Wednesday 03 Jun 2020 | 01:05 | SYDNEY
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About the project

Trade wars, populism, and geopolitics. The world is quickly becoming more fraught as complex forces threaten to disrupt and reshape the global economy in profound ways. In this context, the Lowy Institute launched the Global Economic Futures project aimed at better understanding this rapidly changing global economic landscape, where it might take us, and the key choices to be made.

The project examines the future shape of the global economy especially given rising tensions between the world’s two largest economies – the United States and China – and the possible implications for, and changing roles of, major regional economies, including Australia, India, Indonesia and others.

Latest publications

China, the Pacific, and the “debt trap” question

“Debt trap” diplomacy has been a recurrent rallying cry for critics of China’s Belt and Road Initiative (BRI) and its overseas infrastructure lending activities. Over the past two years, this debate has taken centre stage in the Pacific, with China accused of drowning these tiny economies in unsustainable mountains of debt.

In the vortex of geopolitics, however, objective analysis has been missing from the debate. Our latest Lowy Institute report has sought to fill this gap, drawing upon the unique dataset contained in the Lowy Institute Pacific Aid Map and combining it with other data to provide an evidence-based assessment of the impact of Chinese loans on Pacific debt sustainability and the risks posed in the future.

The problem is not that China’s lending is overly skewed towards countries already at risk of debt problems. Rather, it is the sheer scale of lending, combined with inadequate controls to avoid potentially unsustainable loans.

The Pacific is a central part of the global story surrounding China’s BRI. Our research shows that the small and fragile economies of the Pacific are among the most vulnerable to potential debt problems, while several Pacific countries already appear to be among those most heavily indebted to China anywhere in the world.

Nonetheless, our analysis suggests that China’s lending practices in the Pacific have not be so problematic as to justify accusations of debt trap diplomacy – at least not yet.

According to the regular assessments by the International Monetary Fund, debt sustainability risks are indeed rising in the Pacific, but this reflects a confluence of factors and is more closely linked to the region’s high exposure to disasters, rather than excessive Chinese lending.

Nor has China suddenly become the dominant financier in the region and therefore able to exercise significant leverage over Pacific nations. Traditional creditors (i.e., major domestic banks, Japan, the Asian Development Bank, the World Bank) still play a more significant role, especially if much larger amounts of grant aid are also considered. The exception is in Tonga, where China holds over half of public debt. But this has not exactly been an advantageous position – China has twice agreed to deferring repayments, while getting little in return.

China’s lending terms are also hardly predatory. Whereas its overseas lending in many other parts of the world often comes at market rates, China appears to have been much more careful in the Pacific, with the vast majority of its loans having been concessional enough to qualify as aid, according to the standard of the Organisation for Economic Co-operation and Development (OECD).

Perhaps the most important question is whether China has been lending to countries already facing elevated debt risks. Our research found that in 90% of cases, Chinese loans were made in situations where there appeared at the time to be scope to absorb such debt sustainably. That leaves 10% of cases where Chinese loans looked problematic, but in comparison to other official lenders in the region, this figure would not make China a huge outlier.

The problem is not that China’s lending is overly skewed towards countries already at risk of debt problems. Rather, it is the sheer scale of lending, combined with inadequate controls to avoid potentially unsustainable loans.

Hence, looking ahead, we see clear risks. In particular, our analysis shows that, under a business-as-usual scenario, several Pacific countries (most notably Vanuatu, Samoa, and Tonga) would quickly enter risky territory in terms of their overall burden of debt.

Pacific nations are clearly in the driver’s seat in setting their own borrowing policies. Most have frameworks intended to protect overall debt sustainability, operating with varying degrees of effectiveness.

China also has a role to play. Ultimately, China cannot remain a major player in the region through its current model of cheap loans without eventually fulfilling the debt trap accusations of its critics.

To avoid this, China will need to substantially restructure its approach – in particular by adopting clear sustainable lending rules and, ultimately, focusing far more on grant aid rather than loans.

Positively, China has begun taking debt sustainability more seriously, in particular by signing up to G20 principles and guidelines, which include commitments to key global standards for sustainable lending.

But China is still moving in baby steps. For instance, a new debt sustainability framework released earlier this year by China’s finance ministry remains a “non-mandatory policy tool”. It needs to become a mandatory one for China’s Export Import Bank – which leads China’s overseas lending in less developed countries – and linked to clear lending rules aimed at protecting the debt sustainability of borrowing countries.

Adopting such rules is exactly what the Australian government has done with its own new bilateral infrastructure lending facility for the Pacific, giving more confidence that its activities will remain sustainable.

Clear, sustainable lending rules would bring China up to speed with other official sector lenders. It would also give China far more international credibility that it is indeed acting as a responsible global power.

US-China trade talks: No deal yet, but a breakthrough of sorts

It is only a start, but the Friday trade talks agreement between China and the US is still the best news for the world economy in the almost three years since Donald Trump won the presidential contest. This agreement is sufficient to keep the talks going, which last week was in doubt. More importantly, it suggests the US is beginning to develop a more realistic expectation of what it is possible to achieve in this long quarrel, and what not. That is a breakthrough.  

The quarrel is causing significant damage to the US and China, and to the entire global economy.

Even so, Friday’s agreement can barely be considered a deal. After cutting right back on US soybean purchases, China will now buy more. Whether it will buy as much as it bought before the quarrel began nearly two years ago was not immediately clear. In return the US will not this week increase from 25% to 30% the penalty tariff on $250 billion of China imports, though it will leave all the existing penalty tariffs in place. Neither side has yet traded serious bargaining chips. This is a ceasefire, not a deal.

