figure8.2).Economiesaremoreconnectedandintegratedthaneverbefore.Figures8.3and8.4illustratethisthroughtwokeyandrelatedtransmissionmechanisms:tradeandcapitalflows.From1980to2015,globaltradeflowshaveincreasedsix-fold.Similarly,therehasbeenasignificantincreaseinthesizeofgrosscapitalflows.Globalgrosscapitalflowsincreasedfromlessthan5percentofglobalGDPduring1980toapeakofaround20percentby2007.

Thisincreasedinterconnectednessmeanscountriesaremoresusceptibletothepoliciesandeventsineachother’seconomies.Italsomeansthattheglobalinstitutionsandforumsdevelopedtogoverntheinteractionsbetweencountrieshaveamuchlargertaskontheirhands,requiringincreasedresourcesandabroaderfocus.

Figure 8.2: share of global gDP (ppp) Figure 8.3: global trade volumne of goods and services (1980=100)

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Figure 8.4: global capital flows since 1980

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Whilethesizeoftheglobaleconomyhasincreased,countries’relativesharesofglobalGDPhavechanged.Figure8.2showsthechangeinthecompositionofglobalGDPfrom1994to2015.EmergingmarketanddevelopingeconomiesnowcontributeagreatershareofglobalGDP(purchasingpowerparity)thanadvancedeconomies.Asthecompositionoftheglobaleconomychanges,sotoomustthecompositionoftheinternationalinstitutionsandforumsthatgovernit.Failuretodothisnotonlymeansthattheseinstitutions’decisionswillappearlesslegitimate,butitwouldalsoimpairtheireffectiveness,duetothereductioninthefundingandcoverageoftheiractivities.

Innovationandadvancesintechnologyalsoacttostraintheexistingglobalgovernancearchitecture.Newtechnologiesalterthewaysinwhichcountriesinteract,potentiallyrequiringnewgovernancestructurestodealwithemergingissues.Advancesintechnologyandtransportation,forexample,havechangedthewayinwhichcountriestrade,fromimportsandexportsoffinalproductstoglobalandregionalproductionnetworks.FinancialinnovationhassimilarlyposedchallengesthathaverequirednewregulatoryframeworksthroughthecreationoftheFinancialStabilityBoardandBaselIII.

Retaining the g20 as the preeminent forum for global economic governance

Formanyyears,theG20remainedbelowtheradar,workingquietlybuteffectivelyattheleveloffinanceministersandcentralbankgovernors(Hulst2015).Thischangedin2008when,facedwiththeglobalfinancialcrisis,theneedforsignificantmacroeconomicpolicycooperationledtotheevolutionoftheG20asaforumfornationalleaders.Leadersidentified‘inconsistentandinsufficientlycoordinatedmacroeconomicpolicies’asarootcauseofthecrisis,andrespondedwiththelargestcoordinatedpolicyresponseinhistory,consistingofliquiditysupporttostabilisemarkets,theuseofconventionalmonetarypoliciestosupportdemandandfiscalstimuluspackagescoordinatedacrossalmostallG20countries.

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In2009,underthepresidencyoftheUnitedStates,G20leadersdeclareditas‘thepremierforumforinternationaleconomiccooperation’.Itsattentiongraduallyshiftedfromfightingthecrisistoimplementingthelonger-termpolicies,bothmacroeconomicandstructural,thatwerenecessarytopromotestrong,sustainableandbalancedgrowth.AlthoughthelegitimacyoftheG20asa‘self-appointedclub’isquestioned,theG20istodayestablishedastheonlyglobaleconomicforumwhereadvancedandemergingeconomiescooperateonanequalfooting(Hulst2015).

Since2008,theG20’sagendahasexpandedsignificantly.Itnowincludesspecificagendaitemsdevotedtogrowth,employment,trade,anti-corruption,financialregulation,tax,infrastructure,investment,development,climatechange,energy,foodsecurity,remittancesand,attimes,pandemicsandterrorism.Aconsistentandcross-cuttingthemeoftheG20hasbeenglobalgovernancereform.TheG20hasemergedastheworld’sprimaryvehicleforreformingtheglobalgovernancearchitectureandinhelpingsteertheprioritiesoftheinstitutions,forumsandorganisationsthatunderpinit.TheG20isoftenreferredtoasthe‘globalsteeringcommittee’,withafocusonrules-basedandmarket-orientedapproaches.ThisisanareainwhichtheG20hasaclearcomparativeadvantagegiventhecompositionofitsmembership,reflecting,inparticular,thegrowingdynamismoftheAsiaPacificregionandtheglobalinfluenceofemergingeconomies.

G20decisions,whichtaketheformofpolicyproposalsratherthanenforceablepolicystrategies,mustinmostcasesbebroughtbeforethegovernanceorgansoftreaty-basedinstitutions,suchastheIMF,andbeadoptedbythemonbehalfoftheglobalcommunity.TheG20cannotdecideforothers,althoughthevotingpowerthatG20membershaveinmostinternationalinstitutionsmeansthattheirproposalsarelikelytobecomedecisions(DrysdaleandDerviş2014).

the importance of the g20 to Australia and china

UnliketheG7,theG8ortheformerG10,theG20includesAustraliaandChina.TherearenoguaranteestheG20willbeapermanentfixture,letaloneremainasaglobalsteeringcommittee.Leadershaveavarietyofmultilateral,regionalandbilateralinstitutionsandforumsavailabletothem,aswellastheabilitytocreatenewonesiftheyseefit.IftheG20stopsbeingeffectiveintheeyesofleaders,thentheG20mayquicklyfinditselfreplaced.

LosingtheG20wouldrepresentaparticularriskforAustraliagivenAustraliaismuchmorelikelytobeexcludedfromalternative,smallergroupingsthanisChina,asAustraliaislessimportanttotheglobaleconomy.ButChinafacesriskstoo.ShouldtheG20fallintodisuse,anewsmallergroupingmaybedominatedbyadvancedeconomies,whichmaynotshareChina’sperspectives,concernsandchallengesasanemergingeconomy.Thereisaworsedanger,still,thatcompetingnon-cooperativecentresofglobalpowerareestablished—suchasaBRICSversusG7dichotomy—althoughthesearetobeavoidedwithinaforumliketheG20too.

TheG20isthebestavenueforAustraliaandChinaininfluencingtherules,normsandinstitutionsofglobalgovernanceandthedeliveryofglobalpublicgoods.WorkingwithinthisframeworkisoneofthemosteffectivewaysforAustraliatoengagewiththeinternationalsystem.Australiahasastrongincentivetohaveaseatatthetableandinfluencehowthisframeworkdevelops.Asakeybeneficiaryofglobalgovernancereform,Chinaalsohasa

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strongincentivetoplayanactiveroleinthesediscussions.Asglobalgovernanceevolvestoreflecteconomicrealities,Chinawillfinditselfplayinganincreasingroleinglobalinstitutionsaswellasinshapingtherulesandnormsthatunderpinthem.

IncreasedChineseleadershipinglobalgovernancewillbeofsignificantimportanceintothefuture,particularlywithintheG20.Vines(2015)hasarguedthattwothingsarerequiredforeffectiveChineseleadership.Thefirstisdomesticcompetence.ThisrequirestransformingChina’smodelofeconomicdevelopmentfromexport-ledgrowthtoconsumption-ledgrowth,supportedbyaresilientfinancialsystem(seeChapters1and2).Thesecondisgloballeadership.Thismeansdevelopinganunderstandingofhowtoactontheworldstageandanunderstandingofhowtheactionsofdifferentcountriesmightbebroughttogether.Mostimportantly,thisrequiresChina,andallcountries,tonurtureaforuminwhichinformationisexchanged,preferencesarticulated,discussionstakeplaceandcompromisesreached.TheG20istheidealforumforthistotakeplace.Assuch,maintainingtherelevanceandeffectivenessoftheG20shouldbeatoppriorityforChina.

TheG20isnotjustameansforAustraliaandChinatoinfluenceglobaloutcomes.Itisalsoameansforinfluencingoutcomesandprioritiesdomestically.Whenusedstrategically,theG20canbeaneffectivewayofprovidingpoliticalcovertohelpundertaketoughdomesticreforms.Thiswasondisplay,inparticular,inhowcountriesrespondedtotheglobalfinancialcrisis.Coordinatedstimulusgavepoliticalcovertogovernmentsinimplementingtheirownfiscalmeasures.Showingthatothercountrieswereundertakingsimilaractionsnotonlygavethesepoliciescredibility,italsohelpedalleviateconcernsthatothercountriesmightfree-rideonthefiscalleakagesfromonecountrytoanother.Thecoordinatedlooseningofmonetarypolicysimilarlyhelpedreducetheriskofalossofconfidenceorcurrencyattack(Vines2015).

maintaining the relevance and effectiveness of the g20

TherearepracticalthingsAustraliaandChinacandobothindividuallyandjointlytohelpmaintaintherelevanceandeffectivenessoftheG20.AustraliaandChinamustensureitsagendaisinclusive.Theyshouldworkcollaborativelynotonlyonissuesthatare\importanttotheglobaleconomy,butalsoonissuesthatbothcountriescanexhibitstrongleadershipontohelpmotivateothers.Importantly,AustraliaandChinamustensurethereiscontinuityintheG20’sagenda.

Thetwo-in-fiveagendahasputtheG20inapositiontoensurecontinuityandsupportfortheglobaleconomicrecovery.In2014,countriesputforwardover1000reformswiththegoalofensuringthattheG20GDPin2018is2percenthigherthanitwouldotherwisehavebeen.Countrieshavesinceimplemented,revisedandaddedtothesereformsin2015and2016throughacomprehensivepeerreviewprocess.ThisprocessshouldplayanimportantpartintheresurrectionoftheG20’sleadershiproleininternationalcooperationonmacroeconomicpolicies.Thetwo-in-fiveagendacanhelpovercomethe‘growthversusausterity’debatewithintheG20byprovidinganacceptablemeansforcountriescommittedtoausteritytoundertakepublicinvestmentwhileallcountriessimultaneouslyundertakesupply-sidereformstoboostpotentialoutput.This,inturn,helpsboostglobalaggregatedemandandtakessomepressureoffmonetarypolicy.

Astrategyofinvestingmoreininfrastructureandcarryingoutsupply-sidereformswillstimulateglobaldemand.Thiswouldleadtothecreationofcapitalassets,whichincreasethesupply-sidepotentialoftheeconomy,andwouldalsoincreasedemandduringtheinvestment

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period.Whilepublic–privatepartnershipscanhelpoptimisepublicresources,infrastructureinvestmentwillalsoenableamoderationofausterityinadvancedcountriesthathavefiscalspaceforpublicinvestment.Thejustificationwouldbethatinvestmentininfrastructureleadstothecreationofassetsthatcanbeusedascollateraltotheadditionalpublicsectordebtincurred.Policymakersmaybemorewillingtomoderateausterityintheknowledgethatadditionalinfrastructureinvestmentwillnotleadtoaworseninginthepublicsectorbalancesheet.

IntermsoftheG20agenda,anotheroptionforachievingcontinuitywouldbetocreateapermanentG20secretariat.G20countrieswouldcontinuetotaketurnshostingtheG20Summit,butthesecretariatwouldhelpmanagetheexpandingagendaandensurecontinuityfromoneyeartothenext.Thecostofhavingapermanentsecretariat,however,isthattheG20losesitsstatusasaninformalforum;itmakestheG20lesscountry-ownedasthesecretariatwillbecomeitsownpoliticalentitywhichmustthenbenegotiatedwith,slowingdownreformprocesses.Pastexperiencewithotherinternationalforumsthatcreatedpermanentsecretariatswouldalsosuggestthatthisdoeslittleinimprovingcontinuityandthat,instead,itisthepoliticalwillofcountriesthatdetermineswhetheranyparticularsummitissuccessfulornot.GiventheG20hasroutinelyrejectedthenotionofapermanentsecretariat,emphasisingtheG20’slong-rungrowthagendaislikelyabetteroptionforpromotingcontinuity.

AustraliaandChinacanalsopromotetheG20byactivelyusingittoraiseandnegotiateglobalissues,insteadofusingotherregionalorglobalalternatives.ThisincludeshavingleadersandministersusetheG20forkeyannouncementsthatareofglobalsignificance,aswellasusingtheG20astheplatformforimportantnegotiations.AustraliaandChinacanalsopromotetheG20bybeingambitiousinthecommitmentstheymakeandinencouragingothercountriestodothesame.

EnsuringtheG20remainsaneffectiveforumrequiresAustraliaandChinatoactivelyavoidG20gridlockbynotsupportingorparticipatingintheformationofdamagingstrategicblocs.Inparticular,thismeansavoidingaG7versusBRICSscenariowherecountriesagreetopre-aligntheirpositionswithintheG20.ChinaandAustraliashoulddeliberatelyandpubliclyapproachtheG20onanissue-by-issuebasisandseektobuildcoalitionsonindividualissuesacrossadvanced,emerginganddevelopingdivides,aswellasgeographicallyacrossEurope,Asia,theAmericas,AfricaandtheMiddleEast.

supporting a stronger global financial safety net

Theglobalfinancialsafetynetconsistsoftheinternationalfinancialresourcesandinstitutionalarrangementstohelpcountriesexperiencingafinancialoreconomiccrisisandpreventingitscontagion.ItisoffundamentalimportancetotheAustralianandChineseeconomiesthroughthestabilityitprovidestotheglobalfinancialsystembyensuringcountriescanaccessliquidityfinancingasnecessary.Itsupportsstabilitybyactingasafinancialbackstop,providingemergencyfinancingwhereacountryisunabletomeetexternalpaymentsandcannotaccessmarkets(Sterland2013).Thesafetynetalsoactsasaformofinsurance(Shafik2015).Countriescontributeresourcestothesafetynetand,knowingtheywillreceiveassistanceiftheyexperienceproblemswiththeirexternalpayments,aremorewillingtoopentheireconomies.BothAustraliaandChinahaveplayedkeyrolesinstrengtheningthesafetynetin

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thepast.ThisincludesthroughtheirquotaandbilateralcontributionstotheIMF,theirsupportforG20-ledinitiativesaroundIMFreformand,forChina,throughitsleadershipinregionalinitiativesandestablishingcurrencyswaplinestobolsterthesafetynetintheAsiaPacific.

ItisthereforeimportanttoensuretheadequacyandeffectivenessoftheglobalfinancialsafetynetaspartofthereformoftheinternationalmonetarysystemthattheIMFshouldadvance.AsPBoCGovernorZhouXiaochuanstatedonbehalfofChinatotherecentInternationalMonetaryandFinancialCommittee(Zhou2016),thisrequiresenhancingtheroleoftheIMF,improvingitslendingfacilities,allowingregionalfinancialarrangementstoplayabettersupplementaryrole,andfurtherimprovingthesovereigndebtrestructuringmechanism,withbettercoordinationamongcreditorsanddebtorsandwideruseofitsenhancedcontractualclauses.

Giventhestronginstitutions,macroeconomicpolicyframeworkandflexibilityoftheAustralianeconomy,itisunlikelythatAustraliawillrequireanydirectsupportfromtheIMFinthefuture.ThisissimilarlythecaseforChinagiventhesignificantdomesticbuffersandpolicyspaceavailabletoChineseauthorities—andalsobecause,intheeventthatChinadidrequireexternalassistance,thesheersizeofitseconomywouldmeantheamountofsupportrequiredwouldutterlydwarfthecapabilitiesoftheIMFandallregionalinstitutionscombined.Externalsupportwouldinsteadcomefromcountriesintheregionandthereserve-assetcountries,particularlytheUnitedStatesandtheEuropeanUnion.BigplayercooperationhastobetheanchorforanIMF-basedfinancialsafetynet.TherelevanceoftheglobalfinancialsafetynettoAustraliaandChinaisinthefundamentalroleitplaysinstabilisingtheglobalfinancialsystemgivenitsprovenabilitytotransmitshocksintotheAustralianandChineseeconomiesthroughtradeandinvestmentchannels.

