Commentary on Political Economy

Monday, 31 August 2020

 Here, applied to Australia, is the theoretical analysis that we have advanced for years - notably in our pieces on Friedrich List.

How Australia's big bet on China is going wrong

Adrian Blundell-Wignall

China's trade is managed for geopolitical advantage – and Australia risks becoming a vassal state if it is not careful.

Policy decisions are made with a great deal of uncertainty. A consensus emerges about likely outcomes – let's call them "priors" – and a decision is made. If new facts come to light that contradict our initial expectations, so that the chance of them being realised is reduced, the priors need to be updated. Policy changes are needed as a more informed view emerges.

Sounds sensible enough. But does this describe Western thinking about China?

In the late 1990s, the main prior of global policy makers, economists and businesspeople was that welcoming China into the WTO would bring on prosperity by unleashing a new wave of globalisation; the largest country by population, urbanising and trading with the West. Real wages in cities would rise, imports from the West would accelerate and everyone would gain.

Many of our working assumptions about China turned out to be wrong. Bloomberg

Fast forward to today. China invests and saves 50 per cent of GDP. That requires massive exports to the West at subsidised prices, while imports from countries that China regards as strategic competitors are substituted in favour of those that fit into a global vision with China at the centre. This pattern long pre-dates the 2013 announcement of the Belt and Road Initiative.

The chart below shows the shares of the Five Eyes (the US, UK, Canada, Australia and New Zealand intelligence network) and Japan in Chinese imports versus the BRI countries. The US and Japan, the main strategic competitors of China, have seen a startling decline. Europe holds its own, but mainly because China needs German capital goods. Australia, protected by inelastic demand for its resources, has seen a rise in the past few years. The BRI countries gained strongly.

China's development model is based on funding massive investment intermediated by state-owned banks, Chinese Communist Party presence on company boards and investing in infrastructure in key non-aligned neighbouring countries. The basic goals are security of energy, resources and food supplies; transforming itself into the technology hub for its strategic partners; and pushing lower-value-added manufacturing towards the latter.

The strategy isn't new. President Xi Jinping's BRI announcement has simply brought it more into the open: "We should promote land, maritime, air and cyberspace connectivity, concentrate our efforts on key passageways, cities and projects and connect networks of highways, railways and seaports. The goal of building six major economic corridors under the Belt and Road Initiative has been set, and we should endeavour to meet it.

"We will actively engage in negotiations with countries and regions along the routes of the Belt and Road Initiative on the building of free trade areas.

"We will strengthen international co-operation on energy and resources and production chains, and increase local processing and conversion."

Two world views on how the global economy should work are colliding.

In building its BRI empire, China is doing what it sees as being in the interests of its people. One can't argue against that. But the West must look after its own, too. The China shock has been disastrous for advanced countries with significant basic materials and manufacturing sectors. The hollowing out of jobs for lower-skilled workers and the onset of global deflation forces have been unfolding for decades.

Two world views on how the global economy should work are colliding. The result is a misallocation of global resources; a predictable outcome when finance is subsidised and capital allocation is based on geo-political objectives.

Yet despite evidence that contradicts what was supposed to happen, little has been done to level the playing field.

That priors were not matched by facts should have led to a revision of our thinking. Effective policies to counter the China distortions might have included an explicit focus on state-owned enterprises in trade treaties and foreign investment access; adherence to the Agreement on Government Procurement; contracts that waive sovereign immunity; countervailing duties; and carbon price equalisation taxes.

The role of trade bullying

But the West did not address the fundamental issues because there was no consensus to do so. Consensus gravitated instead towards transforming liquidity support needed in the financial crisis into some sort of permanent quantitative easing to counterbalance the real economy distortions.

The problem is selective thinking. There is an incentive to ignore or dispute facts that you are not responsible for (the global economy, malfeasance), if dealing with them will hurt your local and near-term interests. Businessmen with earnings responsibility and political clout, think tanks and other public opinion influencers become effective weapons against change.


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