But it does make a deal possible. This “substantial phase one deal”, as Trump described it on the weekend, would involve Chinese concessions on enforcement of intellectual property rights, foreign investment in sectors thus far protected, and a commitment to purchase more US goods and services. China would also agree to understandings on foreign-exchange intervention, most likely similar to the policy it already follows.

In return, the US would presumably wholly or partly phase out the penalty tariffs imposed since the first half of last year. If such an agreement is concluded, it could be ceremoniously announced when Trump and China’s President Xi Jinping meet at the mid-November APEC summit in Chile.

Containers at the port in Shanghai (Photo: Luis Ruiz/Presidencia República Dominicana)

Such a deal is entirely feasible because China has already moved to meet US complaints over intellectual property and investment. The argument is now over enforcement and the methods by which the US hopes to monitor compliance.

The key change in the dynamic of the negotiation is that Trump has begun talking about “phases” rather than an overall deal which would meet the larger and unattainable US objective of a major structural transformation of China’s economy. Since China will not agree to adopting a US view on what structural changes are appropriate for its economy (after four decades of rapid structural change, largely decided by China), a phase one deal may well be the only deal possible. If that realisation has dawned in Washington, the likelihood of ending the current quarrel has much increased.

The stumbling block in this negotiation will now not be intellectual property, or greater opportunities for US investment in China, or rules about foreign-exchange intervention. It will be whether the US is prepared at some point to drop the penalty tariffs it has imposed on China over the last 18 months, in return for an agreement which would include larger China purchases of US exports. There is no value to China in an agreement which leaves the penalty tariffs in place. For its part, the US will be concerned that dropping the penalty tariffs leaves it with no negotiating coin and Trump vulnerable to attack from his Democratic opponent in the presidential contest next year.

It will not be easy, but there is much to impel the two sides to some sort of agreement, including recognition that the quarrel is causing significant damage to the US and China, and to the entire global economy.

Global trade volumes fell by nearly 1% in the 12 months to July, the latest available number. Global industrial production growth slowed to under 1% for the same period, the weakest outcome in four years. Globally, business investment is weaker. The US is not exempt from this global slowdown. After a solid three-year increase, US business investment peaked at the end of last year. With fading growth in industrial production, lower world trade, and deteriorating indicators of manufacturing output, the Organisation for Economic Cooperation and Development and the International Monetary Fund have both been lowering forecasts for global growth. When the IMF releases its World Economic Outlook report on Tuesday, it will show yet another decline in forecast global growth for this year and next.

Not all of this weakness is related to the US-China quarrel, but some is. In the eight months to August, China’s goods exports to the US were down 5% on the same period in 2017, the last year before the US imposed sanctions on China. Over the same period, US goods exports to China were down 13%.

Nor is the US making up elsewhere what it loses in trade with China. The overall US trade deficit with the world was up 7.1% for the eight months to August, compared with the same period last year. US exports have fallen, while imports have increased. Despite an increase in repatriated income from last years’ US tax changes, the overall US current account deficit has deteriorated compared with last year, or the year before.

Sufficiently prolonged and intensified, this deterioration in the US economy will increasingly weigh on Trump in the forthcoming presidential contest.

Economic diplomacy: Auditing globalism, trade woes, ASEAN’s future

Dismal science

Revision season is well underway at the top of the institutions that underpin the globalised economy, those same institutions now in the cross hairs of Prime Minister Scott Morrison’s audit of what Australia gets from globalism.

In the last week, the heads of the World Trade OrganisationWorld Bank, and International Monetary Fund have all downgraded their economic outlooks, setting the scene for a truly dismal annual gathering of the much maligned econocratic elite in Washington next week.

But, given the Prime Minister’s new preoccupation (revealed in his Lowy Institute speech), it may be more interesting to see what those leaders also offered up as successful outcomes from a difficult time for their institutions.

David Malpass, the still relatively new World Bank president, says the arrival of digital payments in less developed countries will transform development economics:

[They] would allow poor people to electronically receive remittances, foreign aid, and social safety-net payments as well as their earnings … That would be revolutionary because it allows people the freedom and opportunity they need to improve their living conditions.

The very new IMF managing director, Kristalina Georgieva, highlighted new agency research which finds that carbon taxes are one of the most powerful and efficient tools for dealing with climate change, making the point that:

Additional revenues could be used to cut taxes elsewhere and fund assistance to millions of affected households. These new resources could also support investments in the clean energy infrastructure that will help the planet heal.

Longstanding WTO director general Robert Azevedo notes that despite all the criticism of his institution, attendance at its annual public forum this week is up 30% on last year to 3200.

The enthusiasm has been reassuring. It means we're asking the right questions – and that we are working together to find answers.

It’s hardly stirring stuff, but count this as the first submission for the defence in Australia’s inquisition of “negative globalism”.

WTO Public Forum 2019 on 9 October (Photo: Jay Louvion/WTO)

Off the graph

If the pointing scoring between China and the US and handwringing by economists about the future of globalism gets a bit repetitive, this chart puts the gloomy trade outlook in a new perspective.

It was published by some IMF economists last month in what they claim as the first attempt to chart global uncertainty about trade.

They make the striking point that uncertainty has risen about tenfold from previous crises in the past 25 years, including the Global Financial Crisis, the Asian Economic Crisis, and the serial failure of the Doha trade liberalisation negotiation.