Australiaisanopeneconomythatisdependentonforeignsavingstofinanceinvestment,particularlyforitsminingandresourcessectors,andoninternationaltradeformaintainingitshighstandardofliving.Australianauthoritiesholdlimiteddomesticreserves,relyinginsteadontheeconomicflexibilitythathasbeendevelopedintheAustralianeconomyovermanydecades.AlthoughtheflexibilityofAustralia’seconomy,particularlyitsfloatingexchangeandinflation-targetingmonetarypolicy,helpsitweathervolatilityfrominternationalmarkets,theAustralianeconomyisneverthelesssusceptibletoglobalandregionalshocksthroughtradeandinvestmentchannels.Australiasignificantlybenefitsfromthestabilityderivedfromthesafetynetandfromhavingstrongmechanismsandinstitutionsunderpinningit.AustraliaalsobenefitsfromensuringtheIMFremainscentraltotheglobalfinancialsafetynetbecause,unlikeChina,AustraliadoesnotyetparticipateinanyregionalfinancingarrangementssuchastheCMIMortheEuropeanStabilityMechanism(ESM).

WhileChinadoesparticipateinregionalinitiativesandhassignificantdomesticreserves,theChineseeconomyhasshownitselftobeincreasinglysusceptibletointernationalshocks.TheAsianfinancialcrisis,theglobalfinancialcrisisandmorerecentlytheso-calledTaperTantrumin2013havehighlightedthesusceptibilityoftheChineseeconomytoglobalshocksthroughfinancialchannels.Theseshocks,particularlytheEuropeandebtcrisis,havealsohighlightedthesusceptibilityoftheChineseeconomytoreducedglobaldemandthroughtradechannels.ChinaisakeybeneficiaryfromglobaleffortstohavetheIMF,andglobalgovernancemoregenerally,betterreflecttheeconomicrealitiesofthe21stcentury.ThesereformswillbekeytofacilitatingChina’seconomictransitionandhavingitplayamoreactiveroleintheglobalfinancialsystemofthefuture,aswellasinhavinginputintohowglobalrules,normsandinstitutionsdevelopovertime.

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Ensuringthatcountriescanaccessliquidityfinancing,bothregionallyandglobally,intimesofdifficultyisofcriticalimportance.Theresponsetotheglobalfinancialcrisis,particularlythroughthecurrencyswaplinesestablishedbetweencentralbanks,showedboththeimportanceofensuringadequateaccesstoliquiditybutalsotheadhocandunpredictablenatureinwhichthisiscurrentlysupplied.TheglobalfinancialsafetynetisparticularlyimportantforAustraliaandChina.Emergingmarketeconomiesaremoresystemicallyimportanttotheglobaleconomythaneverbeforeandmanyofthemarefacingdifficulttransitionsandsignificantrisksintheshorttomediumtermthatthreatentoreducetheconfidenceofinvestorsinholdingassetsintheseeconomies.CapitaloutflowsfromemergingmarketshavesurgedtowardUS$1trillionover2014–2015.Thatisapproximatelydoubletheamountthatexitedemergingmarketsduringtheglobalfinancialcrisis(NNInvestmentPartners2015).AccordingtotheBankforInternationalSettlements,investorsareincreasinglyfocusedongrowingvulnerabilitiesintheemergingmarketeconomiesastheyreassesstheglobalgrowthoutlook(BIS2015).

Figure8.5showsthateconomicactivityintheseeconomiesisnowprojectedtoslowforthefifthsuccessiveyear(IMF2015a).Thesedowngradesreflectcommonaswellascountry-specificfactors.Commonfactorsincludeweakerdemandfromadvancedeconomies,weakergrowthinoilexports,adjustmentsintheaftermathofcreditandinvestmentbooms,aweakeroutlookforexportersofothercommodities(includinginLatinAmerica),aswellasmoredifficultexternalfinancingconditions.Shoulddownsiderisksincreaseormaterialisefortheemergingmarketeconomies,theglobalfinancialsafetynetwillhaveacriticalroletoplayinpreventingcontagionandbufferingitseffectsontheAustralianandChineseeconomies.But,asthefollowingsectionexplains,thesafetynet,atpresent,istoosmall,toounresponsiveandtoofragmentedtoplaythisrole.

Figure 8.5: imF gDP forecasts for emerging market and developing economies

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the evolution of the global financial safety net

In2003,thesafetynetconsistedpredominantlyoftheIMFandtheUS$365billionitheldtofightcrises(AustralianTreasury2014).Sincethen,thesafetynethassignificantlyincreasedinsizebuthasfragmentedincomposition.Thereareseveralreasonsforthisfragmentation.ThemostsignificantistheslowpaceinreformingtheIMFsoastoboostitspermanentfundingandmakeitsgovernancestructuremorerepresentativeofthecontemporaryglobaleconomy.

TheslowpaceofIMFreformhasmadetheIMFmorereliantonsecondarysourcesoffunding,suchasbilateralloancommitments,andhasmadetheglobaleconomymorereliantonregionalandbilateralalternativesoutsideoftheIMF.In2010,theeuroareacreatedtheEuropeanFinancialandStabilityFund,whichlaterbecametheEuropeanStabilityMechanism,torespondtotheEuropeandebtcrisis.Similarlyin2010,BRICScountriescreatedtheUS$100billionBRICScurrencyreservepoolandthe13ASEANPlusThreecountriescreatedwhatisnowtheCMIM—apoolofforeignexchangereservesthatexpandedtoUS$240billionin2012(Kawai2015).

Fortheemergingmarketeconomies,theseinitiativesoccurredbecauseofinsufficientIMFresourcesaswellasdissatisfactionwiththeIMF’sresponsetotheAsianfinancialcrisisandtheslowpaceofIMFreform.Thishasalsoseencountriesincreasedomesticandbilateralbuffersthroughforeignexchangereservesandbilateralswaplines,respectively.ForeignexchangereserveshaveincreasedfromlessthanUS$2trillionin1990tooverUS$11trillionin2016whilethevalueofcurrencyswapsutilisedduringtheglobalfinancialcrisiswasoverUS$600billion(AustralianTreasury2014).

ThesechallengesaremoreapparentinAsiathananywhereelse.WhileAsiaislargecomparedtootherregions,thesafetynetinAsiaishighlyfragmentedandpatchyinitscoverage.Asof2016,itconsistsoftheIMF,CMIM,BRICScurrencyreservepool,bilateralcurrencyswaplines,domesticforeignexchangereservesand,potentially,theWorldBankandtheADB—whichprovidedliquiditysupportduringtheAsianfinancialcrisis.

Ofcourse,this‘fragmentation’isnotnecessarilynew.Historically,mostcriseshaverequiredsomeformofacoordinated,adhocresponsebetweendifferentinstitutions,organisationsandcountries,whetheritbeMexicoin1994(requiringacoordinatedresponsefromtheUSadministration,USFederalReserve,theIMFandBankforInternationalSettlements)orAsiain1997(withresourcesfromtheIMF,WorldBank,ADB,theUnitedStates,Japanandothers).Butthesizeofthecurrentdesignatedsafetynetistoosmalltoassisteventhoseeconomiesthatarerelativelysmallandnotnecessarilysystemicallysignificant.

Quantifying the size and adequacy of the safety net

Quantifyingthesizeofthesafetynetmeansaddingtogetheritsmultilateral,regionalandbilateralcomponents(Figure8.6).TheglobalcomponentconsistspredominantlyoftheIMF.AsofJune2015,theIMFhastotalresourcesofUS$1.3trillion,whichincludesitsquotaresources,resourcesfromtheIMF’sNewArrangementstoBorrowandGeneralArrangementstoBorrow,andbilateralloanswiththeIMF.TheregionalcomponenttotalsaroundUS$840billioniftheresourcesavailableinthemajorregionalarrangementsareaddedtogether—theEuropeanStabilityMechanism,theCMIMandtheBRICScurrencyreservepool.Finally,agoodproxyforthesizeofswaplinesduringatimeofcrisisistousethepeakvalueofthedollarswaplinesduringtheglobalfinancialcrisis.Thesepeakedataround

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US$600billion,althoughitshouldbenotedthatmanyoftheseswaplinesnolongerexist(theUnitedStatesstillhasunlimitedswaplineswiththeUnitedKingdom,EuropeanUnion,SwitzerlandandJapan)andadditionalswaplineshavebeencreatedsincethen,particularlybyChina.

Addingthesecomponentstogether,theoverallsafetynetisaroundUS$2.7trillion:about50percentcomesfromtheIMF,20percentfromswaplines,20percentfromtheEuropeanStabilityMechanismand10percentfromBRICSandtheCMIM.TheIMF(2016)estimatesthesafetynettobearoundUS$3.7trillion.ThislargernumberappearsbecausetheIMFincludesadditional,albeitsmaller,regionalfinancingarrangements.Ifweweretoincludeevenmoreregionalarrangements,includingregionaldevelopmentbanks,whichhavehistoricallyplayedaroleincrisisresponse,thesizeofthesafetynetisevenlargerstill,calculatedinthisReportataroundUS$4.6trillion.Howeverastheanalysisbelowshows,theadequacyofthesafetynet’ssizeisquestionableevenusingtheselargerestimates.

Whiledomesticforeignexchangereservescouldbeaddedasafourthcomponent,thesereservesaregenerallyacountry’sfirstlineofdefence.Althoughimportant(asdiscussedbelow),itcanbearguedthattheyarenomorepartoftheglobalfinancialsafetynetthandomesticmacroeconomicpolicy.

Theadequacyofthesafetynetrelatestoitssizeandcomposition,which,inturn,influencesitscoverage,consistencyandspeedinrespondingtoacrisis(IMF2016).Countriesarenowmoreexposedtofinancialcontagionthaneverbefore,soalargersafetynetmakessense.ButtheUS$2.7trillionfigurerepresentedabove,ortheIMF’sUS$3.7trillionfigure,overstatethesafetynetthatisactuallyavailable.

First,Figure8.7showsthat,ifweexcluderesourcesthatarenotimmediatelyavailable,thesizeofthesafetynetdropstoaroundUS$1.75trillion.FortheIMF,muchofitsresourcesaretiedupinexistingprogramsorcomefromborrowingcommitmentsthathavenotbeenpaid-in.Asaresult,itsresourcesdropfromUS$1.3trilliontoUS$421billion.Similarly,theforwardcommitmentcapacityoftheESMdropsfromUS$500billiontoUS$369billion.ItshouldalsobenotedthatthedollarswaplinesfromtheUSFederalReservemaynotnecessarilybeofthesamesizeorextendedtothesamecountries.HowtheUSFederalReservechosethesecountriesalsoremainsunclear.

Second,whetherasafetynetofUS$1.75trillionisadequateornotdependsonthesizeofthecrisisthatitisrespondingto.TheIMF(2016)notesthatthesizeofthesafetynet,andparticularlytheIMF’sresources,havenotkeptpacewiththe25-foldincreaseinglobalcapitalflowssince1980(Lagarde2016).Ithasalsofailedtokeeppacewiththeincreasingstockofdebtamongtroubledeconomies.Greece,forexample,representsjust0.25percentofglobalGDP(PPP;IMF2016).ButiftheIMFwererequiredtoshouldertheburdenoftheGreekbailoutonitsown(approximatelyUS$279billionsince2010),thiswouldabsorbalmost70percentoftheIMF’scapacity.Aworsescenariowouldbebailingoutalargereconomy,suchasSpain.Spainrepresents1.5percentofglobalGDP(PPP;IMF2016)andhasUS$669.5billionofdebttorefinanceinthefiveyearsfrom2015to2020(Gilbert2014).ThiswouldexhausttheIMF’scapacityandmostoftheESM.

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Figure 8.6: The components of the global financial safety net

Total IMF resources; $1,312

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Source:Authors’calculations.

Third,theadequacyoftheglobalsafetynetdependsonwhatismeantbytheterm‘global’.Theactualsizeofthesafetynetdependsonthecountryinquestion.ForAustralia,thesafetynetconsistsentirelyoftheIMFanditsswaplinewithChina,sinceAustraliadoesnotparticipateinanyrelevantregionalinitiatives.Similarly,swaplinesareonlyavailabletothosewhocannegotiatethem,anditisworthnotingthatemergingmarketsanddevelopingeconomieswereexcludedfromtheUSFederalReserveswaplinesintheglobalfinancialcrisis.TheIMF(2016)acknowledgesthatthesafetynet’scoverageisincreasinglypatchy,whichisaparticularriskfornon-developedcountries.

Fourth,marketconfidenceisreducedwheninvestorsareunabletoseeadesignatedwarchestandnecessaryinstitutionalarrangementstorespondtoacrisis.Assumingthatonlyadhocinternationalcooperationwillbeforthcomingduringatimeofcrisisisnotconducivetomarketconfidence.Italsoerodestheimplicitinsurancepolicy,whichencouragescountriestoopentheireconomiesinthefirstplace(Shafik2015).Havingastrongsafetynetcanhelpencouragecross-borderinvestmentandincreaseconsumptionthroughreducedprecautionarysavings.

Fifth,increasedfragmentationmeansgreaterdependenceontheabilityofdifferentinstitutionsandarrangementstocoordinatewithoneanotheratatimeofcrisis.Thiscanmeanaslowerandlessconsistentresponsefromonecrisistothenext(IMF2016).TheG20identifiedtheseconcernsasreasonsfordevelopingprinciplestoguidecooperationbetween

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theIMFandregionalfundingarrangements(RFAs)(G202011).TheIMF(2016)hasalsofoundthatmostcountrieswouldneedtouseseveralelementsofthesafetynettofullycovertheirfinancingneeds,thecoordinationofwhichtheIMFcalls‘astrongassumption’.

Figure 8.7: Total resources compared to available resources

Swap lines during the GFC; $600

Total IMF resources; $1,312

Total IMF resources; $421

European stability mechanism; $369

Chiang Mai; $240

BRICS; $100

0

250

500

750

1,000

1,250

1,500

1,750

2,000

2,250

2,500

2,750

3,000

Total resources Available resources

US$

bill

ions

Mul

tila

tera

l

Swap lines during the GFC; $600

Bila

tera

l

European stabilitymechanism; $500

Chiang Mai; $240

BRICS; $100

Reg

iona

l

Source:Authors’calculations

Finally,theseregionalfinancingarrangementsareweaksubstitutesfortheIMF.Theclosenessofcountriesthatparticipateinregionalarrangementsmeansthatimposingpotentiallypainfulbutnecessaryconditionalitycanbedifficultanduncomfortable.Thenarrowerbaseofresourcesmeanstheyarelessreliable,lessdiversifiedandmoreriskyforcontributingcountries.Surveillanceactivitiesalsotendtobepartialastheglobalpictureisnotasobvious.

Forthesereasons,theIMFshouldremainatthecentreoftheglobalfinancialsafetynet.ItsdiversemembershipandlonghistoryprovidestheIMFwithseveraluniquefeaturesthatareirreplaceableataregionalorbilaterallevel.TheIMFhasthegreatestcapacitytoraiseresourcesintimesofneedandtoensurethatcreditriskisdiversifiedgloballytothegreatestextentpossible.Assuch,itprovidesthemosteffectiveandlowcostinsuranceagainstcrises.

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Avenues for collaboration between Australia and China in the g20

ReformingthesafetynetwouldbenefittheAsianregioniftheIMFtakesaholisticapproachthataddressestherootcausesofitsfragmentation.ThisrequiresafocusonincreasedandmorepermanentfundingfortheIMF,bettertailoredfinancingfacilitiestomeettheneedsofAsianeconomies,anewphaseofreformstogiveAsianeconomiesagreatervoiceintheIMF,andbettercooperationbetweentheIMFandRFAs.

TheglobalfinancialsafetynetisapolicychallengethatG20financeministersandcentralbankershavebeenatthefrontierofforcloseto15years.ItisanissueuniquelysuitedtotheG20asallcountriesbenefitfromthepositiveexternalitiesthatflowfromaneffectiveglobalfinancialsafetynetthattakesinglobal,regional,bilateralandnationalarrangements.

TheG20isuniquelysuitedtoaddresstheinadequaciesofthecurrentsafetynet.One-thirdoftheIMF’sfundingfrombilateralloanswillstarttoexpireover2016and2017,andtheG20willneedtodiscussthenextstageofIMFreformfollowingtherecentratificationofthe2010quotareformsbytheUnitedStatesCongress.TheG20’shistoryhasshown,however,thateffortstoachievesweepingchangestoglobalgovernance,so-called‘grandbargains’,havebeenunsuccessful,exceptperhapsinthecontextofanemergencyonthescaleoftheglobalfinancialcrisis.ThefocusoftheG20undertheFrenchpresidencyin2011,forexample,wastotakeaholisticlookattheinternationalmonetarysystemwithafocusonradicalreforms.Theoutcomesachievedfromthisprocess,however,weresignificantlylessthantheamountofpoliticalcapitalthatwasexpended.

