A reality check for the China-Australia FTA

The free trade agreement with China is generating real excitement. In the view of one source close to it, “China has sent a powerful signal that it is prepared to open and do business with a developed economy”. Australian industry representatives were reportedly “shocked” at the breadth and depth of Chinese “concessions”. Most Australian commentators -- expert and otherwise -- believe the agreement to be far superior and lucrative to other FTAs we have signed with countries such as the US, Japan and South Korea.

Then there are broader claims. For example, some are saying that China is choosing this FTA to prove to the world that it is prepared to do business with a developed country and is dipping its toe in the water with Australia. Others believe that Chinese President Xi Jinping is using the Australia-China FTA to open up China’s economy and hasten domestic reform by inviting outside competition.

The general consensus is that the FTA is a win for Australia, China, and even the liberal economic global system on the assumption that if China is well on the way to opening up domestic sectors to outsiders.

There is much we should be excited about. Access to sectors within the Chinese services market could well offer enormous opportunities for Australian banks, insurance companies, legal firms and financial planners, especially those seeking to make hay in the potentially lucrative and vastly undeveloped Chinese superannuation sub-sectors.

Architectural and urban planning professionals will have their qualifications recognised in China. Up to 105 education institutions and training providers will be offered concessions to market directly to the Chinese market, an increase from 77 currently. And the news for our beef, wine and diary firms is also good, including for value-adding firms such as those making infant formula. Recent tariffs imposed on Australian coal will also be removed within two years.

Of course, China has won its fair share of concessions as well. For example, tariffs will be phased out on 95 per cent of all Chinese imports within four years. Important Chinese exports such as clothes, footwear, household electronics and cars will be tariff free by 2019. Investment from private Chinese firms will be exempt from Foreign Investment Review Board scrutiny for amounts of up to $1 billion. And Chinese investors will be able to have Chinese workers apply for work permits on a case-by-case basis.

So the excitement is justified. But there are some significant unknowns, and for those who like Spiderman and follow trade issues seriously (a small number of people presumably), their spider senses should be tingling. Something doesn’t seem right.

Take concessions granted to Australian beef producers. Even as this has been done, China recently reaffirmed that they will preserve protective policies put in place to ensure that China is almost totally self-sufficient in beef, as well as pork and poultry. Chinese policy still states that it wants to be a net exporter of meat products (as well as what and rice) by 2025 -- explaining why no concessions were given for Australian rice and wheat farmers. So why would China really want more Australian beef in the domestic market?

One reason is that there is immediate rising demand for beef by Chinese consumers that cannot be met by their domestic farmers. It is the same for other agricultural products such as diary. Remember the powdered milk scandal in 2008 in which six children died from contamination while more than 300,000 other children became sick? The event caused public outrage in the country and two executives from the milk powder company were subsequently executed for their malfeasance. It is the reason why you see Chinese tourists in Coles buying two dozen tins of the Australian or New Zealand made stuff when here on holidays. It is also the reason why the Chinese government is more than happy to lower barriers for Australian milk powder.

So China needs to meet domestic demand for many products through imports; a perfectly sensible approach. But China’s longer term plan is to dramatically increase the domestic productivity of its own farmers and producers by helping its companies purchase foreign expertise and technologies through FDI in countries like Australia or else joint ventures with foreign firms in China and abroad.

This was why a Chinese SOE and the country’s largest food manufacturer and processor, Cofco, was so disappointed to miss out on buying Australian poultry giant Inghams. Cofco was more excited by the prospect of buying over Ingham’s world-class processing know-how rather than acquiring the Australian company for the latter’s profit. The point is that the goal is still self-sufficiency if at all possible and imports are a ‘necessary evil’ to meet the demands of Chinese consumers.

But a letter of intent has been signed by Tony Abbott and Xi Jinping. Even if the Maoist mindset of self-sufficiency is pervasive in contemporary Chinese industrial and economic policy, has Beijing ‘given up the farm’ in some sub-sectors to meet short-term needs by signing this FTA?