And they say increases in uncertainty foreshadow significant economic output falls. So, the 2019 first quarter uncertainty spike could be enough to reduce global growth by up to 0.75 percentage point this year. 

RCEP to the rescue

Amid the increasingly bearish tone from his global counterparts, Southeast Asia’s top regional official has doubled down on highly ambitious targets for greater regional integration.

Association of Southeast Asian Nations (ASEAN) secretary general Lim Jock Hoi told a roundtable of regional editors in Bangkok this week that ASEAN was still targeting a doubling of intra-regional trade from the current 23% of total trade by 2025.* This would require trade between the ten member states to increase by around 9% a year, or more than double what it has been growing in recent years. That would certainly be far “beyond business-as-usual,” as Lim characterised the challenge to the roundtable hosted by ASEAN’s think tank the Economic Research Institute for ASEAN and East Asia (ERIA).

There is some nervousness that as the ASEAN chair country Vietnam may become preoccupied with curtailing China’s claims on its own South China Sea territory at the expense of pursuing the RCEP agenda.

However, ASEAN’s own integration measures such as the single customs window are still suffering teething issues despite being officially in place and non-tariff barriers are reportedly on the rise in the notionally near-zero tariff ASEAN Economic Community.

So, getting anywhere near achieving this target may increasingly depend on the successful completion of the 16-member Regional Comprehensive Economic Partnership (RCEP), with ASEAN notionally at its centre.

Trade ministers are back in Bangkok later this week trying to deliver a deal for the Thai-hosted East Asia Summit in early November, with Lim still only prepared to say cautiously that a “conclusion is in sight”. But it seems more likely that while Thailand might get close enough to claim an in-principle deal, the details will still be left for ASEAN’s next chair country, Vietnam, to see through to a signing ceremony next year. Vietnam has been the region’s standout freer trade flagbearer in recent years with a series of bilateral deals and its participation in the revamped Trans-Pacific Partnership.

But, interestingly, there is some nervousness that as the ASEAN chair country Vietnam may become preoccupied with curtailing China’s claims on its own South China Sea territory at the expense of pursuing the RCEP agenda.

Regions rule

Increased regionalisation is the one positive in the latest gloomy assessment of the state of globalisation to come from the financial market economists, who have long thrived on the process.

Capital Economics says globalisation has peaked in this series of assessments, which observes that new technologies have reduced the need for businesses to maintain large and complex supply chains, typically underpinned by liberalised trade regimes.

The Capital economists warn that the risk of “a period of de-globalisation is underappreciated”, but it is not clear how it will unfold.

At one end of the spectrum, we could see a mild form of regionalisation, in which production is clustered in neighbouring countries rather than globalised. At the other end of the spectrum, the world could split into competing blocs.

But they say regionalisation would not be a big problem, given that a lot of trade already takes place between neighbouring countries and regions would probably be big enough to sustain global companies.


 

* Greg Earl was a participant in the ERIA Editors Roundtable.

Economic diplomacy: Tourism power, defining China, and Vietnam jackpot

Paying the piper

Last Thursday as Australia’s Foreign Minister Marise Payne was talking up the role of values in foreign policy to a business audience in Canberra, Indonesia was promoting its tourism investment opportunities to a different business gathering in Sydney.

It will probably never be clear how the intersection of these two different perspectives on international relations played out in President Joko Widodo’s dramatic last-minute intervention on Friday against the proposed changes to his country’s Criminal Code.

And while it is not clear that Widodo’s move to delay the criminalisation of sex outside marriage will prevail in the long term, the demonstrations against the proposed changes this week show the changes were already testing the limits of the country’s increasingly illiberal democracy.

Students rally in Jakarta on 25 September (Photo: Goh Chai Hin/AFP/Getty Images)

But this showdown raises some interesting issues about the role and power of tourism in economic diplomacy, in contrast to the better-known levers – trade and investment regulation.

Only two weeks ago, Asian Development Bank president Takehiko Nakao was visiting Australia talking up the role of tourism in offsetting lost manufacturing jobs right across Asia. The ASEAN+3 Macroeconomic Research Office (AMRO) produced a study earlier in the year making the point that Southeast Asian countries like Indonesia needed to pay more attention to tourism capacity building for the same reason.

This looks like quite creative use of Australia’s one million annual travellers to Bali to make a point about the benefits of mutual economic integration.

It was certainly a key theme of the Indonesian government pitch to Australian investors at the Indonesia-Australia Business Summit last Thursday, with representatives of three eastern Indonesia localities talking up their need for Australian investment in hotels and leisure facilities to serve Australian tourists, and others.

These are some of the putative ten new Balis which Widodo has been touting and which have been a key marketing pitch for the newly signed bilateral trade agreement from his top foreign investment adviser Tom Lembong.

Australia’s change to its travel advice on Indonesia released last Friday, which warned about the impact on tourists of the planned changes to the Criminal Code, was dressed up like a normal update.

But it was anything but that, given that by its own assessment the changes wouldn’t apply for two years. It looks much more like front-footed economic diplomacy in line with Payne’s speech to the Committee for the Economic Development of Australia, which argued that values-based diplomacy is “good for business”.

It is hard to see how Lembong’s quest for an Australian-led high-quality leisure boat tourism boom in eastern Indonesia would gather pace if DFAT was telling people to stay away for fear of being arrested. And the Philippines, Thailand, and Vietnam would quickly fill the void.