Instead,theG20shouldfocusonwhatpragmaticstepsitcantakeinsupportinganincrementalprocesstostrengthenthesafetynet.Tothisextent,AustraliaandChinashouldsupportG20effortsontheissueoftheglobalsafetynetfromfourkeyperspectives:thenextstageofIMFreform,implementingarrangementstomaketheIMFandRFAsmorecohesive,renegotiatingbilateralloans,andstrengtheningdomesticmacroeconomicframeworks.

imF reform

IMFreformisthelinchpinforaddressingthechallengesfacingtheglobalfinancialsafetynet.China’sG20presidencyin2016presentsanawkwardcontradictionwherethecountrychairingtheglobalsteeringcommitteeremainsgrosslyunderrepresentedinmanyoftheworld’smostimportantinstitutions.Whiletheratificationofthe2010IMFreformshelpedaddressthis,thereisstillmuchtobedone.AustraliaandChinashouldencouragetheG20tostartaconversationonthenextstageofIMFquotareform.Thiswillbeanincrementalprocessovermanyyears,anditisreasonabletoexpecthesitationfromsomemembers,notablytheUnitedStates,inwantingtoadvanceanewroundofreformssoquicklyaftertheratificationofthelastround.However,momentumfromtherecentsuccessofthe2010reformsshouldnotbelost.

ThereareanumberofotheraspectsofIMFreformthatsimilarlystillneedtotakeplace.Thisincludesbringingforwardthe15thGeneralReviewofQuotasandimplementingtheagreementreachedin2010wherebyadvancedEuropeancountrieswouldfreeupanIMFboardchairforanemergingmarketeconomy.ThereisalsoadditionalworktodoinreviewingtheIMF’squotaformula,althoughresolutiononthisissuewillrequireapoliticalsolutionandwillnotbesolvedthroughtechnicalreviews.Finally,thereisalonger-termopportunityforAustraliaandChinatobeginplantingtheseedsforhavingarepresentativefromanemergingmarketeconomyappointedastheheadoftheIMFattheendofLagarde’sterm.

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ReformstotheIMFcouldalsofocusonitsfinancingfacilitiestoensuretheyaremeetingtheneedsofitsmembers.Thiscouldincludeagreateruseofprecautionaryfinancingtomakethesafetynetfaster,moreflexibleandmoreresponsive.TheIMFtookasignificantstepinthisdirectionindevelopingtheflexiblecreditlineandtheprecautionaryandliquiditylinein2010.Thesefacilitiesareaimedatstronglyperformingeconomieshitbyexternalshocks—theso-called‘innocentbystanders’.TheIMF(2016)hasfoundthatwithoutpromptliquidityprovision,innocentbystanderscanquicklybecomevulnerableduringsystemiccrises.Thisisalsoamotivationforcountriestostockpileforeignexchangereserves.Havingagreaterfocusonprecautionaryfinancingcouldhelpbettermeettheneedsofmembers,reducefragmentationandimprovetheIMF’sresponsetocrises.

composition of the sDR basket of currencies

On13November2015,IMFstaffrecommendedtherenminbi(RMB)beincludedintheSpecialDrawingRights(SDR)basket(IMF2015c).China,ofcourse,continuestohaveakeyroletoplayinthisregard.LiberalisationofChina’scapitalaccountispivotalnotonlytotheRMB’sinclusionintheSDR,butalsoforChinatoplayanincreasingroleintheglobaleconomymoregenerally.Importantly,theRMB’sinclusioncanbeusedbyChinaasacatalysttohelpdrivedifficultfinancialreformsathome.

strengthening collaboration between the imF and RFAs

WhilereformingtheIMFisthebestwaytoaddressthechallengesfacingthesafetynet,thereareotherstepsthatcanbetakentomakethepatchworkofglobalandregionalinitiativesmorecohesive.Regionalandbilateralinitiativescanhaveanimportantrolewithinthesafetynet,buttheymustberigorousandstructuredsoastocomplementtheIMF.AttheCannesSummitin2011,leadersendorsed‘G20PrinciplesforCooperationbetweentheIMFandRegionalFinancingArrangements’(G202011).ThisshouldbeusedasthebasisfordevelopinganoverarchingframeworkforbettercooperationbetweentheIMFandRFAs.

Suchaframeworkcouldbegraduallydevelopedandstrengthenedthroughinformalandformalmethods.Informally,regulardialoguescouldbeheldbetweentheIMFandRFAstoreachabetterunderstandingonhowtocoordinatewitheachother,suchasestablishingproceduresforinformationsharingandjointlyconductingcrisisscenarioexercises.ThissuggestionwasputforwardbySouthKoreain2012andreceivedbroadsupport(G20IndiaSecretariat2014).IthasalsobeencanvassedbytheIMF(2013)asapracticalsteptofine-tunethecurrentflexibleapproachtoIMF–RFAcooperation.

Moreformally,theG20couldtaskaworkinggrouptodevelopdetailedguidelinesonIMF–RFAcooperation.Suchanagreementcouldformalisetheexpectationthatco-financingoperationswouldbesubjecttocertainprinciplesandsafeguards,similartothosestipulatedundertheIMF’slendingframework.Thedetailedguidelinescouldprovideconcreteguidanceonhowtheseprinciplescouldbeachieved.ThisproposalhasalsobeencanvassedbytheIMF(2013)andshouldbeconsideredbytheG20.

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Renewing bilateral funding of the imF

TheexpirationofUS$369billionofIMFbilateralloanfundingover2016and2017requiresanurgentresponseunderChina’sG20presidency.ThisfundingrepresentsathirdoftheIMF’sfundinganditspotentiallossintroducesanunacceptableamountofsystemicriskintotheglobaleconomyatatimewhenmanyeconomiesaregoingthroughdifficulttransitions.Theseloansmustberenewed.

However,AustraliaandChinashouldnotlosesightoftheultimategoal,whichislong-term,adequateandsustainablefundingfortheIMF.Whilethesebilateralloansarecriticalinfillingashort-termgap,theirrenewalshouldformpartofabroaderdiscussionaroundthetimetablesforquotareformsothat,ultimately,thesebilateralloanscanbefoldedintolonger-termformsofIMFfinancing.

strengthening domestic frameworks

Finally,thesafetynetalsoneedstobeconsideredinabroadercontext.Itisnotapanacea.Itis,andshouldremain,alastresort.Thereneedstobeanequalfocusondomesticreformstobuildsoundmacroeconomicframeworkswithincountriestocushionagainsteconomicshocksandensureflexibleresponses.AustraliaandChinashouldensurethatthemacroeconomicfocusoftheG20growthstrategiesisnotlost,andthatthesestrategiesandtheG20peerreviewprocessexpresslyconsiderhowdomesticframeworkscouldbestrengthened,withanalyticalsupportfromtheIMF.

supporting and promoting the global trading system

Theglobaltradingsystemreferstotherules,normsandinstitutionsthatgoverninternationaltrade.Althoughitcanbecharacterisedinmanyways,thesystemconsistsofmultilateral,plurilateralandbilateralcomponents.Bilaterally,itconsistsofhundredsofFTAsorotherformsoftradeagreementthathaveemergedoverthelast20years.Plurilaterally,thesystemconsistsofregionalandcross-regionalagreementssuchastheNorthAmericanFreeTradeArea(NAFTA),TPP,RCEPandTTIP.Multilaterally,thesystemconsistsoftheWTOandthemultilateralagreementsithasproduced.

AustraliaandChinaactivelycooperatemultilaterallythroughtheWTOaswellasbilaterallythroughChAFTA,whichhassetnewdirectionsintradepolicystrategy.Differencesemerge,however,inregardstoplurilateralarrangements.WhileAustraliaandChinacooperatethroughRCEPundertheauspicesofASEAN,AustraliaisamemberoftheTPPwhileChinaisnot.Figure8.8givesasnapshotofhowAustraliaandChinafitwithintheincreasinglycomplexglobaltradingsystem.

Allthreeofthesecomponents—multilateral,plurilateralandbilateral—areimportantandrelevanttotheAustralia–Chinarelationship.AustraliaandChinaarebothtradingnations.Bothcountrieshavebenefitedimmenselyfromtheglobaltradingsystemthroughincreasedconsumption,investmentandhigherproductivitythroughthemoreefficientallocationofresourcesthattradeliberalisationfacilitates.

Exportsrepresentabout21percentofAustralianGDPandabout23percentofChina’sGDP.ComparethistotheUnitedStates,whereexportsrepresentjust13percentofGDP,anditisclearthatAustraliaandChinahavestronginterestsintheefficiencyandeffectivenessofthe

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globaltradingsystem.AustraliaandChinahaveaparticularinterestinensuringtheglobaltradingsystemsupportsregionalandglobalvaluechainsbyfacilitatingtradeandinvestmentflowsacrossborders.Thishasbeenaidedbyimprovementsinphysicalinfrastructureandlogisticsservices,rapiddevelopmentsofinformationandcommunicationtechnology,andfallsintradebarriersandtradecosts,allofwhichhavehelpedexpandtradeandforeigninvestment.ThefactthattheWTOhasbeenlockedinadecade-longpreoccupationwith20thcenturytradeissues(suchastariffsandagriculture)intheDohaRoundhasmerelyexacerbatedthisregionalisationeffect(Baldwin2013).

AustraliaandChinagainthemostfromtradeliberalisationwhenitismultilateral,ratherthanbilateralorplurilateral.Inshort,theGDPand,moreimportantly,consumptiongrowthenjoyedbyAustraliaandChinawillbebiggerwhenliberalisationeffortsareundertakenwithinlarger,andpreferablyworldwide,groups(McKibbin1998).Thelargerthegroup,thegreaterthepotentialformoreefficientallocationofresourceswithintheseeconomiesis.Inlargergroupingsthestimulationofdemandforexportsandcapitalastradebarriersarealsolowered.Alargergroupingalsohelpspreventtradebeingdivertedawayfromnon-participatingcountries.

TherearethreepriorityareasforcollaborationbetweenAustraliaandChina.First,giventhebenefitsofmultilateraltradeliberalisationtobothcountries,AustraliaandChinashouldrefocustheG20’seffortsonboostingthemultilateraltradingframeworkbypromotinganincrementalprocessthroughwhichtheG20canworktowardsWTOreformoverthecomingyears.Second,AustraliaandChinashouldfocustheireffortsintheG20,WTOandRCEPontakingpracticalstepstotrytoreducefragmentationintheglobaltradingsystem.Third,giventheimportanceofinvestmenttotheeffectivenessoftheglobalandregionalvaluechainsAustraliaandChinaparticipatein,bothcountriesshouldsupporttheG20onanincrementalprocessthatsupportsamultilateralframeworkforinvestment.

Figure 8.8: Australia and China within the global trading system

NS PACIFICTNERSHIP

TPPTM

World Trade Organization162 members

TPP

United States

Peru

Canada

Mexico

Chile

TRANPART

T

RCEP

India

China

Korea

Philippines

Indonesia

ThailandMyanmar Malaysia

Vietnam

Brunei

Singapore

New Zealand

Australia

Japan

Laos

Cambodia

ASEAN


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Promoting multilateral liberalisation and WtO reform through the g20

TheresponsibilityforglobaltradegovernancehasrestedwiththeWTOsinceitscreationin1995.Itsmembershiphasgrownto162asofMay2016.TheWTO’scentralfunctionistoprovideaforumforinternationaltradenegotiations,whichresultsinWTOagreements.TheWTO’sotherfunctionsincludeadministeringWTOagreements,monitoringnationaltradepolicies,andprovidingtechnicalassistanceandtrainingfordevelopingcountries(Baldwin2013).

TheWTOisthepreferredvehicleforpursuingtradeliberalisationandmanagingtheglobaltradingsystemforboththeAustralianandChinesegovernments.Itistheonlyorganisationthatcantakeacomprehensiveviewoftheincreasingcomplexitiesoftheevolvingeconomicengagementsbetweencountries.ButWTOnegotiationshavenowbeenstalledfortwodecades,largelyoveradivideonmajorissuessuchasagriculturesubsidies,industrialtariffsandnon-tariffbarriers.

Asaresult,theWTOhasnotkeptupwiththeevolutionoftheglobaltradingsystem,particularlythedevelopmentofglobalandregionalvaluechainsandtheintertwiningoftrade,investment,intellectualpropertyandservices.WhiletheWTOremainedfocusedontariffsandagriculture,morecomplexglobalandregionalproductionnetworkswereforming.WithoutWTOreformthatallowsentrenchmentofthestrongerregulatoryandinstitutionalarrangementsnecessaryformorecomplexinternationalcommercialties(intrade,servicesandinvestment),theglobaleconomyrisksthesteadydeclineintherelevanceofoneofitsmostvaluableinternationalinstitutionsandtheconsequentlossofextraordinaryopportunitiestoimprovegloballivingstandardsandcreationofapermanentlyfragmentedglobaleconomicsystem.

ThedifficultyinreformingtheWTOisnotincomingupwithalternativerulesorinstitutionalframeworksbutinachievingpoliticalagreementthatreformisrequiredandonwhatformitshouldtake.Thefocusneedstobeondevelopinganincremental,inclusiveandrobustprocessthroughwhichsuchissuescanbediscussed.TheG20presentsthemosteffectiveforumgivenitsglobalgovernancefocus.

TheG20’sfocusontradehasbeenmovinginthewrongdirectioninrecentyears,givinggreateremphasistoFTAsandregionalagreements.UnderAustralia’sG20presidency,asunderTurkey’s,thefocuswasondomesticstructuralreformsinnationalgrowthstrategiestoreducethecostofdoingbusiness,streamlinecustomsprocedures,reduceregulatoryburdensandstrengthentrade-enablingservices.Whiletheseareimportantareasoffocus,theG20’skeyareaofcomparativeadvantageisintendingtothemultilateralsystemandshapinghowbilateral,plurilateralandmultilateralcomponentsfittogether.Increasingly,communiquésdepicttheG20asaforumforinformationsharingontradeissuesratherasthedrivingforceforinstigatingnecessaryglobalgovernancereform.

TheG20needstorefocusonthemultilateraltradingsystemanddevelopaprocessformovingforwardonWTOreform.PangestuandNellor(2014)providepracticalsuggestionsonhowaG20processcouldbedeveloped,buildingonthecreationofadesignatedG20workinggroup.TheysuggestthatleadersannouncetheappointmentofanEminentPersonsGroup(EPG)comprisedofhighlyregardedpeopleininternationalgovernance,tradeandotherareas,taskedtomakerecommendationsontheglobaltraderegimeandspecificallyontheprinciplestobeobservedbyG20membersastheyconsidergovernancereforminregardstotrade.ThecompositionoftheEPGshouldreflecttheneedtomovetradediscussionsbeyondthenegotiationparadigmtoreflectthebroadereconomic‘wins’ofastronger,moremodernregime.

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ReformingtheWTOandentrenchingitsauthorityisofcentralimportancetoAustraliaandChina.Regionalagreementsarefragmentingtherelationshipandbothcountriesbenefitthemostfromtradeliberalisationthatisundertakenacrossthelargestnumberofcountriespossible.WTOreformisalsothelinchpinforaddressingfragmentationintheglobalsystem,whichbenefitsneitherAustralianorChinagiventheincreasedcostoftradeandinvestmentitentails.

Integraltothiswillbegivingthebusinesscommunity(representedthroughtheBusiness20,or‘B20’)agreatervoicewithintheG20.TheB20hasafundamentalroletoplayinadvisingG20leaders,ministersandofficialsonthepracticalstepstheG20cantaketoimprovetheeaseoftradinganddoingbusinessacrossborders,particularlybyproducingamorecohesiveinternationaltradearchitecture.TheG20needstoensureitprovidesplatformsfortheB20tomakeitsrecommendationstoleaders,includingsignificantengagementbyleaders,ministersandofficialswiththeB20anditsrecommendations.ResponsibilityalsofallstotheB20toensureitsrecommendationsarespecific,targetedandfirmlyrootedinarobustevidence-base.TheB20canplayacontinuedroleintheimplementationofthoserecommendationsandshouldnotconcernitselfonlywiththerecommendationsthemselves.

