Submission to the Inquiry into Diversifying Australia’s Trade and Investment Profile

China is far and away Australia’s biggest export market, and it is growing faster than other markets. But China carries unique risks for Australian businesses.

While the Australian Government should pursue, significant diversification is at best a long-term prospect. Even then, China is likely to remain Australia’s top export market and considerable scope for economic coercion will remain.

The Australian Government (the government) must have other strategies to counter economic coercion. Strengthening world trade rules is one way, but this will take time. In the interim, the government’s best response is to put in place policy settings that demonstrate it will not give in to coercion.

A credible policy to counter coercion will necessarily require the risks of Chinese Communist Party (CCP) coercion to fall on businesses. In response, the government should make sure it is disciplined in its approach to China, open about the risks of doing business with China, and increase support for businesses to expand to other markets.

This is a copy of Mercury’s submission to the Joint Standing Committee on Trade and Investment Growth. The original submission can be found here.

Australian exporters rely heavily on China

This submission will focus on Australian exports to China.

China accounts for 33% of export sales, around 8% of Australia’s GDP. Japan is the next biggest export market (13% of exports), followed by South Korea (6%) and the United States (5%).[1]

Australia’s merchandise exports to China have grown by a compound annual growth rate of 13% since 2009. None of Australia’s top 10 export markets come close to this growth rate. Merchandise exports to Japan, the second biggest market, grew by 4% over this period. Merchandise exports to India were lower in 2019 than in 2009.[2]

Looking forward, exporting to China is one bright spot in an otherwise bleak outlook for the Australian economy. At the end of 2021, the World Bank forecasts China’s GDP to be 8% higher than in 2019. Japan, the US and Europe are forecast to have smaller economies in 2021 than 2019.[3]

China is Australia’s largest export market by far, and its share of Australian exports is only likely to grow.

China presents risks as well as opportunities

The long-anticipated tension between having the same country as Australia’s main economic partner and primary security concern has become a reality. The CCP sees its imports from Australia as leverage. Leverage it is not afraid to use.

The last few years have seen disruptions to Australian exports to China of coal, beef and wine, tariffs on barley and CCP warnings about Australia to Chinese tourists and students.

As the 2020 Defence Strategic Update makes clear (although without expressly naming China), strategic competition with China is increasing.

One of the key factors that shaped Strategic Update is the expanding use of grey-zone activities—measures to coerce countries without provoking conflict. The coercive use of trade and economic levers is one of the grey zone activities the update highlighted.

In the coming years, Australian exports to China are likely to continue to surge, while the bilateral relationship will continue to be difficult. If the CCP is willing to use trade as leverage over Australia, more Australian exports to China means more leverage for the CCP.

Diversification is at best a long-term prospect

There has been much focus on diversifying exports as a way of addressing the risks China poses. But this is problematic.

Diversifying means reducing the proportion of exports to China. Or to look at it another way, increasing the proportion of exports elsewhere.

One way to diversify is to divert exports to other markets.

The problem with this is Australia sells as much to China as its next five biggest export markets combined.

To meaningfully reduce the share of exports to China—from say, from 33% to 25%—Australia would need to find new markets for $36bn in exports. This is about the value of Australian exports to South Korea (third-largest export market) plus Indonesia (12th-largest).

Having said that, it should be possible to identify sectors most at-risk of economic coercion and put in place sectoral strategies that aim to grow other markets. Wine and beef are obvious, while other agricultural commodities, infant formula and vitamins are also likely targets. Such an approach would help, but there would still be plenty of targets for China to attempt coercion.

The other option is for the government to set policies that reduce exports to China.

Not only would the value of exports to Australia’s largest market would decrease, it would also lose an important source of growth to help climb out of recession.

There’s also the possibility the CCP will realise its recent assertiveness has been too costly and moderate its behaviour. If Australia abandons the market, it will take years to rebuild exports.

Then there’s the important people-to-people links from trade.

While exporting to China carries the risk of economic coercion, it’s better to wear that risk than not earn the revenue at all. If the CCP’s actions cause lost revenue in the future, at least Australia has earned it in the interim.

In the long term, it is possible to gradually increase the share of exports to the rest of the world. Over-exposure to China means there are markets where Australia is under-exposed. But accessing these markets would take hard work and a long-term commitment. And even with a diversification strategy in place it’s likely China will remain be Australia’s major export market for the next two decades or more.