So, this looks like quite creative use of Australia’s one million annual travellers to Bali to make a point about the benefits of mutual economic integration, which has been harder to make in other cases such as the beef trade.

A display from the “Contemporary Worlds Indonesia” exhibition (Photo: Timothy Tobing/DFAT)

But having set this precedent, the interesting thing now is when this lever will be used again, especially given how Southeast Asian tourism resorts from Phuket to Cebu usually tolerate plenty of poor behaviour by their Australian customers. They don’t always make good ambassadors for Payne’s Australian values.

And before the hubris about this new economic diplomacy power sets in, it’s worth noting that the Australian tourism dollar is not what it once was. Chinese visitors have been challenging Australians as the top Bali visitors over the past year, and Indians are rising fast. Outbound tourism by Southeast Asians themselves has roughly doubled in the past decade.

These travellers probably don’t like the implications of criminalisation of unmarried sex any more than Australians, but they and their governments are more likely to deal with it in a low-key way.

Category killer

Prime Minister Scott Morrison may not be aware of Nobel Prize–winning economist Simon Kuznet’s idiosyncratic division of countries into four categories: developed, developing, Japan, and Argentina.

But Morrison has certainly reopened a hornet’s nest of debate about how to categorise countries in a disrupted world economy with his definition of China as a “newly developed economy” during his US trip.

For the record, this is a more pointed definition than he used in his June headland foreign policy speech, where he said China had reached a “threshold level of economic maturity”. Although his more general point about the need for China to change its behaviour in the World Trade Organisation (WTO) was quite consistent.

Prime Minister Scott Morrison addresses the UN General Assembly (Photo: Cia Pak/United Nations)

China has played a more productive role in the WTO than peers such as India and South Africa, but in an institution where countries self-define their development status, it has not sufficiently recognised its own rapid economic evolution since it joined two decades ago.

But these definitional dilemmas run rife. A good example is the US Central Intelligence Agency’s own widely quoted World Factbook, which treats China as a developing economy because it aligns with International Monetary Fund definitions. South Korea, Singapore, Mexico, and Turkey have all been subject to debate about how they should be categorised by different institutions at different times. And Russia is not a developed country, despite once being an acknowledged superpower.

China needs to change the way it categorises itself in international institutions, for example, by joining the Organisation for Economic Cooperation and Development aid measurement system, given the significance of its Belt and Road Initiative.

But having a big debate about its appropriate development category is not going to end the global uncertainty over a trade war.

Sweet spot

Vietnam’s status as the biggest winner from the US-China trade tensions has been underlined by Asian Development Bank analysis of how production supply chains have shifted in Asia this year.

While US imports from China fell 12% in the first six months of the year, they rose about 10% from the rest of developing Asia dominated by Vietnam (up 33%), Taiwan (up 20%), and Bangladesh (up 13%). The bank’s economic outlook update says the trade war has escalated a pre-existing shift of upstream production from China to lower-cost sites outside the country.

New foreign direct investment (FDI) in Vietnam from China and Hong Kong rose 200% in the first seven months of the year, while in Thailand FDI applications doubled, led by Japan and China. Meanwhile in Malaysia, approved FDI in manufacturing, mostly from the US, rose more than by 80%.

While this used to be called the “China Plus One” strategy, the ADB argues so much of the offshore investment is from China that ties between China and South East Asian countries, in particular, are only likely to strengthen. It says:

Given that production now occurs mostly along global value chains, the ripple effect of the conflict on global trade is likely much stronger than it would have been two decades ago.

What’s so strategic about baby-food?

The discussion about China’s bid for baby-formula supplier Bellamy’s Organic shows the usual confusion about just what should guide decisions on foreign investment in Australia.

Of course there will be some proposals that are defence-strategic. But baby formula is not one of them. Nor is Bellamy’s an iconic brand like Arnott’s biscuits, where it could be argued that we are selling off a chunk of our culture. Nor is it a dominant supplier of China’s vital raw materials, like Rio-Tinto. There isn’t any obvious intellectual property – no “secret sauce” ­– as there are many producers of similar products.

As China grows and diversifies its assets, its foreign investment in Australia will expand hugely.

Will production shift offshore? Maybe, but it seems that most of the raw materials aren’t produced in Australia anyway, with the milk powder inputs coming mainly from New Zealand and Europe. In any case, milk-powder is just another global commodity. The value-add is not so much in the production process itself, but in the ability to market the branded product to the 15 million babies born in China each year.

Bellamy’s penetration of the Chinese market was greatly aided by the melamine-scandals associated with Chinese-made formula. Since then, Bellamy’s roller-coaster share price has reflected the fluctuating prospects of enlarging its market position in China, against other foreign suppliers. The brand name is now well-established among Chinese mothers and the $1.5 billion bid is a reflection of the value of reputation. But its future value still depends on the whim of China’s byzantine regulatory structure. If the sale is blocked, Bellamy’s might find itself continually thwarted in China’s market. This might be unfair, but not much could be done.

China wants to ensure security of supply, especially for vital foodstuffs and the mess they make (Photo: Lyn Lomasi/Flickr)

The importance of this case comes from the likelihood that this dilemma will come up again and again in future. As China grows and diversifies its assets, its foreign investment in Australia will expand hugely. It will also want to ensure security of supply, especially for vital foodstuffs. The challenge for Australia is to make the most of this inevitability. Join ownership between the two countries might be the ideal: the Australian owners, still in charge of production, acting as guardians of quality and reputation, while the Chinese owners facilitate marketing in China’s commercial environment with its lack of transparency.