A more cohesive and integrated global trading system

ThereareotherpracticalstepsAustraliaandChinacouldsupporttohelpaddressfragmentationintheglobaltradingsystem.Calledthe‘noodlebowleffect’inthecontextofAsia,tradefragmentationrisksreducingtradeandinvestmentflowsbyincreasingthecostandcomplexityofdoingbusinessacrossborders(Urata2013).Thesecostsincludedifferentandcompetingtariffschedules,exclusionlists,rulesandstandards.Sincethecoexistenceofbilateral,plurilateralandmultilateralagreementsisunlikelytochangeanytimesoon,thefocusshouldbeonachievinggreatercoherencebetweenthesediverseagreements.

Preferentialtradeagreementshavepositiveandnegativeeffects.Thepositiveeffectscomefromtheexposureofuncompetitive,shelteredhomeproducerstocompetitionfromlower-costpartnercountrysuppliers.Thenegativeeffectsarethattheseagreementsdiverttradeawayfrommoreefficientandcompetitivethirdcountrysupplierstowardspartnersupplierswhoonlybecomecompetitivebecauseofthepreferentialtreatmenttheyreceiveundertheagreement(Armstrong2015;seeChapter7).Havingalargenumberofintertwinedpreferentialtradeagreementsnotonlyriskstradediversionbutalsoexacerbatesthesenegativeeffectsbyincreasingcomplexityandcompliancecosts.The‘noodlebowl’canmakeAsianfirms—particularlysmall-andmedium-sizedenterprises,whichdisproportionatelyuseFTApreferences—facecostlybusinessproceduresandcumbersomerequirements(Baldwin2013).Ensuringcoherencebetweentheseagreementshelpseliminatethesenegativeeffects.

ThegoalfortheTPPandRCEPmustbetoensuretheyactasastepping-stonetowardsmultilateralisation.TheTPPwassignedinFebruary2016,althoughitstillawaitsapprovalintheUSCongressandinotherjurisdictions.ThereisariskthattheserulesandstandardshavebeennegotiatedbilaterallysuchthattheTPPmayhavesomeofthecharacteristicsofaseriesofbilateralarrangementsratherthanagenuinelycommonsetofregionalrules.Thisisfarfromidealintermsofeconomicefficiencysinceitwillprotectsupplierswithinthearrangementagainstlowercostsuppliersoutsideit,suchasChina,IndonesiaorEuropeforinstance,divertingtraderatherthancreatingit(Drysdale2015).

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ThefocusofAustraliaandChinashouldnowbeonworkingwithpartnersinRCEPtoensureitisnotonlycomplementarywiththeTPPbutgoesfurtheronkeyissuessoastoraisethestandardforregionalagreements.ThisrequiresastrongpoliticalcommitmentfromleaderstobetterintegratethefiveASEANPlusOneFTAswithChina,Japan,SouthKorea,IndiaandAustralia–NewZealand.Fromapracticalpointofview,theASEANPlusSixcountriesshouldadoptagradualapproach,whichhasbeenshowntobeeffectiveintheestablishmentoftheASEANFreeTradeArea(AFTA),intariffelimination,aswellasaco-equalapproachinthedefinitionofrulesoforigin(Urata2013).

Thereareotherpracticalthingsthatcanbedonetohelpensurecoherencebetweentheseagreements.Theseincludeencouragingrationalisationandflexibilityofrulesoforigin,upgradingoriginadministration,improvingbusinessparticipationinFTAconsultationsandstrengtheningsupportsystemsforSMEs(Baldwin2013).TherearealsoimportantwaysinwhichtheWTOprocesscanbeusedtoassistwiththeseregionalintegrationeffortstohelpensuretheyactasstepping-stonesformultilateralisation.Forexample,theWTOandASEANcouldcollaborateonjudicialandmonitoringfunctionstoensuregreatercoherencebetweenglobalandregionalrules(Oshikawa2013).

Finally,implementationoftheTradeFacilitationAgreement(TFA)offersopportunitiesforreducingthecostoftrade.The2015OECDTradeFacilitationIndicatorsfindthattheimplementationoftheTFAcouldreduceworldwidetradecostsbybetween12.5and17.5percent.CountriesthatimplementtheTFAinfullwillreducetheirtradecostsbybetween1.4and3.9percentagepointsmorethanthosethatdoonlytheminimumthattheTFArequires(OECD2015).

AustraliaandChinashouldusetheirinfluenceintheG20tomodifytheG20growthstrategyprocesstorequireeachcountrytoincludespecificreformstoimplementtheTFA.Tradeisalreadyacomponentofthegrowthstrategies;however,todateithasbeenoneoftheweakestareas.TheTFAprovidessomethingtangibleforcountriestoaspireto.TheOECD’sTradeFacilitationIndicatorsshouldbeusedtomeasureandreportonthelevelofambitionbeingdisplayedbyindividualcountries.

multilateral cooperation on investment and infrastructure

Whiletradebarriershavetypicallyfallenoverpastdecades,barrierstoforeigndirectinvestmentremainhigh.ThenDirectorGeneraloftheWTO,PascalLamy,callsthisagapininternationalcooperation:

Weseetheabsenceofmultilateralrulesoninvestmentasagapincooperation.Currentbilateralarrangementsarenotasatisfactorysubstituteforacomprehensiveinternationalinvestmentagreement(Lamy2013).

BarrierstoforeigninvestmentareasignificantissueforAustraliaandChina.Foreigninvestmentflowsarefundamentaltothespreadofglobalproductionnetworks,fromwhichAustraliaandChinaaresignificantbeneficiaries.

Asacapital-importingcountrythatreliesonforeignsavingstofinanceinvestmentinfundamentalsectorsofitseconomysuchasmining,resourcesandagriculture,Australiahasastronginterestinensuringthesechannelsremainopen.ForChina,likemanydevelopingcountriesinAsia,muchofitssuccessinparticipatinginglobalvaluechainshascomefrom

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beingabletoattractthenecessaryinvestmenttobuildproductionbases.Since2008,EastAsia,andChinainparticular,attractedthelargestshareofglobalforeigndirectinvestmentbecauseofitshighgrowthrateandlargemarkets(ZhangandWang2014).

Globally,subduedinvestmentremainsastubbornlegacyoftheglobalfinancialcrisis.G20leadersnotedin2014that‘tacklingglobalinvestmentshortfallsiscrucialtoliftinggrowth,jobcreationandproductivity’(G202014).Figure8.9showstotalinvestment(publicandprivate)asapercentageofGDPforadvancedandemergingmarketeconomies.Foradvancedeconomiesinparticular,investmenthasstruggledtoreboundfromitsfallfollowingtheglobalfinancialcrisis.Whileinvestmenthasbeengrowingrapidlyovertimeforemergingmarketeconomies,ithasplateauedsince2009andisnowgrowingatalowerrate.Emergingmarketeconomieshavealsofacedsignificantinvestmentchallengesinrecentyearsasglobalcapitalflowsrespondtomonetarypolicychangesinadvancedeconomies.Improvingdomesticinvestmentclimatesisacriticalelementinaddressingthis.

Addressingtheseglobalinvestmentchallengeshasthreecomponents.Thefirstisdomestic.Improvingdomesticinvestmentandfinancingclimatesisessentialtoensuringthecompetitive,stableandpredictablereturnsnecessaryforattractingprivatesectorinvestment.AustraliaandChinashouldsupporttheG20inthespecialfocusithasgiveninrecentyearsonreformstoimprovedomesticinvestmentenvironments.Theseincludeincreasedpublicinvestmentininfrastructure,regulatoryandinstitutionalreformstoleveragepublic–privatepartnerships,introducingtaxincentivestoraiseinvestmentandenhancingaccesstofinanceforSMEs.

Thesecondcomponentinaddressingtheglobalinvestmentchallengeismultilateral.Therehasbeenanunrelentingmovementtowardstheadoptionofadefactoinvestmentagreementatthegloballevelthroughavarietyofmultilateral,regionalandbilateralinitiatives(Dhar2013).TheseincludeinvestmentmeasuresunderGATT,theWTOAgreementonTrade-RelatedInvestmentMeasures(TRIMs),theOECD’sDeclarationandDecisionsonInternationalInvestmentandMultilateralEnterprises,UNCTAD’sInvestmentPolicyFrameworkforSustainableDevelopment,theG20’sGlobalInfrastructureHub,andregionalinitiativessuchastheEuropeansinglemarket,NAFTA,theASEANInvestmentAreaandtheinvestmentcomponentofRCEP.Theseinitiativeshavedevelopedgoodpracticeguidelinesforforeigninvestment,butthisisinsufficient.Acaseemergesforaneventualmultilateralagreementoninvestmentcoveringtransparencyoninvestmentrulesandinvestorfacilitation,ideallyhousedintheWTO(Baldwin2013).

TheG20standsasthemosteffectiveforumforcontinuingthispush.Ithasalsotakenimportantstepsinregardstotheneedforcollective,multilateralactiononinvestmentthroughitsglobalinfrastructureinitiativeandworkonSMEfinancing.ThenextstepisfortheG20toconsolidatetheworkdonetodateandbeginaholisticdiscussionarounddevelopingamultilateralforeigninvestmentframework.Importantly,theG20’sworkalsoneedstoaddressincreasingfragmentationbetweenregionalagreementsandtheinvestmentmechanismstheyembody,specificallyoninvestor–protection.Theinvestor–protectionmechanismsembodiedinanumberofregionalagreements,particularlytheTPP,aswellasthedifferencesbetweentheseagreements,acttosignificantlyfragmenttheexistingsystem.Consolidatingtheexistingworkonamultilateralforeigninvestmentframeworkneedstohaveaspecificfocusonachievingharmonyacrossthesemechanisms.

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Figure 8.9: investment as a percentage of gDP

10

15

20

25

30

35

1990

19

92

1994

19

96

1998

20

00

2002

20

04

2006

20

08

2010

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12

2014

Advanced economies Emerging market and developing economies

Source:IMFWEO2015,Investment(publicandprivate)asapercentageofGDP.

DespitealltheshortcomingsofthedeadlockedDohaRoundWTOnegotiations,thebestframeworkforsuchaninitiativeisstilltheWTO.NotonlydoesitalreadycontaingeneralprinciplesonMFNstatus,nationaltreatment,generalexceptionsandtherighttoregulate,amongotherkeyelements,butitalsohasthemosteffectivesystemunderinternationallawtosettledisputesbetweenstates.Theshapeofsuchanagreementandwhatflexibilitieswouldbeavailableforspecificcountriesaremattersthathavetobediscussedandsettledduringthenegotiations(Jara2013).

ZhangandWang(2014)haveshownthataforeigninvestmentframeworkcouldbeobtainedbyconsolidatingtheworkdonebytheG20,UNCTADandtheOECD.Butitshouldgofurther,toahigher-levelarrangementthatrealisesanintegratedframeworkbeyondTRIMs.Itisimportantthatasingleagreementatthemultilaterallevelbetheultimategoal.Basiccomponentsshouldincludetransparencyoninvestmentpolicies,rulesandregulations,withaclearidentificationofagenciesresponsibleforissuingrelevantlicenses,permitsandapprovals.Foreigninvestorsshouldalsoberequiredtocommittotransparencyintheirlabourandenvironmentalstandards,andpublicscrutinyoftheirconformance.

Thethirdcomponentforaddressingtheglobalinvestmentchallengerelatesspecificallytoinfrastructureinvestment.AccordingtotheOECD,totalglobalinfrastructureinvestmentrequirementsby2030fortransport,electricitygeneration,transmissionanddistribution,waterandtelecommunicationswillcometoUS$71trillion,orabout3.5percentoftheannualglobalGDPfrom2007to2030(OECD2012).Howeveritiswidelyrecognisedthatpublicinvestment,includingthatfromthemultilateralandnationaldevelopmentbanks,willbeinsufficienttomeettheglobalshortfallininfrastructureinvestment.Greaterprivatesectorinvestmentininfrastructurewillbefundamental.Althoughinvestmentopportunitiesareplentifulacrossdevelopedanddevelopingcountriesalike,investorsarenotfullyseizingthem—oftenduetogapsinthedomesticinvestmentenvironment(OECD2012).

InfrastructureinvestmentisasignificantdomesticpriorityforthegovernmentsofbothAustraliaandChina.Thereareanumberofbenefitstobothcountriesfromsupportingacontinued,andgreater,internationalfocusonthisissue,bothasparticipantsintheglobaleconomyandforcountry-specificreasons.

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ThecommoninterestsbetweenAustraliaandChinaoninfrastructureinvestmentshouldbecapitalisedonwithininternationalforumsandinstitutions.ThefocusofthecollaborationeffortsbetweenAustraliaandChinashouldbeonmaintainingastrongfocusthroughChina’sG20presidencyoninfrastructureinvestment.Asdiscussedearlier,thisisacross-cuttingthemethatiscapableofassistingonmultiplefronts—includinggrowth,macroeconomicpolicycoordination,development,trade,energyandclimatechange.Infrastructureinvestment,particularlythroughtheG20’stwo-in-fivegrowthagenda,hasthecapacitytobridgethegapintheinternationalcommunityontheneedformacroeconomicpolicycooperation.Itprovidesamuch-neededframeworkforsurpluseconomiestoincreasepublicinvestmentandcontributetoglobalaggregatedemandwhiledeficiteconomiesundertakecommensuratestructuralreformtoboostthesupplysideoftheireconomies.

ChinashouldbuildontheeffortsofAustraliaandTurkey,utilisingtheG20growthstrategyandmutualassessmentprocessestodeliverambitiouscommitmentsfromG20membersand,fromTurkey’spresidency,usingtheestimated1percentagepointincreaseintheaggregateG20investment-to-GDPratioasameansfortargetingG20efforts.ThereiscontinuedscopeforgreaterpublicinvestmentfrommanykeyG20countriesaswellasincreasedeffortsacrossthemembershipinimprovingdomesticinvestmentenvironmentsandidentifyinginnovativewaysofcrowdinginprivatefinance.

AustraliaandChinashouldusetheirinfluenceintheG20toachievebettercooperationandsynergiesbetweentheAIIBandNewDevelopmentBankwithexistingmultilateraldevelopmentbanks.ChinahasalreadyoutlinedthisasapriorityintheconceptnoteforitsG20presidency.Thereshouldsimilarlybeanincreasedfocusoncoordinatingfundingbetweenthesedifferentinstitutions,centredonaconcretelistofbankableprojectsthatcouldbedevelopedthroughG20support.TheG20shouldcontinuetosupportanddrivetheeffortswithindevelopmentbankstooptimisetheirresourceswithaneyeonhowbesttoleverageprivate-sectorfinance.

supporting global energy governance reform and action on climate change

Theexistingarchitectureforglobalenergygovernancehasbeendescribedas‘amess,withmanyactors,manypriorities,littlecoherenceandlimitedeffectiveness’(Florini2012).Therearecountlessmultilateral,regionalandbilateralinitiativesrelatingtoenergy.Figure8.10givesasnapshotofjustafewofthemandshowshowAustraliaandChinafitinwiththisbroadframework.

Theneedforglobalenergygovernancereformiswellrecognised,particularlybytheG20,whichhashadaspecialfocusonthisissueinrecentyears.Theglobalenergysectorhasundergone,andcontinuestoundergo,significanttransitions.WorldenergyconsumptionandtradeusedtobedominatedbythedevelopednationsoftheOECD,butnowmajordevelopingnationslikeChina,IndiaandBrazilareamongstthelargestplayers(Hirst2012).Countries,likeChina,whichjustafewyearsagoweremajorenergyexporters,havebecomeenergyimporters.Chinaisnowtheworld’slargestenergyconsumerandtheworld’slargestoilimportingcountry.TheUnitedStates,whichusedtobethelargestoilimporter,hassimilarlymadespectaculartechnicalprogressinoilandgasproductionandisnowheadingtowardsself-sufficiency.

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Globalenergygovernancehasnotkeptupwiththesetransitions(Hirst2015).Itisnowwidelyrecognisedamongpolicymakersandcommentatorsalikethattheglobalenergygovernancearchitectureneedstobereformed.Atpresent,thereisnogenuinelyglobalenergyorganisationthatcanbringthemajorenergyconsumercountriesaroundtotabletoaddressthecoreenergychallengesofsecurity,equity,developmentandtheenvironment(Hirst2015).

