Wednesday, February 26, 2020

Is Australia too dumb and too China-dependent?

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Having been labelled ‘dumb’, ‘getting dumber’ and ‘too dependent on China’, it’s been a rough few weeks for Australia’s exports. Luckily, these criticisms are largely misguided. They misunderstand how and why markets produce certain outcomes in an open economy. The remedies proposed are solutions in search of a problem.

Take the ‘dumb and getting dumber’ criticism first. This comes from the Harvard Kennedy School’s Atlas of Economic Complexity. The Atlas ranks Australia 93rd out of 133 countries in the complexity of its exports. And Australia is getting worse on that measure, falling 36 rungs down the ladder since 1995.

Being the eighth-richest economy in the world (in per capita terms), Australia is obviously ‘rich and dumb’ according to commentators panicked by a perceived lack of complexity and innovation in an otherwise wealthy economy.

But the Atlas measures the diversity and complexity of a country’s exports, not its economy. Coal and iron ore — Australia’s two largest exports — account for about a third of its total exports, but the entire mining sector accounts for less than one-tenth of its economy. Australia’s exports might be concentrated, but its economy is much more diverse.

And a few things are conspicuously absent from the Atlas. Most notably, it doesn’t include education, which happens to be Australia’s third-largest export (education is omitted from the Atlas because education is not reported consistently by countries).

But the most substantial problem with the ‘dumb and getting dumber’ criticism is that it misunderstands how trade and markets work in shaping a country’s trade profile. This is a misunderstanding that fuels another common criticism of Australia’s exports: that they are too dependent on China.

It’s true that Australia exports a lot to Chinaabout 38 per cent of its exports. This is far more than to Japan, Australia’s second-largest export destination at around 16 per cent. At roughly AU$144 billion (US$99 billion) a year, exports to China contribute 8 per cent of Australia’s GDP.

Is this a problem? Some fear that these benefits could be at risk if China were to weaponise its trade with Australia as part of a geopolitical dispute, or if the Chinese economy were to suffer a crisis. Luckily, neither is a realistic threat.

As Shiro Armstrong and Peter Drysdale have noted, China has zero strategic interest in weaponising trade against Australia. Yes, Australia is dependent on China, but China is also dependent on Australia. Australia supplies 61 per cent of China’s iron ore, 53 per cent of its coal and 23 per cent of its thermal coal. Australia’s shares in each are increasing.

Others warn that an impending financial or economic crisis in China puts Australian trade at risk. But historically the opposite has been true. Economic shocks in China have often brought increased demand for Australian exports as Chinese authorities seek to stimulate their economy. China is more than capable of managing shocks. In fact, most analyses suggest that Chinese authorities have too much control over their economy, not too little.

At its root, the concern that Australia’s exports are too concentrated — both in what it sells and who its sells it to — reflects a misunderstanding of how and why markets deliver these outcomes in an open economy.

The reason is straightforward. Trade is about specialisation. As with all countries, Australia has limited resources — limited capital, labour, energy and materials — with which to produce things to sell to other countries. Because Australia is a clever country, it produces things that it is good at making and that receive the most money on international markets. This process of specialisation maximises returns and the prosperity of the Australian people. It is a process that is delivered by markets, not governments, and is made possible by free trade.

Some argue that Australia should cut trade with China out of fear that this trade might one day be cut in a geopolitical dispute. This is a bit like becoming so worried your car might be dented in the supermarket car park that you get in first and dent it before anyone else does. It seems strange to bring forward the thing you fear.

Australia trades with China and not with Iceland, for example, because that’s where the money is. Australians could ship coal and iron ore to Iceland, but the shipping costs would be high — and Icelanders probably don’t want Australian coal and iron ore anyway.

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