There is not much prospect of this kind of join-enterprise model coming out of the current Foreign Investment Review Board (FIRB) processes in Australia. It is difficult to see FIRB finding any good reason to oppose this bid on current criteria, so the case will be decided on whether the current owners see the offer price as a suitable reward for their past efforts and their guess of future prospects.

Perhaps FIRB processes should shift from emphasising the various negative hurdles which foreign bids must clear (e.g. not be a security threat, not be an icon), towards an emphasis on positive aspects which the proposed venture might offer. A proposal might recognise explicitly the long-held concern that Australians might become merely “hewers of wood and drawers of water”, with the interesting jobs and the big value-add going to foreigners. Retaining production in Australia and involving Australians in the development of the marketing in China would be seen as virtues for a proposal. Another positive might be a readiness to pay company tax in Australia, rather than shift the value-add to low-tax jurisdictions through transfer pricing.

This “positive characteristic” approach might be hard to implement and harder to enforce. But at least it addresses the overwhelming non-security issue facing China’s foreign investment in Australia, that China will want a far larger ownership stake in Australian enterprises than we are comfortable with. A deep rethink of FIRB objectives is needed.

Economic diplomacy: Indonesian trade, ADB v BRI and Chinese money

Slow but steady

It has often been said that despite periodic diplomatic upheavals, Australia has been fortunate to have a sprawling multi-ethnic Asian neighbour to its north that has managed to remain largely unified.

But here’s a fresh take on Indonesian stability that puts the recently agreed bilateral trade agreement into an interesting new context: Indonesia now has the world’s most stable economic growth rate.

Its annual economic output growth around 5% has not been generating much excitement in recent years in a region where countries from India to the Philippines have been recording up to 7% and overtaking China.

But this research by the Australian National University’s Paul Burke and Padjadjaran University’s Martin Siyaranamual shows that same lacklustre 5% annual expansion also underpins the world’s most stable growth rate since the beginning of the century. Australia comes second, which means the new trade agreement will be between the world’s two most steadily growing economies.

The research was prepared for ANU’s annual Indonesia Update conference last week and also presented this week at the Lowy Institute. Vietnam, one of Australia’s newer fast-growing trading partners, comes third. India and China, which are ranked 26 and 69, are included in the chart to provide some context.

Burke made the powerful point that predictable, if unspectacular, growth has “helped Indonesia consolidate democracy”.

While Indonesia is sometimes regarded as a one-dimensional commodity-exporting economy (and in that a sense a competitor with Australia), Burke argues that the steady growth reflects a more complex situation. It is less trade-exposed than many peers, actually has a diverse economic base with manufacturing and services as well as commodities, has benefitted from political stability, and has an established record of macroeconomic crisis management and risk mitigation.

It is a moot point whether a bit more volatility (and hopefully higher growth) might be worth it when Indonesia is widely estimated to need annual economic growth above 5% to keep generating sufficient new jobs for its youthful population.

But at a conference which was this year principally focused on the quality of Indonesia’s democracy over the past two decades rather than its economic performance, Burke made the powerful point that predictable, if unspectacular, growth has “helped Indonesia consolidate democracy”.

The Indonesia-Australia Closer Economic Partnership Agreement – still waiting for ratification in both nation’s legislatures – is intended more to increase the current relatively low trade intensity between two close neighbours rather than change the pace of economic growth. But reinforcing Indonesia’s relatively steady economic trajectory (and indeed Australia’s own stability) can only be a positive for the eventual use of the agreement.

Confucius says

Asian Development Bank president Takehiko Nakao provided an interesting insight into the psychology of competition between Asia’s financial institutions this week by revealing he drew on Confucian thought rather than Japanese classics to interpret the world.

But he seemed to resort more to Sun Tzu–style divide-and-conquer tactics when it came to the existential threat his institution faces from China’s two-pronged approach to providing alternate development finance.

In his one public speech during a visit to Australia, Nakao praised the Asian Infrastructure Investment Bank (AIIB) for cooperative and responsible lending while criticising the broader Belt and Road Initiative (BRI) for creating potentially risky debt in surprisingly frank language.

“I am a little bit cautious about the BRI because it is lending too much,” Nakao said in a speech at the Australian National University.

The AIIB is not lending too much and the (excessive) debt issue is more caused by the Export Import Bank of China and the China Development Bank. These are Chinese public finance institutions and are part of the Belt and Road Initiative. The AIIB is not an agency for the BRI.

But while Nakao said he had a productive relationship with the AIIB, he rather dismissively described it as a relatively small institution of only 200 staff mainly focused on “financial modality”. The ADB, by contrast, had more than 3000 staff, lent much more and had a much broader remit in knowledge sharing, concessional finance, and governance. “There is a serious competitive edge for the ADB,” he declared in an insight into the emerging rivalry between the regional institutions.

Asian Development Bank headquarters in Manila, Philippines (Photo: ADB/Flickr)

Nakao also expressed strong frustration at the way China’s leaders persistently expected their country to be treated as a developing country when it was really a “great industrial power”. This was particularly a problem when trying to compare development finance lending because China resisted being included in the accepted Organisation for Economic Cooperation and Development data collection. Nakao said:

The idea that they are still a developing country, a small and not influential country, is not correct. They are already a superpower, equivalent to the United States to some extent.

Nevertheless, while Nakao confirmed he was facing opposition to continued lending to China from amongst his ADB shareholders, he still wanted to continue non-concessional lending in areas such as climate change because China was a significant player in that sector.