Figure 8.10: Australia and China within the global energy governance architecture

China

Australia

IEA

CEM

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IEF

OPEC

United StatesBahrainAzerbaijan

Afghanistan

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Libya

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MauritaniaPhilippines

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Sudan Pakistan

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MoroccoVietnam

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Acronyms:OrganisationofPetroleumExportingCountries(OPEC),InternationalEnergyForum(IEF),InternationalEnergyAgency(IEA),Groupof20(G20),CleanEnergyMinisterial(CEM).Source:Authors’schema

Thefactthatmajoremergingmarketanddevelopingeconomiesareunderrepresentedintheglobalenergygovernancearchitectureisaseriousproblemforseveralreasons.First,itlimitsthescopeforglobalcooperationonenergypolicy,whichiscriticalinaddressingbroaderchallengesarounddevelopment,infrastructure,theenvironmentandclimatechange.

Second,amajorobjectiveofinternationaldiplomacymoregenerallyisinmanagingtheinclusionofthesenewpowersinglobalgovernancesothattheymakepeacefulcontributionstoworldleadership.Thisisespeciallytrueinthefieldofenergy,whichhashistoricallybeenasourceofconflict.

Third,theInternationalEnergyAgency’s(IEA)limitedmembershipunderminesglobalenergysecuritybyweakeningtheIEA’semergencyoilplans.TheseplansrelyonIEAmembersholdingstrategicoilreservesequivalentto90daysofimports.Themorecountriesthatareabsentfromthesearrangementstheweakerthesereservesare.Hirst(2015)hassimilarly

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shownthattheexistinggovernancestructurepreservesthedividebetweendevelopedanddevelopingcountries.TheIEA’srestrictedmembershipresultsinitbeinginsufficientlyengagedontheenergychallengesfacingdevelopingnations,particularlydevelopmentandaccesstoaffordableenergy.Thisleavesabiggapattheheartofitsprocess.

Finally,theexistingfragmentedgovernancearchitecturehasresultedinaseriouslackofcooperationonspecificareasofenergytechnologyandpolicy.Technologycollaborationhasrightlybeenidentifiedasacrucialdimensionofclimatechangemitigationand,asdescribedabove,thishasledtothecreationofanumberofnewcollaborationsinthemostimportantareas.Unfortunately,mainlyduetothelimitedmembershipoftheIEA(andnotwithstandingthefactthattheIEA’stechnologynetworkshavebeenopenedtonon-membersoftheIEA),thesecollaborationshavegenerallynotbeenbuiltontheIEA’snetworksbuthave,tosomeextent,duplicatedthem(Hirst2012).Thereisanobviousneedforbettercoordinationofthesebodiesthroughbroadergovernancereform.

the benefits of governance reform to Australia and china

TheenergysectorplaysavitalroleinboththeAustralianandChineseeconomies.Giventhesignificantextenttowhichthissectorisshapedbyglobalforces,AustraliaandChinahaveastrongcommoninterestinensuringtheyareactivelyparticipatinginglobalenergypolicymakingandinshapingtherules,normsandinstitutionsthatwillgovernthissectorintothefuture.

TheslowdowninglobalcommoditypricesandthedeteriorationinAustralia’stermsoftradeinrecentyearshaveillustratedtheextenttowhichglobalforcesshapetheAustralianeconomythroughitsenergysector.Australiaistheamongtheworld’slargestexportersofLNG,coalanduranium,andAustralia’simportancetoglobalenergymarketswillcontinuetogrow(DepartmentofIndustry2014).

Chinaistheworld’slargestenergyconsumerandhasbeenthekeydriveroftheincreaseinenergyconsumptiongloballyoverthelast10years(EIA2015).In2009,itwentfrombeinganetexportertoanetimporterofcoalforthefirsttimein20years.Itisnowthelargestproducerandconsumerofcoalintheworldandaccountsforalmosthalfoftheworld’scoalconsumption.Chinaissimilarlytheworld’ssecond-largestconsumerandimporterofoilandthefourth-largestconsumerofnaturalgas.

MultipleAustralianprimeministershavenotedthedeficienciesintheexistinggovernancearchitectureandtheneedforreform.PrimeMinisterTurnbullinNovember2015said‘thereformoftheInternationalEnergyAgencyisveryimportant…theIEA’smembershipshouldreflecttherealityoftheenergyproducersandconsumersof2015,notthe1970s’(Turnbull2015).Similarly,forChina,inaspeechinAbuDhabiin2012,thenpremierWenJiabaohighlightedthedeficienciesintheexistingarchitectureandproposedmultilateralcooperationonenergy‘withintheframeworkoftheG20’ChinahassincebeenastrongsupporterandadvocatefortheG20’sworkonreformingglobalenergygovernance(Hirst2012).

Importantly,theUnitedStatesandotherkeycountriesarealsostrongsupportersoftheG20’seffortstoreformtheglobalenergyarchitecture.WhenSecretaryofState,HillaryClintonadvocatedforChineseandIndianmembershipoftheIEA(Hirst2012),andHenryKissinger,thefoundingfatheroftheIEA,hascalledfortheevolutionoftheinstitution,notingthatit‘standsatacriticaljuncture’(Kissinger2009).IntheirNewDelhisummit

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communiqué,theBRICSnationshavesaidthat‘strengtheningrepresentationofemerginganddevelopingcountriesintheinstitutionsofglobalgovernancewillenhancetheireffectiveness’(BRICS2012).

EnsuringsecurityandtheroleofstrategicoilstockpilesaresimilarlyimportantissuesforbothAustraliaandChina,fordifferentreasons.Chinahasbeenbuildingitsoilstocksforsometimenow(Hirst2012).Australia,ontheotherhand,doesnotstockpileoilreserves.Asaresult,AustraliahasbeeninbreachoftheIEATreatyforsometime.ThisgivesAustraliaastrongincentivetoworkwiththeIEAandemergingeconomies,particularlyChina,inhelpingshapetherulesandnormsthatwilloperateintothefuture.

supporting the g20’s progress in reforming global energy governance

WhiletheG20hasmadesignificantprogressontheissueofglobalenergygovernancereform,thereisstillmuchworktobedone.ItisintheinterestsofAustraliaandChinatosupportthisincrementalprocessandtheChineseG20presidencyprovidesauniqueopportunitytodoso.

Althoughtherewassomediscussionofenergytopicsin2012and2013,itwasnotuntil2014,undertheAustralianpresidency,thatenergybecameamajorpartoftheG20’sremit.Hirst(2015)outlinesthreehighlysignificantdevelopmentsfromthe2014G20summit:first,leadersagreedtoworktogethertoachievenine‘G20principlesonenergycollaboration’,includinghavingenergygovernancereflecteconomicreality;second,leadershadG20energyministersmeetin2015andreportonthewayforward;andthird,leadersconsolidatedtheroleoftheG20energysustainabilityworkinggroupasaregularforumforG20seniorofficials.

Itisimportantnowtobuildonthispositivemomentum.ThisshouldfollowthepragmaticapproachthathasbeenadoptedbytheG20,whichfocusesonbuildingandadaptingexistingorganisationsandensuringthattheyworktogethereffectively.HirstsuggeststhatapracticalwaytodothiswouldbetohavetheG20’sEnergySustainabilityWorkingGroupcommissionfromthemaininternationalorganisationstheiranalysesoftherolestheycanplayindeliveringtheprinciplesagreedbytheG20,includinghowtheycancooperatewithotherorganisations,theactionsthattheyareplanningandanygapsthattheysee.

G20energyministerscouldreporttoleadersonprogress,offertheirsuggestionsonhowtoimprovecooperationbetweentheorganisationsandfillgapsinthedeliveryoftheprinciples.TheIEAhasavitalroletoplay,especiallyinhowitrespondstotheG20’scallsto‘makeinternationalenergyinstitutionsmorerepresentativeandinclusive’.TheIEAcouldconsiderfurtherstepstowardscloserrelationswiththeotherpartnercountriesintheAssociationinitiative.

climate change and energy transformation

ChinaandAustraliabothhaveavitalinterestinstrongglobalactiontolimitfutureclimatechange.Bothcountriesareparticularlyexposedtotheexpectedfutureimpactsfromclimatechange,whichwouldbringsignificanteconomicandsocialrisks.TheUNParisAgreementonclimatechangeprovidesasolidbasisfornationallydeterminedyetinternationallyagreed,andtosomeextentcoordinated,actiononclimatechange.

TheParisAgreementsetsoutastronglong-termglobalambitionoflimitingglobalwarmingtolessthantwodegrees,thatwasagreedtobyallcountries.Itputsinplaceasystemofnationallybasedpledgesforemissionstargetsandactions,andamechanismforregularreviewandratchetingupofnationalpledges.BothChinaandAustraliahavebeensupporters

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oftheagreement,andintheirrespectivecapacitiescontributedtothesuccessfulconclusionsofthenegotiationprocess.Bothcountriescanpositionthemselvestomaximisegainsfromsuccessfulglobalactiononclimatechange.

Aspartofthis,thereareopportunitiesforAustraliaandChinatojointlydevelopnewstrategiesforgrowthinbothcountriesbasedonthelow-carbontechnologiesofthefuture.SuchstrategiescouldentailAustraliasupplyingresourcesandenergy,aswellasspecialisedknowledgeservices,andChinautilisingAustralia’sinputstosupportitsindustriesandthenprovidecapitalforinvestmentsinAustralia.Thispatternissimilartowhatisalreadystartingtooccur.However,thenewwavesofeconomicintegrationandgrowthwouldrelyondifferentresourcesandnewtechnologies.

Chinaisstrengtheningitsclimatechangepolicyportfoliowiththeaimofachievinga60to65percentreductionintheemissionsintensityofitseconomy(theratioofcarbondioxideemissionstoGDP)in2030comparedto2005,withapeakincarbondioxideemissionsby2030orearlier.The2020targetisa40to45percentreductioninemissionsintensityrelativeto2005(GovernmentofChina2015).

Chinaisontracktoachieveits2020target,andcanachieveoroutperformthe2030targetifthecurrentpolicyeffortisintensified.Thetargetsrequireanaverageannualreductioninemissionsintensityofaround4percent.Chinahasachievedthisonaverageoverthelast10years,largelybywayofreducingtheenergyintensityofitseconomy(Figure8.11).Thiswasmadepossiblethroughimprovementsinenergyefficiencyandstructuralchange.China’sslowingeconomicgrowthisnowtendingtomakeitmorechallengingtoachievethe4percentannualdecarbonisationrate.However,ifthatratecontinuestobeachievedthenaslowingeconomymeansthatthepeakinemissionswillbeachievedearlier.

Figure 8.11: China’s annual growth in gDP, CO2 emissions, energy and emissions and energy intensity, 2005–2014

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GDP CO2 emissions Energy use Energy intensity of GDP (Energy/GDP)

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%

Source:BP2015(fortotalprimaryenergyuseandCO2);IMF2015a(forGDP).

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Infuture,limitingandthenreducingemissionswillrequiremuchgreaterstructuralchangeinChina’seconomytowardshighervalue-addedactivities;continuedimprovementsinthetechnicalefficiencyofpowergeneration,industry,transportandhousing;andasustainedshiftawayfromcoalasthemainstayofenergysupplytowardsrenewableenergy,nuclearpowerandgas,withremainingcoalusepotentiallyequippedwithcarboncaptureandstoragetechnology(DeepDecarbonizationPathwaysProject2015;Tengetal2014).Thesechangesarealreadyunderwayanditisexpectedthattheycanbesustainedatrelativelyhighannualratesfordecadestocome(JotzoandTeng2014).

Australia’snationalemissionstargetisareductionof26to28percentinemissionslevelsat2030relativeto2005(DepartmentoftheEnvironment2015).Achievingthiswillrequireaturnaroundinemissionstrends.Itistechnologicallypossibletoachievethisandmoreambitioustargets,includingnetzeroemissionsbymid-century(Denisetal2014).Thekeyisasustainedshiftfromcoaltowardsrenewableorotherzero-carbonenergysources,acceleratedimprovementofenergyefficiencyandsequesteringcarbonemissionsontheland,includingthroughforestplantations.

ArecentstudyofAustralia’soptionsforfuturesustainabilityandeconomicgrowth(Hatfield-Doddsetal2015)foundthatAustraliais‘freetochoose’atrajectorythatwillresultinbetterlong-termenvironmentaloutcomesandsustainedeconomicgrowth:thetechnicalopportunitiesarethere,butthenewtechnologiesandactivitieswillbecomewidelyusedonlyifthereisdeliberateandbroad-basedpolicyintervention.

Benefiting from low-carbon growth

Chinahasrecognisedtheopportunitiesfromlow-carbongrowthandhasbeguntograsptheminanumberofareas,ashavesomeWesterncountries.Archetypalexamplesarerenewableenergysystems,whichduringthelastdecadehaveseenmassiveimprovementsintechnologyandcosts,andtheemergingwaveofelectricvehicles.ForChinatoachievethetransitiontoaninnovation-driveneconomywithanenvironmentallysustainabledevelopmenttrajectory,Chinawillneedtoinvestsignificantlyinresearchanddevelopmentandknowledgeindustries(JinandZhang2016).

InAustralia,policydevelopmentandbusinessinvestmentonthewholehasbeenmoredefensivetodate,witharelativelystrongemphasisontraditionalresourceextractingindustries.ToquoteMartinParkinson(2015):

Thiscapacityfortechnologicalleap-frogging,combinedwiththeneedtoaddressglobalandgeographicallyspecificenvironmentalproblems(i.e.climatechangeandairandwaterpollution),liesbehindChina’smassiveinvestmentsinlow-emissionstechnologies.TheUSisalsoinvestingmassivelyinthesetechnologies.Australiaisnot.

ReducingcarbondioxideemissionsgoeshandinhandwithotherChinesepolicyobjectives,includingimprovingairquality,improvingenergysecuritybyshiftingawayfromfossilfuelsandtheemergenceofnewmanufacturingindustriesintheproductionofwindturbinesandsolarpanels,forexample(TengandJotzo2014).

ItislikelythatChinaisalreadypastthepointofpeakconsumptionofcoal,astheproductionofcommoditiessuchassteelandcementisdeclining,theefficiencyofcoalusekeepsimprovingandalternativeenergysourcesaregrowing.China’scoalimportshavefallenandathree-

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yearbanonapprovalsofnewcoalmineshasrecentlybeenputinplace.Therateofemissionsgrowthhassloweddramaticallyinthepasttwoyears,andsomeobserversbelievethat‘peakCO2’couldoccursoonerthanisimpliedinChina’semissionstargets(GreenandStern2015).

ForAustralia,themostsignificanteffectsarerelatedtoexportsofenergyandenergy-intensiveproducts.Alow-carbontransitioninChinaandgloballyposesnear-termdifficultiesforsomeindustries,butalsolonger-termopportunities—potentiallyofverylargemagnitudes—forothers.

Internationalmovestowardslower-carbonenergysystemsmeanlessfavourableconditionsfortheexport-orientedfossilfuelindustry,inparticularforproducersofthermalcoal(asdistinctfromcokingcoalusedforsteelproduction).Globalcoaldemandgrowthhasbeentailingoff,andsteamcoalpriceshavefallen(byaround60percentoverthelastfiveyears)(WorldBank2016).

CoaldemandcontinuestoriseinmanydevelopingcountriesincludingIndia,butthisgrowthcannotlastiftheworldistoachievemeaningfuloutcomesonclimatechange.Eveniftechnologytousecoalwithcarboncaptureandstoragebecametechnologicallymature,thelonger-termoutlookforglobalcoaldemandisweakening.

DemandinChinaandgloballyfornaturalgas,bycontrast,isincreasingandisprojectedtoincreaseforsometimegivenincreasingclimateaction.Gasismuchlowerincarbondioxideemissionsthancoal,andisasuitablebridgefromcoaltoazero-emissionsenergysystem.ItalsoburnsmuchmorecleanlythancoalandisthereforeattractivetoChinaandmanyothercountriesinthebidtoreduceairpollution.Australia’sgasindustryisbenefitingfromstrongglobaldemand.Demandforuranium,whichAustraliaalsoexports,issettoincreaseaswell.