Not at all. China has signed many FTAs and other trade agreements. These agreements tend to be manly tariff reduction or elimination agreements such as the one with Australia. Even when there have been agreements slashing or eliminating tariffs, Beijing has frequently resorted to using ad hoc regulatory hurdles to restrict the import of goods if the government believes that China is not ‘winning’ from the agreement; or sometimes this is done for political reasons.

For example, Beijing banned American beef in 2003 (largely at the request of domestic beef producers) after Chinese authorities discovered the existence of mad cow disease that was traced to just one cow in Washington state, and has yet to comprehensively relax the ban. Beijing banned American pork that uses small amounts of growth-inducing chemicals, even as Chinese farmers use the same or similar hormones.

In 2012, China banned the import of Filipino bananas on the basis that scale insects were found in one shipment of bananas from the Philippines. The largest exporter of bananas in the world, China then accounted for one third of all Philippine banana exports and the ban directly threatened the livelihoods of 35,000 growers. The ban also occurred ‘coincidentally’ during a tense stand-off between China and the Philippines over sovereignty of the Scarborough Shoal.

We also know about the increasing use of domestic anti-trust laws passed in 2008 against giants like Microsoft when Beijing has had enough of overseas companies outdoing or even threatening domestic competitors (especially SOEs) in sectors deemed important by the government. There’s the raft of regulatory barriers blocking outsiders from accessing the government procurement market despite trade agreements signed -- significant when one considers that the government procurement sectors are of especial importance in China’s political-economic model.

And then there are licensing requirements and hoops needed for foreign firms to do all manner of things in China. They have felled many a foreign firm. These do not exist just because Beijing wants to be annoyingly bureaucratic. They are there to also ‘regulate’ foreign entry and access.

The point is that Beijing tends to lower tariffs when the domestic market needs particular imports but will use regulatory and other obstacles selectively to achieve its domestic policy priorities of protecting domestic firms when it is needed for the latter to survive and thrive against international competitors -- or when foreign firms threaten to become too dominant. In this sense, China remains only partially committed to free and open trade as a tactical fix to increase the competitiveness of the Chinese economy and Chinese firms. Beijing still wants its firms to ‘win’ in the end, or at least hold their ground.

Finally, one should note that the real prize that China wants out of this FTA is for its SOEs to be exempt from FIRB scrutiny for investments of $1bn or less. The Abbott government has so far held firm on this and a final determination will be negotiated in a future time. China is desperate that this concession be eventually made since it is determined that its SOEs be allowed to invest in leading Australian firms to hasten the technology and know-how transfer that they desperately need.

The dilemma for the Abbott government is that Chinese SOEs (with the support of their government) tend to be somewhat ‘loose’ when it comes to protecting the intellectual property and trade secrets of a foreign firm they have invested in (or with a joint-venture partner in China.) They might not be saying it publicly, but I suspect that Australian government negotiators know this full well, which explains their insistence on not offering the same $1bn threshold to Chinese SOEs at this point in time.

This author is not trying to be a party pooper.There is much to celebrate and we need Chinese capital in Australia as much as we need the Chinese consumer. The FTA is a great win for the Abbott government and opens up real opportunities for Australian firms especially in sub-sectors not designated strategically important for China like architecture and some dairy categories, as well as fruits and vegetables, and of course wine. But we should tone down the commentary about the special economic relationship that we are forming with China, or that China is about to dramatically embrace domestic reform and the global liberal economic order. Beijing knows exactly what it seeks to gain by signing agreements and offering concessions -- and under what circumstances such concessions through other regulations will be drawn back. We should too.

Dr. John Lee is an adjunct associate professor at the University of Sydney, a senior fellow at the Hudson Institute in Washington DC, and a Director of the Kokoda Foundation defence and security think-tank in Canberra.