Another theme during the visit was the ADB president’s enthusiasm for the tourism industry as a new employment generator everywhere from developed countries such as his own native Japan to the fragile Pacific island economies. He argued this would offset the loss of jobs in other sectors and was a high lending priority for his bank.

Follow the money

Australia’s continuing relative attractiveness for Chinese investment is underlined by a new US study warning of a growing divide between the US and the European Union over how to manage Chinese capital inflows.

The Washington-based Peterson Institute for International Economics analysis says the EU approach to Chinee investment is based on commercial concerns such as competition policy and data protection, rather than security and espionage.

It says this only complicates the dilemma faced by US allies as US actions against the Chinese force them to choose between the two rival countries.

The cost of new technologies in such a scenario is likely to increase as supply chains will have to be replicated and the speed of innovation slows because opportunities for research collaboration no longer exist.

The study contrasts the massive 89% decline in Chinese investment into the US between 2016 and 2018 with the less than the 50% decline in investment into the EU and the general fall in Chinese outward investment of about 55%. Even though Australia has taken a tougher approach to telecommunications company Huawei and critical infrastructure than the Europeans, it has not faced such a sharp fall in Chinese investment.

The KPMG/University of Sydney survey released in April showed Chinese foreign direct investment into Australia had fallen only 47% from the peak year in 2016 to last year.

A light amid the gloom of the US-China trade war

Despite an optimistic bounce in global financial markets Friday, the relentless trade war between the US and China resumed Sunday. Threatened 15% tariffs by the US on another $250 billion of China imports went into effect Sunday morning, as did new China tariffs on US crude oil, soybeans and pharmaceuticals.

More increases are planned. President Donald Trump has announced that existing 25% tariffs on $250 billion of China imports will be increased to 30% on 1 October, and 15% tariffs on the remainder of China exports to the US will be imposed 15 December.

China promises equivalent pain. Already China has dramatically cut back on US imports of soybeans and liquid natural gas. More and precisely targeted reprisals will follow, probably including cars.

The discretion about the contents of the document exercised by both sides suggests this is still a real negotiation, taken seriously by both sides, which may yet result in some sort of agreement.

Talks between the US and China may resume in a week or two, but against a background of ill-will, increasing tension, and the likelihood that the entire goods trade between these two economic giants will be discouraged by punitive tariffs within four months.

As Australia’s Reserve Bank Governor Phil Lowe pointed out at the recent Jackson Hole central banking symposium, the trade war is becoming a serious risk to the global economy. World trade is well down. The CPD World Trade Monitor calculates a decline in global trade volumes of 0.7% in the second quarter of this year, following a smaller fall in the first quarter. The WTO Trade Barometer suggests trade volume growth will remain weak through this third quarter.

Trade between the US and China has led the decline. In the year to June, China’s goods exports to the US were down 13%, and US goods exports to China were down 17%. Along with the decline in trade, there has been an associated decline in world industrial production, and increasing hesitancy in global business investment.

Not all of the slowdown is related to the US China quarrel, but as Lowe and Reserve Bank of New Zealand Governor Adrian Orr argue, the weakness in global investment spending is probably now linked to uncertainty about the global trade outlook. Reflecting on the Jackson Hole discussion, Orr mentioned the “pockets of volatile politics” affecting trade, investment, and growth, and the “ongoing funk” in world business.

Marking positions: US Trade Representative Robert Lighthizer (left) followed by Chinese Vice Premier Liu and US Treasury Secretary Steven Mnuchin for a photo-op during talks in July (Photo by Ng Han Guan/AFP/Getty)

For all the gloom, however, there are still signs that a deal may be possible. Sooner or later pretty much everything leaks in Washington, but not so far the mystery document at the heart of these economic negotiations between China and the US. This is the 150-page paper presented by the chief US negotiator, US Trade Representative Robert Lighthizer, to his Chinese counterpart, Vice Premier Lui He, in Beijing at the end of April.

China’s leadership asked for revisions on the paper, said by the American side to summarise the agreements reached after a year of talks. The US then protested that China was backing out of commitments already made, and the talks broke down. Four months and several rounds of threatened tit-for-tat tariff increases later, the world economy poised precariously on the lip of a serious downturn, the contents of that document remain secret.

It has not yet been confirmed that negotiations will resume in Washington mid-September, though Trump has said they will. What is clear, however, is that the success or failure of negotiations, the risk of a painful slowdown in the global economy arising from the increasingly costly trade war between its two biggest members, depend on what is in that 150 page document, and the nature of the revisions sought by China.

The trade war is becoming a serious risk to the global economy (Photo: Mark Ralston/AFP/Getty Images)

The discretion about the contents of the document exercised by both sides suggests this is still a real negotiation, taken seriously by both sides, which may yet result in some sort of agreement. So, too, does the report, not convincingly repudiated by the White House, that Trump’s 1 August decision to impose additional tariffs on China was opposed by almost all his advisers, including Lighthizer and Treasury Secretary Steven Mnuchin.

While the April paper remains secret, we can presume that it covered intellectual property protections, the removal of some China investment restrictions, increased purchases of US goods by China, and something about industry subsidies – the major elements of the negotiation. To get as far as it did, we may presume it does not contain clauses about the role of the Communist Party or of state-owned enterprises or state planning, all of which would have been ruled out by Lui very early in the discussions. In explaining China’s refusal to accept the document in its then form, China analysts refer not to the substance but to the enforcement provisions, thought belittling and unnecessarily prescriptive.