Inthelongertermhowever,Australia’sopportunitiesasanenergyproducerlieinentirelynewindustries.Australiahasverylargetechnicalandeconomicpotentialtobecomean‘energysuperpower’inacarbon-constrainedworld(Garnaut2015).

Australia as a zero-carbon energy supplier to china

Achievingtheglobalgoaltokeeptemperaturerisestowellbelowtwodegreeswouldrequireacompletede-carbonisationoftheworld’senergysystem(IPCC2014).ThepaceanddepthofthistransitionlargelydetermineshowclosetheworldcangettothegoalsetoutintheParisAgreement.

InscenariosrunbytheDeepDecarbonisationPathwaysProject(DDPP2015),adetailednationallygroundedtechnicalstudy,underatwo-degreecompatibletrajectory,electricitybecomesnearlycarbon-freeby2050,withaveragecarbonintensityacross16majorcountriesreducedbyafactorof15belowits2010value.TheChineseDDPPstudyshowsascenariowithdramaticallyreducedemissionsbyshiftingelectricityproductiontoamixofrenewablesourcesandnuclearpowerandbyequippingthemajorityofremainingfossilfuelpowerplantswithcarboncaptureandstorageby2050.

Australiaisinafavourablepositionasalargescaleproducerofrenewableenergy,onaccountofitspracticallyunlimitedaccesstoarangeofdifferentrenewableenergysourcesincludinghighinsolationrates,largeamountsofavailableland,extensivetechnicalexpertiseandbusinessframeworksinenergyindustries,andacomparativelystableregulatoryandinvestmentenvironment.Australiaisthuswellplacedtosupplyalargeshareofitsdomesticenergyusefromrenewableenergysources.

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Agloballow-carboneconomycouldbringnewandlarge-scalecomparativeadvantageforAustralia.First,Australiacouldbeaproducerofenergy-intensivecommoditiesusingzero-emissionselectricity(Denisetal2014).Thiscouldinclude,forexample,aluminium,whichrequireslargeamountsofelectricitytoproduce.GiventhatthemajorityofAustralia’sheavyindustryinstallationsarerelativelyold,thiswouldmeanbuildingupanewstockofindustrialinfrastructure.

Second,Australiacouldbeanexporterofrenewableenergy,producingfuelssuchashydrogenormethanolinAustraliausingrenewableenergyandexportingthesetothedenselypopulatedareasofEastAsia(Drew2015).Producingandshippingsyntheticrenewablefuelswoulddrawonabroadlysimilarengineeringbaseandindustrialstructuresasexistingindustriessuchasnaturalgasproductionandprocessing.

ThepotentialforAustraliaasalargeproducerofzero-carbonenergyisobvious;however,theprospectsforbuildingexportindustriesbasedonthatpotentialrequiremuchfurtherinvestigation.Researchisneededinto:thetechnologicalbasisforproducingexportablerenewableenergyandenergy-intensiveproductsusingrenewableenergy;whetherandtowhatextentAustraliahasacomparativeeconomicadvantageandcostadvantagethatwouldwarrantproductionforexport;towhatextentsuchenergyandenergy-intensiveproductscouldfitinwithChina’sfutureenergyandindustrialsystem;andwhatpolicyandregulatoryframeworkswouldbeneededtofacilitatethedevelopmentofthesetechnologiesandindustries.

Thepotentialbenefitsofarenewables-basedenergyexportindustryforAustraliainadecarbonisedworldeconomyareverylarge,asarethepotentialbenefitstoChinaofhavingasecuresourceofsuchlow-carbonenergyandenergyintensiveproductstosupplementdomesticproduction.

A new agenda for cooperation

AustraliaandChinacanbenefitbybroadeningandextendingthebilateraldialogueandcollaborationonclimatechangemeasuresandthetransitionofenergysystems.

Afirstplankistointensifygovernment-to-governmentcooperationonclimatechangeissues.TheParisAgreementhaspreparedthegroundforanewphaseofinternationalcollaborationsonclimatechange.AustraliaandChina’sobjectivesonclimatechangearecompatibleandcomplementary.Thetwocountriescanbuildonavarietyofforumsfordialogueattheofficialandpoliticallevel,includingtheministerial-levelconsultationsonclimatechangethathavetakenplaceonseveraloccasionsandtheAustralia–ChinaClimateChangeForumsheldattheANUandtheUNSWinrecentyears.

Second,thetwocountriesshouldstrivetofacilitatebusinessandinvestmentrelationshipsintheareasofclimatechangeandlow-carbonenergy.Thismayinvolvereducingremainingregulatoryhurdlestoinvestmentinnewenergytechnologies,especiallyforChineseinvestmentinAustralia.Thetwocountriescanalsostrivetoenhanceknowledgeexchangeatthebusinesslevel.Thereisalsoacriticalopportunitytobetterinvolvethefinancialsectorcooperativelyacrossbothcountriesthrough‘greenfinance’.AspartofabroaderfocusofintegratingfinancialservicesandfinancialflowsbetweenAustraliaandChina(discussedindetailinChapter5)bothcountriesshouldexplorehowcooperationonfinancialproductsandfinancialservicescanbetailoredtoimproveaccesstofinanceforgreenprojects,suchasinvestmentinrenewableenergyandlow-carbontechnologies.

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Third,experiencehasshownthatactivesupportbygovernmentsforresearchinenergytechnologydevelopmentcanbringsubstantialbenefitsinacceleratingtechnologicalchange.Chinahasprovidedsubstantialsupportinmanydifferentformstothedeploymentofrenewableaswellasnuclearenergy,andadvancedenergy-savingtechnologies.InAustralia,therearenewgovernmentinstitutionsthathaveprovedsuccessfulinsupportingthedevelopmentanddeploymentofcleanenergy,especiallytheAustralianRenewableEnergyAgency(ARENA)andtheCleanEnergyFinanceCorporation(CEFC).ThesemodelsmaybeattractiveforChinaalso.Themodelofco-financingcommercialinvestmentsincuttingedgecleanenergyviaagovernment-financedbodyliketheCEFCmayprovesuccessfulinstimulatinginvestmentinnewenergyoptionsintheAsianregion.OptionstolinkthistooperationsoftheAIIBmaybeworthinvestigating.

Finally,collaborationshouldbefosteredbetweenresearchorganisationsanduniversitiesinAustraliaandChina,intheformofjointinitiativesonscientificresearchandengineeringaswellaseconomicandregulatoryframeworks.PromisingmodelsexistsuchastheAustralia–ChinaResearchProgramonClimatePolicy,whichhasbroughttogetherresearchersfromseveralleadingAustralianandChineseuniversitiestoworkonspecificjointresearchprojects.Theprogramhasoperatedatrelativelysmallscale,convenedattheANUandwithparticularsupportatTsinghuaUniversityinChina.Itcouldbereadilyexpandedtocoverabroaderrangeofissuesandawiderrangeofresearchinstitutions,andscaleduptoanationalinitiativeinbothcountries.

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CHAPTER9conclusions

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Conclusions

ChinaandAustraliaarenaturaleconomicpartners.China—already,ononemeasure,thelargestnationaleconomyintheworld—hasreliedonAustraliafortherawmaterialsitrequiredtoindustrialise;Australia,asmallopeneconomydependentontrade,hasoutperformedmostofitsadvancedcountrypeersthanksinnosmallparttoitstradewithChina.AsthenextphaseofChinesedevelopmentproceeds,thereiseveryreasontobelievethatthisrelationshipcanbecomeofevengreaterimportancetoChinaandtoAustralia.ChinaandAustraliaalsoshareaprofoundcommoninterestintheevolutionofinstitutionsofregionalandglobalgovernanceandcooperationtoreflecttherealitiesofthe21stcentury.Inthissense,theChina–Australiarelationshiphas,ifstewardedwithprudenceandforesightbythepublicandprivatesectors,thepotentialtobecomeapowerfulforceforstabilityandprosperitybeyondthebilateralrelationship.

ThereisnoeconomicorgeopoliticalfutureforChina,AustraliaortheworldthatwouldnotbeimprovedbyChina’ssustainedandbalancedeconomicgrowth.AndyetthefuturedirectionofChinesegrowthwillbeverydifferentfromthatoverthepastfourdecades.TheforcesofchangethathavealreadyunleashedawaveofconsumptiongrowthareaffectingtherelationshipwithAustraliaprofoundly.EconomicreformandliberalisationcanintensifytheongoingchangeinthestructureoftheChineseeconomyand,whilethesechangesimplyalessheavyrelianceinAustraliaontheresourcesectorforeconomicgrowth,thereareopportunitiesforgrowthinagriculture,advancedmanufacturing,investment,finance,healthcare,education,tourismandotherservices.Buttheseopportunitieswillnotmaterialiseautomatically;theirbenefitscanonlybebroughttofruitionthroughconcertedreformandactiononbothsides.Itwillrequiresubstantialrepositioningofpolicyandcommercialstrategiesbybothcountriesandthedevelopmentofastillcloserrelationshipbetweenthetwocountries.

Therecenthistoryofthegrowingtiesbetweenthetwocountriesshowsthatthedeterminedpursuitofadeeperrelationshipyieldstangiblebenefits.TheinstitutionsandpolicyframeworksthathaveemergedtoprovidestructurefortherelationshipinrecentyearsprovideastrongstartingpointforthenextphaseoftheChina–Australiapartnership.

AustraliahasembracedChina’sopennessandreformasacriticalfactorinAsianprosperityandstability,andChinahasembracedthepartnershipwithAustraliaasastrategicelementinitsforeigneconomicpolicystrategies.Bothcountrieshaveinvestedheavilyintheirpartnership.Thepath-breakingrecordoftheAustralia–Chinapartnershipinopeningtheresourcetrade,foreigninvestment,regionalcooperationinitiativesandChina’saccessiontotheWTOprovidesalegacyonwhichtobuildnewinternationalstandardsintotheirbilateraltrade,investmentandallotherdealings.Theirhigh-levelComprehensiveStrategicPartnershipandtheChina–AustraliaFreeTradeAgreement(ChAFTA)aremajorinstitutionalassets,embodyingmutualtrustandpracticalcommitment,thatcanbedeployedtomanagechangeoverthedecadesahead.Stillcloserengagementandinstitutionalarrangementsareneededtocapitaliseontheopportunitiesthatthesefoundationspresent.

ChAFTAisablueprintforinitialchange,notanend-pointinthebilateralrelationship.Ajointworkplanforachievingchangewillnotonlydefineprogressinthebilateraltrade,investmentandcommercialrelationshipoverthecomingdecade;itwillalsoprovidethefoundationforAustraliaandChinapushingliberalisationandreformintheAsianregionandsettingoutthepathwaytowardsreformandstrengtheningoftheglobaltradeandeconomicsystems.

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Thescaleandsignificanceofdevelopmentsthatarenowtakingplace—especiallyinChinathroughitsadvancetowardsahigh-incomeeconomyanddeeperfinancialintegrationwiththeworld—recommenddeeperbilateralinstitutionalarrangementsbetweenAustraliaandChina.Thesearrangementswouldbuildonexistingbilateralframeworks,includingintheareasofinvestment,tourism,peoplemovement,scienceandeducationalexchanges,withboldnewbi-nationalinitiatives.Theywillneedtobedirectedatcapturingtheopportunitiesintherelationship,andmanagingtherisksandprocessesthatareaninevitableconsequenceoflarge-scaleeconomicandsocialchange.

Bothcountrieshaveadeepintersectionofinterestsinworkingtogethertostrengthentheestablishedregionaleconomiccooperationarrangements(suchasAPEC,theASEANPlusframeworksandtheEastAsiaSummit)andtosecuretheframeworkofpoliticalconfidenceandsecuritywithinwhicheconomicprosperitycanbeattained.ButtherearegapsinregionalpolicystrategiesthatAustraliaandChinamustnowworkmoreactivelywithregionalpartnerstofill.

TheAustralia–Chinarelationshipisanchoredinglobalinstitutionalandpoliticalarrangements.Australiahasadirectandimportantstake,inpartnershipwithChina,inworkingtoensureChina’ssuccessintheassumptionofitsroleofsharedleadershipinglobaleconomicaffairs.

AustraliaandChinashouldaspiretoabilateralrelationshipofthehighlevelandscopethattheyestablishedduringthefoundationalperiodofeconomictiesinthe1980s,whentheyagreedona‘modelrelationship’forcooperationbetweencountrieswithdifferentsocialsystemsandatdifferenteconomicstagesofdevelopment.TheenormoustransformationofChina’seconomicmodelandtheimpactthatthisishavingontheAustralianeconomycallsfortheelevationandcalibrationoftheirpartnershiptoachievethesegoals.

new model for the relationship

• TheframeworkofanewmodelforeconomiccollaborationrequirestheAustralianandChinesegovernmentstoelevatetheAustralia–Chinarelationshiptoaunique,higherlevel,inaComprehensiveStrategicPartnershipforChange.ThispartnershipshouldpromotechangethroughtheachievementofjointgoalsinthebilateralrelationshipandforgecommonprioritiesandinitiativesonregionalandglobalissuesthroughtheStrategicEconomicDialogueandparallelministerialmechanisms.

• TheAustralianandChinesegovernmentsshouldunderpintheirStrategicEconomicDialoguewithjointpolicytaskforcesandworkinggroupsonpolicyandinstitutionalchangethat:

– developinitiativesonissuesflowingfromthedialoguesandothercommitments;

– workwithstateandprovincialauthoritiesindevelopingtheseinitiatives;

– encourageprogramsofresearchwithinandbeyondgovernmentandhighereducationalinstitutionsonlonger-termaspectsoftherelationship;

– engagewiththebusinesssectorsinbothcountriesinundertakingtheirwork;

– promotejointtrainingandthedevelopmentoflong-termworkingassociationsinkeyareasamongtheofficialsofbothcountries;and

– reflectuponcommunityinterestsandconcernsinbothcountries.

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CHAPtER 9: Conclusions

• Bothgovernmentsshouldwork,inthedecadeahead,todeveloptheirnewpartnershipintoacomprehensivebilateralframeworktreatythatembedsfrequenthigh-levelgovernmentdialogue;institutionalisesandenfoldsofficialbilateralexchangesandtechnicalcooperationprogramsbetweeneconomicandforeignaffairsministries,includingbranchesofthemilitary;poolsapproachesbetweenfederal–stategovernmentsinAustraliaandcentral–provincialgovernmentsinChina;andprovidesforthecomprehensivesettingofstrategicbilateralobjectivesinaforwardagenda.Thereisprecedentformovingtowardsacomprehensivebilateraltreatyinthe1976BasicTreatyofFriendshipandCooperationbetweenAustraliaandJapan.

• Thehigh-levelcapacitiesnecessarytothisengagementshouldbepromotedthroughtheestablishmentbybothgovernmentsofanindependentandwell-resourcedbi-nationalAustralia–China(Ao–Zhong)Commissiontoboostthelevelandrangeofpolitical,scientific,official,businessandcommunityexchangesbetweenthetwocounties.ItsnearestparallelinAustralianexperiencewouldbethetreatyarrangementbetweenAustraliaandtheUnitedStatesthatestablishedtheAustralian–AmericanFulbrightCommission.TheAustralian–AmericanFulbrightCommissionisanindependentbi-nationalnon-profitorganisation,establishedbyatreatybetweentheAustralianandUSgovernments,thatpromoteseducationandculturalexchangebetweenAustraliaandtheUSthroughmanagingabilateralexchangeprogramstudents,researchersandscholars.

Partners for change

Inthenextdecade,theAustralia–Chinarelationshipwillbere-shapedbythelarge-scaletransformationsnowunderwayineacheconomy.InChina,theeconomicstructureisshiftingtowardstheservicessectorandhigh-technologymanufacturing,whileconsumerspendingisbecomingalargerpartoftheeconomyashouseholdincomesrise.

Chinafindsitselfatapointinitseconomictrajectorythathasinsomeothercountriesprovedchallenging.Somemiddle-incomecountries,especiallyinLatinAmerica,haveseenrelativelyweakgrowthratesandproductivitystagnation.Othercountries,likeJapanandthe‘Tiger’economiesofEastAsia,adaptedtheirinstitutionsandpoliciestothechallengesofmiddle-incomestatusandconsequently‘graduated’tohigh-incomestatusrelativelyquickly(KharasandGill2016).China,AustraliaandtheworldatlargewouldallgainimmeasurablyfromChina’srapidprogressionfrommiddle-incometohigh-incomestatus.Butthepaththroughmiddle-incomestatuswillneedtobesupportedbyreformstoliftChinaupthemanufacturingvaluechainandincreaseproductivityacrosstheeconomy(Huang2016).Theseproductivity-enhancingreformswillsupportChina’seffortstomovefromamodelofgrowthcentredonimitatingideasfromadvancedeconomiestowardsamodelofgrowthbasedondomesticinnovation.