Balancing risk and return is critical for Australia’s future

Ultimately, unless there is a complete economic decoupling, the CCP will retain an ability to use trade as leverage over Australia.

The question then becomes how the Australian Government most effectively reduces the risk of economic coercion while maintaining the benefits of the economic relationship with China.

Strengthening world trade rules is one option that should be pursued. But this will be a long term prospect.

In the short term, the most effective way to deter coercion is to not give into it. Coercion through disrupting trade has costs for China as well as Australia. If the CCP knows it can’t coerce the Australian Government, it will be less likely to try.

This is basically the current policy: the government has said it does not conflate trade and other issues. But it has not fully articulated what this policy means for business. The government should more clearly state that a policy of treating trade separately to other policy areas means that it will not give into economic coercion, and it will not impose restrictions on trade with China.

Businesses should know that if the CCP attempts economic coercion, they are on their own. The costs will fall entirely on them. Businesses should also have the certainty of knowing the government will not restrict access to their most important market (except in the most extreme circumstances).

If businesses are bearing the risks, the government should do more to help them

But if businesses are to wear the risks of the CCP’s displeasure with the Australian Government, as a quid pro quo they should expect three things from the government: discipline, openness and support.

First discipline, which cuts in two directions. The government must be highly disciplined in the way it talks about China. Substantive policy disagreement is one thing, but it needs to avoid unnecessary provocation. Discipline also means being (and being seen as) firm in not giving into coercion. The hint of giving in will invite the CCP to further test Australia’s resolve.

Second, openness about the risks of doing business with China.

Businesses need to know about economic coercion when it’s attempted and have a clear understanding of the other the risks of trading with China: from trade disruption to cyber targeting to arbitrary detention. They also need strategic, longer-term assessments to help guide investment decisions.

While ministers have made statements addressing economic coercion, we have not been able to find any other mention on trade portfolio websites. The ‘doing business in China’ sections of the Austrade and DFAT websites do not appear to mention the trade disruptions, nor does EFIC’s ‘world risk development’ publication. As mentioned above, the Defence Strategic Update 2020, which does mention economic coercion, does not link it to China.

If the government feels it cannot speak openly about the risks of doing business in China for fear of upsetting the CCP, it should establish an independent agency that is capable of delivering arms-length assessments (something like the Productivity Commission or Parliamentary Budget Office).

Finally support.

The government has taken some important steps to helping businesses diversify to other markets. This includes the Varghese India Economic Strategy, hosting the ASEAN Summit, working to maintain the WTO and expanding Australia’s FTA network. But these appear to be ad hoc and there is no sign of any coherent strategy.

A strategy would couple these high-level settings with significantly scaled-up services to businesses in target markets. This would involve increased resources for agencies like DFAT, Austrade and Tourism Australia to grow the profile of Australia in-market, and make it easier for businesses to enter those markets. It should also look at working with like-minded countries to leverage emerging technologies to streamline processes and strengthen the rules of the trading system.

Discipline and openness will enable Australia to stand firmer against attempts at economic coercion while support will help diversification in the longer term.

A note on foreign investment and imports

This submission has not considered inwards foreign investment, as there is no clear reason to diversify. The United States (US) and United Kingdom (UK) are Australia’s largest sources of foreign investment. This has been the case for many years and, to date, this has not been a cause for concern.

Since 2001, these two countries have owned, on average, around 26% and 21%[4] of Australia’s foreign investment stock—roughly the same levels they own now.

While the ABS only publishes data going back to 2001, it’s likely these two countries have held similar (if not larger) shares of Australian foreign investment stock for many years.

Imports are not included in the Inquiry’s terms of reference. However, we note that while the overall level and direction of imports does not warrant diversification, there may be some critical imports where Australia depends on a single market.

It is important that the government separately consider which critical supply chains are over-reliant on one market, and how to diversify.



[1] DFAT, Trade in goods and services, https://www.dfat.gov.au/trade/resources/trade-statistics/trade-in-goods-and-services/Pages/trade-in-goods-and-services

[2] ABS, 5368.0 – International Trade in Goods and Services, Australia, May 2020, Table 14a

[3] World Bank, Global Economic Prospects, https://www.worldbank.org/en/publication/global-economic-prospects

[4] 5352.0 – International Investment Position, Australia: Supplementary Statistics, 2019, Table 2

Published by Heath Baker

Principal of Mercury International Consulting

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