If a deal cannot be reached in September, it will become progressively more difficult as the US presidential and congressional races preoccupy political attention and limit options. With an increasingly severe commercial assault on leading Chinese technology company Huawei, both the breadth and the depth of the sanctions the US is imposing on China will soon pose more difficult choices for third countries – including Japan, Korea, much of Southeast Asia, and Australia.

A tough trade negotiation between the two giants is one thing. Prolonged economic warfare is quite another.

Economic diplomacy: Exporting education, tapping Vossies, more

Study this

It was only about a decade ago that some economists started declaring that the price of iron ore was the single most important indicator of the outlook for the export reliant Australian economy.

Annual exports of the mineral ($77 billion last financial year) still account for about twice the export revenue of education. But the remarkable baton change in the growth rate for these two key exports in the past five years (flat for iron ore and around 15% a year for education) suggests the current debate about Australia’s exposure to selling education to foreigners is well overdue.

However, finding the right metric for measuring that risk is going to be much harder than watching the iron ore price.

University of Sydney Vice Chancellor Michael Spence made an interesting start in this ABC Radio National interview conceding that his institution had reached peak China with about 25% of its students coming from that country.

University of Queensland Chancellor Peter Varghese, a former diplomat,  seemed to be less settled but more worried speaking at an education conference:

The big question with international students is what is the right proportion of international students at our campuses before we fundamentally change the character of our universities. Is it a third? Is it half? Is it three-quarters? At the end of the day ... we are Australian public institutions and we have a primary obligation to Australian students.

But these sort of figures are already too high according to this report by Centre for Independent Studies fellow Salvatore Babones, which says Australian universities disclose less information about their exposure to foreign students than counterparts in the US and Britain.

“Australia’s universities do not seem to understand the high levels of financial risk inherent in their overreliance on the Chinese market, and they certainly do not make sufficient data available to the public to inform a public debate on these risks,” he argues.

Federal Education Minister Dan Tehan says he is confident universities have risk management plans in place to cope with a sharp shift in student numbers amid a parallel debate about quality standards and foreign influence.

But if actions speak louder than words, it was instructive that University of Melbourne Vice Chancellor Duncan Maskell announced not one, but two, diversification strategies in India and Indonesia in the one overseas trip last week.

Follow the Vossies

Prime Minister Scott Morrison’s Vietnam visit finished with what is now almost a ritual for such exercises: the floating of a bilateral free trade deal and the roll out of a high-profile business figure (in this case Woodside’s Peter Coleman) to talk up the country.

Vietnamese officials have shown a greater comfort with trade liberalisation in recent years than, for example, counterparts in India and Indonesia. So closer trade ties are worth exploring, although Australia already has good links through the ASEAN Australia New Zealand Free Trade Agreement and the revamped Trans-Pacific Partnership.

But amid all the talking up of conventional Australian investment in Vietnam, what was overlooked in Morrison’s comments, the communiqué, and the media coverage was the growing flow of Vietnamese refugees or their children back to Vietnam from Australia.

This is one of the more interesting new economic sinews which Australia has into the Asian region: a relatively new migrant community which is building deep links from Australia back into one of the region’s fastest growing economies.

New migrants generally haven’t played a big role in Australian offshore investment. But amid the endless debate about how Australian business should tap into Asian growth, these so-called “Vossies” are a fascinating development. They may cement a deeper economic relationship with Vietnam than other Asian countries well beyond the boilerplate bilateral visit talk of a new trade deal.

Ungrouped

It says something about the state of globalisation that the near inability of the world’s once-richest countries to produce anything resembling a normal meeting statement is mostly being greeted as a success. It is variously masterful French diplomacy (see Herve Lemahieu here), skilful Donald Trump management or the last bid for relevance by the Group of Seven (G7) countries.

But Citigroup chief economist Catherine Mann has provided the essential background to this dissonance in an examination of the end of globalisation, appropriately released as the G7 leaders convened on Sunday.

While not entirely new, she neatly draws together the indicators which show globalisation peaked around 2008 and suggests this may not in retrospect be surprising given some limits to demand for globalised products and globalised supply chains.

She concludes that the data on trade and financial flows are not sufficient “to either cheer or bemoan globalisation in retreat.”

Cargo ships in the Port of Melbourne (Photo: JosephB/Flickr)

However, she points out that the process of global economic integration reached its peak a decade ago but many of the political and economic problems evident at the G7 summit have only emerged since then. She argues that domestic political management of the consequences of globalisation by education, redistribution, and like policies has been inadequate for a long time and is only now been exposed.

Her solution does provide something of a rallying cry for increasingly directionless gatherings like the G7:

A renewed commitment to globalisation, married with the distributional objectives of domestic policies and business decisions, is needed to revive prospects for workers, firms, and the global economy.

No banana republic here

Amid all this gloom, Reserve Bank of Australia deputy governor Guy Debelle produced some interesting numbers this week that show how much Australia’s economic interaction with the world has changed since former prime minister Paul Keating’s infamous 1986 warning that it was a banana republic in the making.

Take, for example, Australia’s vulnerability to capital withdrawal in the event of a global crisis, something that remains very real for many countries.

Australians have now owned more foreign shares than foreigners have owned Australian equity since 2013, thanks mainly to offshore diversification by the large superannuation funds – which were in large part seeded by Keating as Treasurer.