Toliftproductivity,asforeshadowedunderthe13thFiveYearPlan,Chinamustimprovetheefficiencyofinvestment,inpartthroughpushingaheadwithfinancialmarketreforms.Greaterprivatesectorinvolvementinanumberofindustriesstilldominatedbystate-ownedenterprises—suchasbanking,utilitiesandtransport—couldunlockproductivitygainsinthesesectors.ForAustralia,therelativedeclineinitsproductivityperformanceoverthepastdecadecanbeaddressedthroughdomestic-ledinitiatives,suchasimprovinglabourmarketregulation,strengtheningandextendingnationalcompetitionpolicy,andfacilitatingtheefficientallocationandmanagementofinvestmentinsocialandphysicalinfrastructure.

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China’stransformationanddeeperfinancialintegrationwiththeworldwillhaveaprofoundimpactontheinternationaleconomy,includingAustralia.

China’slargeandgrowingmiddleclasswilldemandanincreasinglybroadrangeofgoodsandservices,providingvastopportunitiesforexportersinareasfromfinancialservicestofood,whileamoreopencapitalaccountcouldfundamentallyreshapetheglobalinvestmentlandscape.Chinesespendingoneducation,medicalservices,culturalactivitiesandtourismwillgrowsteeply.Overallretailsalesareexpectedtoincreasebytwo-thirdsbetweennowand2020.WhileAustraliabenefitedmorethanmostfromChina’scommodity-intensivegrowthofthelastdecade,Australiawillneedarenewedfocusonproductivityenhancingreformstocapturetheseemergingexportmarketsandmaintainprosperity.ParticularlygiventhesechangesoccurringinChina,Australiamustalsoadjustitspolicystrategiestohelpfacilitateinnovationandsupporttheup-takeofnewproductiontechnologiesandconsumerservices.Increasingcompetitioninshelteredindustrieswillbecrucialindrivingproductivityandinnovation,aswillremainingopentoforeigninvestmentandskills.

• Tosupporttheeconomictransformationunderwayineacheconomywillrequireacontinuingcommitmenttomarketreformstothosepartsoftheeconomythatremainshelteredfromcompetition,overly-regulatedorwherethedegreeofpublicsectorinvolvementisunwarranted.TheAustralia–ChinaComprehensiveStrategicPartnershipforChangeshouldbeshapedandevolveasacloseworkingpartnershipthatadvancesthereformagendasinbothcountriestopromoteeconomictransformation.

• TheinnovationinbilateralarchitecturethatisproposedcanbealignedundertheAustraliangovernment’sNationalInnovationandScienceAgendaandwiththeChinesegovernment’sprioritisationofinnovationinits13thFiveYearPlan.Thiswouldseetheprioritisationofbilateralcooperationinfutureopportunitiessuchasresearchanddevelopment,capitalsourcing,STEMcollaboration,researchcommercialisation,techlandingpads,thedigitaleconomy,andpeople-to-peopleentrepreneurialexchanges.

Transforming trade and investment

AustraliaandChinahaveastrong,establishedtradeandinvestmentrelationship,builtonthedeepcomplementaritybetweentheireconomiesandtheircloseness,whichisinpartalegacyfromthehigh-levelcommitmenttotherelationshiponbothsides.ThatrelationshipisbasedgenerallyontheexchangeofAustralianrawmaterialsforChinesemanufacturedgoods.AustraliawillcontinuetobeakeyandreliablesourceofrawmaterialstoChina,supplyingmorethanhalfofChina’sironoreneedsandamajorproportionofothermineralsandenergyproducts.Resourcesecurityisprovidedthroughthefunctioningofglobalcommoditymarketstowhichbothcountriesarecommitted.

InlessthanthreedecadesthegeographicalorientationoftheChineseeconomyhaschangedfundamentally,frombeingcontinentallyself-containedtobeingthelargestmaritimeeconomyintheworld.Resourcedependencehasgrownascommoditypriceshavefallenandhigh-costdomesticsuppliershavebecomelessattractivesourcesofindustrialinputs.ThisdevelopmenthasnaturallyandsteadilydrawnChinaintothemaritimeeconomy,includingtheconstructionofhugeseafreightcapacities,interestinmaritimesafety,andconcernaboutsecuringinternationalsupplies.Asoneoftheworld’slargestmaritimeresourcesuppliers,Australiafullyreciprocatestheseinterests.

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ThinkingabouttheimplicationsofChina’smaritimeeconomyhaslaggedbehindthepaceofthischange.ThemajoreffortnowunderwayinChinatoredressthisdeficiencywouldbeassistedbycollaborationbetweenAustraliaandChinaregardingtheimplicationsofgrowingresourcedependencyforresourcesecurity;maritimeresourcedevelopmentandprotection;maritimescientificandweatherresearch;andAustralianparticipationintheMaritimeSilkRoadinitiative.

Theshifttowardsconsumption-ledgrowthinChinaisnowforginganeweconomicrelationshipbetweenAustraliaandChinathatrequiresnewstrategiesandinstitutionalarrangementstosupportclosercommercialengagementinawholerangeofnewmerchandiseandservicestradesaswellascloserinvestmentandfinancialmarketties.Energy,agricultureandfoodproductsprovidesignificantopportunitiesbothtodevelopregionalAustraliaandtomeetnewpatternsofdemandbymiddle-incomeChineseconsumers.DevelopmentgoalsinAustraliaprovidenewopportunitiesforupgradingChina’stradestructureandinvestmentinAustralia’seconomicfuture.

Tosupportthecontinuedeconomicadjustmentinbotheconomies,andtohelpbothsidesweatherthechangestakingplaceintheglobaleconomy,itisnecessarytogobeyondamerelytrade-focusedapproachtoacomprehensiveeconomicpartnership.

• ThisrequirestheelevationoftheAustralia–ChinaComprehensiveStrategicPartnershipintoanAustralia–ChinaComprehensiveStrategicPartnershipforChange(seeabove)andcommitmentoverthenextdecadetoputinplaceatreaty-levelcommitmentcoveringbothcountriesmutualinterestsinopenmarkets,resourceandenergysecurity;sustainableagriculturaldevelopmentandfoodsecurity;andreliableaccessforforeigninvestmentinbothcountries.Itshouldalsoacknowledgetheglobalmarketcontextoftheadjustmentsthataretakingplaceinmaterials-basedmanufacturing(suchassteelproduction)andcommoditymarkets(suchasironore).

• ThisPartnershipcanonlybebuiltonmoreextensivetop-levelexchangesbetweenthetwocountries.AustraliaandChinashouldconcludeaformalagreementtosetupanAustralia–China(Ao–Zhong)Commissiontopromotedeeperexchangesbetweenthetwocountriesassoonasispracticable.

• ChAFTAprovidesafoundationforadvancingtheopeningofnewmarketsandthetransformationofthebilateraltraderelationship.Ahigh-leveljointworkingpartyconsistingofrepresentativesfromgovernmentandbusinesscansupporttheworkoftheAustralia–ChinaStrategicEconomicDialogueinadvancingtheimplementationofChAFTAand,beyondChAFTA,thedevelopmentofreliableinvestmentarrangementsandfinancialandservicemarketopeninginitiatives.

• Deliveringreliabletradeinhigh-qualityfoodproductsandinternationallycompetitivetourismandeducationservicesrequiresadeepunderstandingofeachcountry’sconsumers,andatailoredapproachtotradeandinvestmentincountryandmarketknowledge.Bothcountriesshouldsupportprogramsofpublicandcommercialtrainingandengagementatthenationalandlocallevelsthatwillcontributetotheexpansionofnewmarketopportunities.

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• InvestmentflowsfromChinatoAustraliaandfromAustraliatoChinawillplayacriticalroleinthedevelopmentoftheneweconomicrelationship.Bothcountriesshouldcommittoa‘negativelist’approachtoforeigninvestment,inwhichforeigninvestmentiswelcomedexceptinspecificallydesignatedsectorsoftheeconomy.AnewbilateralinvestmentagreementbetweenAustraliaandChinacanbeconcludedaheadofChineseagreementswiththeEuropeanUnionandtheUnitedStates,andcouldserveasthenucleusofbroaderregionalgovernancearrangementsforbilateralinvestmentflows.

• AustraliashouldprovidereliableaccesstoChineseinvestmentthroughstandardisingthethresholdforscreeninginvestmentsacrossallsources,includingthosefromChina,offeringequaltreatmenttomarket-conformingstate-ownedenterpriseinvestments,andmovingfroman‘applicationandreview’toa‘notificationandcompliance’systemundertheForeignInvestmentReviewBoard(FIRB).ChinashouldprovidereliableaccessforAustralianinvestorsbyestablishingmechanismstoensurethat,aftertheirestablishment,AustralianinvestmentsaresubjecttonationaltreatmentaswellasconsistentandequitableregulatorytreatmentintheChinesemarket.

• Thepartnershipmustbeenabledonbothsidesbytheprovisionofsupportingfinancialinfrastructure(includingaccesstoeachother’sfinancialservicesmarkets),theabilitytomakeinvestmentsthatsupportfurthertradeandservicedelivery,andcontinuedandeasierflowofpeoplebetweenthetwocountries.

• Thefreermovementofpeoplebetweenthetwocountriesforcommerce,business,educationandtourismisimportanttodevelopmentoftheoverallrelationship.Thetwocountriesshouldestablishajointtaskforcewhosemandateistoestablishmost-favoured-nationtreatmentinvisaandothermattersaffectingsojournineachcountry,includingtheexpansionofworkingholidayvisasforyoungpeoplebothways,andopportunitiesforAustralianstoaccessloansforstudyintopChineseuniversities.ThisisaclearareaofmutualbenefitandcouldbeanearlyreformsuccessstoryinthenewAustralia–Chinapartnershipforchange.

• CooperationbetweenAustralianstatesandChineseprovinces,sistercitiesandNGOs,andbilateralcommunityorganisationssuchastheAustralia–ChinaYouthAssociation(ACYA),shouldbeincorporatedintonationalpolicydevelopmentthroughtheexpansionandformalisationoftheroleoftheAustralia–ChinaState/ProvincialLeaders’ForumintoanAustralia–ChinaLeaders’Forum,toidentifyfurtherpracticalareasforcooperation,aswellastobuildtheunderstandingandtrustthatisthebasisofatruepartnership.

• Peakbusinessbodiesinbothcountriesshouldbeencouragedtomakeanongoinginputintothedevelopmentoftherelationshipthroughtheestablishmentoftheirownjointworkingpartiesandtaskforcesaswellastheirparticipationinthoseestablishedbybothgovernments.

• Effective,independentresearchandanalysisandthefosteringofthecapacitiestoundertakeitarecriticaltoeffectiveunderstandingoflonger-termdevelopmentsintheeconomicrelationship.TheChinaEconomyProgramshouldbeencouragedtofulfilitsnationalresponsibilityinbuildingeconomicresearchcapacitieswithinstitutionsacrossAustraliaandpromotingresearchcollaborationwithChinesethinktankssothatthereiseffectiveindependentadviceonlonger-termdevelopmentsintherelationshipavailabletobothgovernments.

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• ThecollaborationestablishedbetweentheChinaCenterforInternationalEconomicExchanges(CCIEE)andtheEastAsianBureauofEconomicResearch(EABER)atTheAustralianNationalUniversityandtheirgovernmentandnon-governmentpartnersinbothcountriesthroughthisstudyprovidesanaturalfoundationforcontinuingtheimplementationoftheinitiativesrecommendedhere,especiallythedevelopmentofcloserresearchandofficialrelationshipsbetweenbothcountriesandthecommitmentstosecondmentofofficialstoanongoingprogramofworkoverthecomingyears.

Financial integration

Chinaisatacriticalpointofitseconomictransition,committedtocontinuedfinancialreformandcapitalaccountliberalisationwhilesimultaneouslymanagingassociateddomesticandexternalchallenges.TheextenttowhichChinacansuccessfullyliberaliseitsfinancialsectortobetterchannelcapitaltothemostproductivesectorsofitseconomywilllargelydeterminewhetheritwillstagnateatmiddlelevelsofincomepercapitaorwhetheritcan,likeitsneighboursinNortheastAsia,rapidlyattainhigh-incomestatus.Australia,Chinaandtheworldatlargehaveeveryinterestinthesuccessofthisendeavour.Similarly,capitalaccountliberalisationinChinawillunlockavastpoolofsavingsandunleashfinancialflowsthatwillprofoundlychangethefinancialstructureoftheregionalandglobaleconomies.Handledintelligentlyanddeftly,thischangewillconstituteapowerfulforceforprosperityintheregion.

ThelessonsofthepastthreedecadesofAsianfinancialhistoryarethatfinancialsectorliberalisationandcapitalaccountopeningmustbemanagedwithcarebypolicymakers,withparticularattentionpaidtothecorrectsequenceofreforms.Chinesepolicymakersareawareoftheneedtoproceedwithprudence.Australiaoffersthepossibilityofa‘testingbed’fortheopeningupofChinesefinancetotheoutsideworld.Australia,meanwhile,mustbecarefulnottosquanderthehistoricopportunitiesinherentinthisfundamentalreshapingofthefinancialgeographyoftheregionandtheglobe.SeizingthepotentialbenefitswillrequireactiveengagementonAustralia’spartwithChinaonthelatter’sfinancialopeningratherthanreactivepolicymaking,or,worse,aturntowardsprotectiveeconomicnationalism.

ThesereformprocessesclearlyhaveparticularimplicationsforthefutureoftheAustralia–Chinarelationshipacrossitseconomic,politicalandsocialdimensions.ButifthegovernmentsandprivatesectorsofAustraliaandChinapositionthemselvesstrategically,thesereformsofferaonce-in-a-lifetimeopportunitytodeepentherelationshipinfinancialservicesandfinancialflows,whicharestillnascentcomparedtotherelationshipinmerchandisetrade.

FinancialservicesarethelargestsinglecomponentoftheAustralianeconomy.WithA$6.4trillioninassets,thefourth-largestsuperannuationsystemintheworld,arobustregulatoryframeworkandoneoftheleastrestrictiveindustriesintheregion,Australiahasaclearcomparativeadvantageinexportingfinancialservicesintotheregion.InvestingindeeperlinksandgreaterengagementwithgrowingChinesemarketsoffersanimmenseopportunitytotheAustralianfinancialservicesindustry.ItisaninvestmentinfuturegrowththatwillbekeytosupportingtheAustralianeconomy’stransitiontowardsservicesfollowingtheminingboom.

ForChina,AustraliaofferstheopportunityofatestinggroundforreformsthatwillsupportChina’scontinuedopeningandfinancialintegration,bothregionallyandglobally.AustraliacansupportChinaacrossthemanyreformsitisundertaking,includingexpandingaccess

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toinsurance,promotinginclusivefinance,raisingtheproportionofdirectfinancialintermediation,liberalisinginterestrates,promotingtheinternationalisationoftheRMB,andhelpingstrengthenfinancialandprudentialregulationandtheinstitutionsthatunderpinit.

Butbuildingthisrelationshipwillnothappenonitsown.Itisanambitionthatwillnotbeachievedquickly.Itwillrequiredeterminationandcommitmentfromthehighestpoliticallevelsandwillbemorechallengingthanwasthecaseinbuildingtherelationshipinmerchandisetrade.AustralianandChinesegovernmentsandprivatefirmsshouldstrategicallypositionthemselvesandbuildtheinfrastructurenecessarytofosterthisrelationshipthroughthefollowingmeasures:

• TheAustralianandChinesegovernmentsshouldengagewiththebusinesssectorsofbothcountrieswhiledevelopingaformalprogramonfinancialservices,developmentandreform.ItwouldcomplementtheStrategicEconomicDialogueandengageministers,officials,regulatorsandfirmsinaworkprogramtodeepenbilateralfinancialintegrationthatwouldbefocusedon:

– pilotingtheselectreleaseofregulatoryandlicensingrestrictionsonAustralianfirmsinChinaasaphase-inforregionalliberalisation,throughexpandingthefinancialservicescomponentsofChAFTA;

– developingaregulardialogueandamutualrecognitionframeworkbetweenfinancialregulators,andsupportingthedevelopmentofRMB-denominatedassetsandsecuritieslistingsinAustralia;

– pursuingmutualreformsofmacroprudentialregulationsanddividendimputationschemestoensurethatAustralianandChineseentitiesarebetterabletoengagewithone-anotherintheregion;

– promotingthebilateralandregionalopportunitiesarisingfromfintechanddigitalfinance;and

– commissioningresearchbetweenAustralianandChineseinstitutionsonfinancialservicestradeandcross-borderinvestment.

Therearealsoopportunitiesforpartnershipinregionalfinancialcooperation:

• BothcountriesshouldworktobuildabilateralfinancialinfrastructurefocusintoregionalinitiativessuchasOneBelt,OneRoad,theAsianInfrastructureInvestmentBankandtheAsianDevelopmentBanktoimprovepaymentsystems,creditinformationbureaus,collateralregistriesandfinancialintermediariesandinstitutionsthroughouttheAsiaPacific.

• Chinashouldsignonto,andAustraliaimplement,APEC’sAsiaRegionFundsPassportandbothcountriesshouldadvocateitsgreateruseintheregion.

Framework for capturing opportunities and managing risks

ThereareuntappedopportunitiesintheAustralia–Chinarelationshiptoincreasetwo-waybilateraltrade,investment,financeandcooperationonregionalandglobalissues.Successwillbeimportantforthelong-termeconomicperformanceandsecurityofbothcountries.Therearethreemajortypesofrisksthatneedtobemanagedinrealisingtheopportunities:

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commercialrisks,macroeconomicrisksandsystemdifferencerisks.Commercialrisksaretheprovinceofnormalbusinessstrategies.Macroeconomicrisksarecommontoalleconomicpartnershipsandcanbeavoidedortheircostsmitigatedthroughappropriatepolicysettings,strategiesandinvestinginpolicycapabilities.Systemdifferencerisks—whichareaconsequenceofsovereigntyandarealsonormalinallmajorbilateralrelationships,evenbetweencountriesthathaverelativelysimilarinstitutionalandpoliticalsystems—arestructuralandthereforemorecomplexincharacter.However,therearebilateral,regionalandinternationalinstitutionalframeworksfordealingwiththemanydimensionsofsystemdifferenceriskthatcanbedeployedtoalleviatingthoserisksparticulartotherelationshipbetweenAustralia,Chinaandtheworld.

TheopportunitiesintheAustralia–Chinarelationshipwillbebestachieved,andtherisksbestdealtwith,throughhigh-levelpoliticalleadershipandcommitmenttoinstitutionalarrangementsthatpromotecommonunderstandingsandnormsofbehaviour,andmobilisebi-nationalandplurilateralworkprogramstoadvancepriorityinterestsintherelationship.

AustraliaandChinahaveabilaterallegacyfromthe1980sofa‘modelrelationship’thatwasinitiatedbetweenthetwocountriesasaneffectivemeanstopropeltheirrespectivedomesticreformagendas.ThishistorycanbedrawnuponinforginganewStrategicComprehensivePartnershipforChangethatwouldbothcapturethenewopportunitiesintherelationshipandamelioratetheimpactofsystemdifferencerisks.Thispartnershiprequiresentrenchingacultureofcooperationwithintherelationshipacrossgovernment,businessandbothcommunitiesthroughregularworkingengagements,jointlytargetedpolicyinitiativesandthroughinculcatinginChinaandAustraliaadeepunderstandingoftheothercountry’ssociety,cultureandeconomy,aswellasclosepersonalconnections.High-levelpoliticalcommitmentandaunitingvisionarekeytocommandingtheattentionandfocusingofficialresourcestoaddresssystemrisks,andkeytoprovidingtheconfidenceandleadershipthatencouragesprivateinitiativestoflourish.

• TheAustralia–ChinaComprehensiveStrategicPartnershipforChangewouldprovideanoverarchingframeworkforlong-term,high-levelengagementthatcreatesacultureofcooperationandtrustbetweenthetwocountries’differentsystemsthatadvancestheirrespectiveeconomictransformations.

• TheAustralia–Chinarelationshipshouldbeamodelofhowcountrieswithdifferentsocialsystemsandatdifferentlevelsofeconomicdevelopmentcancollaboratetoenhancedomesticaswellasmutualbilateral,regionalandmultilateralobjectives.

• TheessenceofanupgradedpartnershipwillbeAustraliaandChina’sworkingtogetherinastrategicfashionwithinbilateralcollaborationsthatdeliverspecificobjectivesofcommonpriorityandfocusonsharedambitionsforreformandchange.

• Thetop-levelleadershipsofbothcountriesshouldestablisha‘workinggrouponbilateralreform’thatwillstructurethefuturebilateralpoliticalrelationshiptoachieve:increaseddepthandscopeofpoliticaldialogue;strategicforwardagendasforleaders’meetings;jointworkinggroupsonreformbetweengovernmentagencies;andjointprotocolsforworkingtogetherandmanagingdifferences.

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• ThenewAustralia–China(Ao–Zhong)Commission(seeabove)shouldenablethetwonationalgovernmentstopooltheirresourceswiththosefromprivateandothersourcestonurturetherelationshipthroughcreatinganindependentlygovernedpublicinstitutionforprogramsofexchangeanddevelopmentsponsoredbysubnationalgovernments,corporatebusinesses,academicinstitutions,culturalfoundations,communityorganisationsandindividuals.Theheadsofgovernmentofbothcountrieswillserveasdualpatrons.

• TheCommissionwillfosterhigh-qualityresearchandacademicexchangetoincreasethepoolofAustralia-andChina-literatehumancapitalacrossAustralianandChinesesociety.Thiswillinclude:scientificresearch;thepromotionoflanguageandculturaleducationatalllevels;publicandprivatelysponsoredpostgraduate,postdoctoral,early-careerresearcherandsenioracademicexchanges;andlong-termpartnershipsforinnovationandentrepreneurialcommercialisation.

• TheCommissioncanassisttofosterpolicyexchangestoproducefuturecohortsofpoliticalandgovernmentleadersinbothcountrieswhoarefamiliarwiththepolicymakingdynamicsoftheothercountryandhavedeeppersonalnetworkswiththeirbilateralcounterparts.Deeperpolicylinkageswillbeachievedthroughanintensificationofjointworkonpolicyinitiativesandagreedobjectives,professionalsecondments,researchfellowships,andtrainingforAustralianandChineseofficialsinbothcountries.TheCommissionwillleverageexistingpartnershipsbetweentheAustralianTreasuryandChina’sNationalDevelopmentandReformCommission(NDRC),theReserveBankofAustraliaandthePeople’sBankofChina,betweentheANUandtheCentralPartySchool,andbetweenANZSOGandChina’sOrganisationDepartment,aswellastheNationalParliamentaryFellowshipsProgramproposedbetweentheAustralianParliamentandtheNationalPeople’sCongress.

• TheCommissionwillfosterbusinessandeconomicexchangetopropelstrategiccollaborationoneconomicreformprioritiesthatwillhelpAustraliaandChinatomanagetheirrespectivetransformations.ThiswillbesupportedbytheforwardworkagendafromthisReportonAustraliaandChina’seconomicpolicymakingstructuresandhowAustraliaandChinacanrelateeffectivelytoeachotheracrossgovernment,businessandsociety.

• TheAustralia–ChinaCEORoundtablecanbeupgradedwithasecretariatstructurethatsustainseffectivecollaborationsonenhancingthebusinessrelationship,includingthroughstrategicengagementandtherecommendationoffuturepolicyprograms.

• Theprocessofplanning,launchingandimplementingtheAustralia–China(Ao–Zhong)CommissionandtheComprehensiveStrategicPartnershipforChangewouldlaythegroundworkforAustraliaandChinainthelong-termtoupgradetheir‘model’relationshipintoabilateraltreatyframework.ThistreatyframeworkwouldhelpenshrinetheprinciplesoutlinedinthisReportandprovideanumbrellaforfuturebilateralagreements.Suchaframeworkisagoaltobeworkedtowardsoveraperiodofmanyyears,butthisprocesswillcementpoliticalcommitmenttotherelationship,institutionalisebilateralcooperationandperpetuatebothcountries’economicreformpartnerships.

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Regional initiatives

AustraliaandChinahavebothenjoyedeconomicprosperityasaconsequenceoftheirdomesticeconomicreformsandtheirintegrationintotheinternationalandregionaleconomy.Openness,withinthebroadercontextofamoreintegratedregionaleconomicorder,hasbeenanimportantdimensionoftheireconomicsuccess.TherearelargechangesunderwayinAsiaduetothescaleandpaceofeconomicgrowthandAsia’sgrowthhascreatedamorecomplexandmultipolarregionalandglobalorder.TheexistingregionalinstitutionsandarrangementsinEastAsiaandacrossthePacificwerenotdesignedtodealwithallthechallengesthathavecomewiththechangingstructureofregionalandglobaleconomicpower,andtherearegapsintheirmembershipandissuecoverageofeconomicandpoliticalcooperationinstitutions.

NeitherAustralianorChinawouldhaveprosperedwithouttheconfidenceandstabilityofferedbytheregionalcooperationandgovernanceframeworksthathaveunderpinnedAsiangrowth.Neithercountrywouldbebenefitedweretheseprocessesandinstitutionstofallintodisrepairorirrelevancebecausetheydidnotevolvetorespondtothenewchallengesfacedbytheregion.

• AustraliaandChinashareacommoninterestinworkingtogethertoforgeanewconsensusaroundtheprinciplesthatwillguidefutureAsianregionalcooperation.Tothatend,theyshouldworkwithpartnersinAsiaandthePacifictostrengthenandbetterconnectexistingregionalinstitutionsandarrangements,suchasAPEC,theASEANPlusSixarrangementsandtheEastAsiaSummit,andtoinitiatehigh-levelpoliticaldialogueonimportant,cross-cuttingissuessuchasenergyandenvironmentaltransformationandregionalinfrastructuralfundingandinvestment.

• AustraliaandChinashouldalsoworktomobiliseacoalitiontohelpdefinethepathforwardinmakingtheTrans-PacificPartnership(TPP)andRegionalComprehensiveEconomicPartnership(RCEP)inclusiveandcomplementary,andintransformingtheTPPandRCEPintoaFreeTradeAreaoftheAsiaPacificthatstrengthenstheWTOandtheglobaleconomicsystem(seeGlobalGoalsbelow).

• Asia’sfutureeconomicgrowthandintegrationisincreasinglydependentoninvestmentincriticalinfrastructure,andAustraliaandChinashouldseektocreateacommonframeworkforregionalinfrastructureinvestmentandfundingthatdrawstogetherkeyactorsintheregionincludingAIIB,theADB,theWorldBank,nationaldevelopmentfundinginstitutions,andrecipientregionalgroupingssuchasASEAN.AustraliaandChinacanuseambitiousbilateralinitiativesdevelopedthroughChAFTAasamodeltoadvanceprogressinregionalandglobalarrangements,especiallybydrivingregionalinvestmentandservicessectorliberalisationthroughRCEP.

Bothcountriesshouldcontinuetobuildtheirgrowingbilateralmilitary-to-militaryrelationshipasanimportantsteptowardscreatingeffectiveworkingrelationshipsonsecurityissuesintheregion,andinstrengtheningthefoundationsofpoliticalconfidenceonwhichregionaleconomicprosperitycancontinuetogrow.

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global goals

ThejointinterestsofAustraliaandChinainregionalcooperation,andthepotentialtousethebilateralrelationshiptoprosecutethesesharedinterests,isjustasvalidonthegloballevel.AustraliaandChinabothbenefitfromstrongglobalinstitutions,thatareinclusive,rules-based,andpromoteopenandefficientinternationalmarkets.Manyoftheinstitutionsthatunderpintheinternationaleconomicsystemwerecreatedmanydecadesagoanddonotaccuratelyreflecttherelativesizeandimportanceofmanycountrieswithintheglobaleconomy.

TheG20hasemergedastheworld’sprimaryvehicleforreformingglobalgovernanceandsteeringtheprioritiesoftheinstitutions,forumsandorganisationsthatunderpinit.Itistheonlymajorforumwhereadvancedandemergingeconomies,andtheworld’smajorborrowersandlenders,cooperateonanequalfooting.MaintainingtheG20’sstatusasthe‘globalsteeringcommittee’andthepreeminentforumforeconomiccooperationisinbothAustralia’sandChina’sinterests.WithouttheG20,therewouldbeaparticularriskforAustraliagivenitismuchmorelikelytobeexcludedfromsmallergroupings.ButChinawouldalsobedisadvantagedinasmallerforumdominatedbyadvancedeconomies,withlessinfluenceoverglobalrulesetting.

AustraliaandChinaalsoneedtoensuretheadequacyoftheglobalfinancialsafetynet.Theneedsoftheregionarenotbeingmetbyglobalinstitutions,leadingtogreaterrelianceonmorecostlyandlessefficientregionalandbilateralarrangementsandtheaccumulationofforeignexchangereserves.ThehugepotentialforChinesefinancialsectorreformandcapitalaccountliberalisationtotransformthestructureoftheregion’sfinancialintegrationmeansthatitisimperativethattheglobalsafetynetissufficienttorespondtoinstability.

AustraliaandChinabenefitthemostfromtradeliberalisationwhenitismultilateralratherthanbilateralorplurilateral.AustraliaandChinashouldworktosupportthecohesivenessoftheglobaltradingsystembyencouragingtheG20torefocusonthemultilateraltradingsystemratherthanregionalandbilateralalternatives.

Theglobalgovernancearchitecturefacesadditionalchallengesintermsofitsrepresentativeness,effectivenessandlegitimacy,andneedstobereformed.ThesechallengesimpactonAustralia,ChinaandtheAsiaPacificregioninparticular.Australia,Chinaandtheirpartnerscaneffectincrementalchangeinaddressingtheseissues,andthethreeareassetoutabovedeservespecialpriority:

• AustraliaandChinahavepowerfulinterestsinentrenchingtheG20asthepreeminentforumforglobaleconomicgovernance.TheyshouldactivelyuseandpromotetheG20,ensureitsagendaisinclusiveandtargetedandensurecontinuityacrossG20presidenciesbyprioritisingitsmulti-yeargrowthagendaanddeepeningitsagendaonglobalgovernancereform.

• Inthenearterm,ChinashouldworktobuilduptheanalyticalcapacityoftheASEANPlusThreeMacroeconomicResearchOfficeandstrengtheninstitutionalcollaborationandinformationanddatasharingbetweentheChiangMaiInitiativeMultilateralization,theBRICScurrencyreservepoolandregionaldevelopmentbankswiththeIMF.

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• Withaviewtothelongerterm,AustraliaandChinashouldencourageG20discussionsonthenextstageofIMFquotareform,assumealeadingroleinrenegotiatingbilateralloansbetweenG20countriesandtheIMF,andfocustheG20growthagendaonstrengtheningdomesticmacroeconomicframeworkstoimprovefinancialresilience.

• AustraliaandChinashouldleadagreaterG20focusonthemultilateraltradingsystem.AustraliaandChinashouldinitiateapragmatic,incrementalprocessaroundWTOreformanddefineapathwayforRCEPandregionalarrangementslikeTPPtobothraisethestandardofregionalagreementsandstrengthentheWTO.TheyshouldencouragetheuseoftheG20growthstrategiestoachieveambitiouscommitmentsundertheTradeFacilitationAgreementandencouragetheG20toconsolidateexistingworkprogramstoinitiateastep-by-stepprocesstowardsamultilateralframeworkforinvestment.OtherimportantareasforcollaborationareonglobalenergygovernanceandthereformofthemembershipandstructureoftheInternationalEnergyAgency,developingtheirpartnershipintheglobalresponsetoclimatechangeandpromotingbettercoordinationofglobalfinancingforinfrastructureinvestment.IneachoftheseareasthereisscopeforAustraliaandChinatocollaborateandusetheirparticipationinglobalandregionalforumstosupportandsteerpragmatic,incrementalstepsintheinterestsofbothcountries.

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