At the same time, the periodically politically controversial foreign debt is not a risk, according to Debelle, because it is more likely these days to be long-term government debt in $A, rather than bank debt in a foreign currency. He concludes:

The external accounts do not constitute a source of vulnerability and have become increasingly resilient over the past 30 years.

But bringing this all back down to earth, he points out that this has all occurred under the current rules-based globalisation system of which “Australia has clearly been a major beneficiary.”

Economic diplomacy: China dependency and a notable departure

Switch hitting

If Australia’s senior international ministers were surprised by the sharpness of US Secretary of State Mike Pompeo’s approach to economic dependence on China at the recent AUSMIN talks, they should have studied the US trade data the previous day.

A great divergence has opened up between the US trade relationship with China and that of Australia. If current trends continue Australia seems set to end this year being about twice as dependent on China for its two-way trade than on the US.

So far this year, China has fallen from the largest US trading partner to number three behind Mexico and Canada, or put another way from a longstanding 16% of the two-way trade share to 13% as of June.

This shift reflects both the rhetoric and the tariff reality of the US-China trade tensions, but more notably arguably lays the groundwork for even tougher rhetoric about China, as occurred at the AUSMIN talks. However, the move to delay implementing the latest tariffs on a range of products suggests there is at least some rising concern about what the decline means for US supply chains.

US Secretary of State Mike Pompeo and Australia’s Foreign Minister Marise Payne (Photo: US Secretary of Defense/Flickr)

The situation is quite different in Australia. The two-way China trade share has steadily been rising from 21% to 25% over the past five years, and it is picking up further this year. For example, good exports have risen 27% over a year.

And this is more than a story of iron ore, or increasingly students. Australian imports from China have also been growing at a faster rate over the past five years than exports, and faster than imports on average from elsewhere. This underlines the integration of the two economies. The Reserve Bank of Australia has pointed out this integration also extends to lending.

There is no clear correct answer to this China dependency conundrum, although it is particularly confused by the constant mixing of apples and oranges in the data used to make the claims.

As noted here and here, this has led to an emerging new line in strategic analysis that Australia needs to reduce its dependence on China, and this was underlined by an ABC News report last week that cited unnamed intelligence agencies urging this approach to the government.

While it might be more comfortable to be less exposed to China, there are two fundamental problems with implementing this new dependency theory.

The first is that shifting trade based on thousands of businesses buying products at the prices that suit them is not going to happen easily or quickly without heavy-handed intervention such as tariffs. Two-way trade growth over five years with the obvious alternatives the US (4.4%), Japan (2.8%), and Indonesia (1.9%) lags behind China (8.1%). Only India seems to offer some hope at 15.2%.

Second, even China sceptics seem a little at odds over the right approach. While Pompeo seemed to be implying that Australia’s prosperity had been built on China’s unfair trade practices, others (including US Ambassador Arthur Culvahouse here) have taken a different line by arguing that Australia is much more dependent on economic ties to the US than China.

Pompeo had a bet this way as well. He claimed the US invested US$170 billion in Australia “each and every year”, when this is more likely to have been a reference to the US direct investment stock of about $190 billion. Annual investment flow is much lower.

Meanwhile, a new contribution to the dependency debate has emerged with this Australian Financial Review analysis suggesting that China is actually more dependent on Australia when it comes to resources and so would be reluctant to take adverse actions against Australia.

There is no clear correct answer to this China dependency conundrum, although it is particularly confused by the constant mixing of apples and oranges in the data used to make the claims.

Two years ago we published this chart, which sought to place the basic data down in a common format to put the competing claims in some perspective. It seems just as relevant now.

Smorgasbord time

Martin Parkinson, Australia’s departing most senior public servant, is better known for the domestic reforms and controversies during his career leading the Departments of Climate Change, Treasury, and now Prime Minister and Cabinet.

But a little appreciated constant theme through all of these roles and even before has been his sustained involvement in shaping Australia’s approach to economic diplomacy.

So, the points made in his last official speech on this subject to an Asia Society Australia conference last week are worth recording, particularly in this space, when US President Donald Trump is constantly challenging the settled rules in this arm of international relations.

Departing PM&C head Martin Parkinson seems more comfortable with a messier form of rules-based order than many of his bureaucratic counterparts (Photo: QUT Media/Flickr)

Parkinson seems more comfortable with a messier form of rules-based order than many of his bureaucratic counterparts by accepting that failures of global management under the old Bretton Woods institutions has sparked a legitimate demand for new regional institutions, such as an Asian Monetary Fund. He says:

We should expect, and even welcome, this kind of institutional smorgasboard if it means countries in our region stepping forward to ensure collective leadership and collective resilience.

And Parkinson makes little concession to the new US diplomatic boilerplate that China’s rise has been due to rorting the global system. As he sees it:

The economic success of China is surely the single greatest thing to have happened globally over the last three decades and is to be welcomed, not resented.

When regional leaders such as Indonesia’s Joko Widodo still talk up traditional manufacturing as the driving force of their economic policies, Parkinson has quite serious doubts about whether this will actually work. He argues:

New technology may be reducing the development benefits from manufacturing industries. Countries are reaching “peak” industrialisation at levels lower than they were in the past.

And he says whatever happens with a trade deal, the economic rules-based order has already been seriously damaged by the US-China tensions prompting changed supply chains and production arrangements from new sovereign risks which could last for decades.

Despite all this, he says foreign investors ultimately bet on a country’s national character rather than a narrow checklist and on this measure Australia still stacks up very competitively after three decades of national reform debate.

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