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Assessing the Future of the Asia-Pacific - US/Australia Dialogue

31st January 2015  |  Comments  |  Speeches

Charismatic new leaders in the world’s two most populous nations, President Xi of China and Prime Minister Modi of India, are this year pressing ahead with ambitious economic and political reform plans.

President Xi is taking on two of China’s most daunting challenges: re-balancing the world’s second largest economy away from investment and towards consumption , and tackling the corrosive, pervasive corruption that, as the President acknowledges, threatens to undermine the Beijing regime’s legitimacy.

Across the Himalayas, Prime Minister Modi has promised to “cut the red tape and roll out the red carpet” – upending stereotypes of bureaucratic and protectionist India, and striving for a return to growth rates achieved between 2003 and 2011[1]

In Tokyo too, an new/old leader , Shinzo Abe, plans to finally achieve structural reform of his economy’s notoriously inefficient services sector as the third arrow in the Abenomics quiver.

In the past year Australia concluded Free Trade Agreements with South Korea, Japan and China, three of our four top trading partners[2].   Trade Minister Andrew Robb is now shuttling between Canberra and Delhi negotiating a similar agreement with India.

Prime Minister Modi enthusiastically endorsed this goal during his recent visit Australia in which he packed out arenas usually reserved for the likes of Taylor Swift and One Direction.

While Australia has been busy on the bilateral front, we’re also working closely with the United States and other nations to advance the Trans Pacific Partnership, the ambitious twelve-nation regional trade and investment treaty proposed by the US. 

The TPP has grown in importance given the failure to conclude the WTO’s Doha round.

Needless to say, the effectiveness of the TPP will be considerably enhanced by the inclusion of China whose constructive participation in regional elements is a central element in its peaceful rise.

Across the entire Asia-Pacific, cross-border flows of goods, services and capital are not only increasing, but becoming ever more free. That brings complications, specific challenges for our developed economies (which I will outline shortly), and a new role for political leaders in unraveling complexity.

The big picture: emerging Asia’s economic rise

The rebooting of India, economic rebalancing in China, structural reform in Japan, and continued liberalisation of trade and investment.  These are four complex but vitally important issues for the Asia-Pacific.  I’ll speak more about them shortly, particularly free trade.

But first I should note the to note that beyond these immediate events shaping the near-term outlook for the Asia-Pacific lies a much bigger story.  That of course is the great geopolitical transformation of our time – the economic rise of emerging Asia, ex Japan, led by China[3].

Obviously the questions posed by emerging Asia’s rise are pivotal to the future of the Asia-Pacific:

●      How quickly will these economies expand in the next few years, and what reforms are required to rekindle the rapid catch-up growth of the early 21st century? (and by catch-up growth I mean the process by which developing economies converge with the productivity of developed economies)

●      What will the global distribution of economic production look like when the most rapid phase of catch-up growth has run its course in China, India and Indonesia?

●      How will tensions along the way be handled, including those arising from the inevitable translation of enlarged economic resources into enhanced military power?

●      What are the implications for the environment, and for supply and demand for natural resources?

●      And how ready are Western nations and Western-dominated multilateral institutions to adapt to a very different distribution of global power than that which they’ve been used to? 

Whilst I have framed this as the Indian and Chinese economies growing to catch-up with developed nations, we should remember that from antiquity until as late as the mid 19th century, China and India were the two biggest global economies, typically accounting for 40 to 50 per cent of world GDP according to the economic historian Angus Maddison[4].

So while some in the West struggle with the very thought of a future where China and India are two of the world’s three largest economies, the Chinese and Indians are likely to view it as a return to the status quo ante.

Of course decisive shifts in the relative resources controlled by great powers are not always benign transitions. Change produces anxiety, suspicion and all too often conflict, as Thucydides reminded us 2500 years ago.   Historically, increased economic power has been accompanied, after a lag that can range from years to decades, by broadly commensurate increases in diplomatic influence, military capabilities, capacity to develop and combine complex technologies…and in due course in ‘soft’ power – the ability to project (and influence) values and culture.

We shouldn’t expect the rise of Asia’s two largest powers to be any different – and we already see increasingly sophisticated military capabilities in China, including indigenously developed stealth fighters and drones, as well as the means to project military force beyond its immediate neighbourhood.

The speed of Asia’s rise, culture differences between East and West (and the lingering effects of colonialism) could exacerbate the likelihood of conflict.  This transition in global power will be a very different hand-off than from Britain to the US a century or so earlier. 

Some suggest China will in time invoke a latter day Monroe Doctrine asserting its hemispherical primacy as the United States did nearly two hundred years ago. But this analogy is quite inapt. The Western Hemisphere in 1823 consisted of the United States of America, the British colonies in Canada and an assortment of struggling, weak, unstable Latin American colonies which had either just become independent or were seeking to be so. The Western Pacific today on the other hand, apart from China, includes a nuclear power in Russia, the world’s third largest economy in Japan, the world’s fourth most populous nation in Indonesia not to speak of other powerful, rapidly developing powers. The construct of the Western Pacific as a lake in which there are only two players - the US and China - is just dead wrong. 

China has under President Xi both sought to build stronger ties with countries in the region, including Australia, and at the same time firmly restated China’s claim to various islands, reefs and shoals in both the East and South China Seas. 

This maritime muscularity is very different from the approach to various disputed land borders a decade ago, which saw, for example, the settlement of the border between Russia and China.

While Chinese strategic thought is especially sophisticated in its view of contradiction, there seems little doubt that the tough line on the disputed islands and reefs has been quite counter productive. It has served to do no more than remind China’s neighbours of the importance of a strong continuing American presence as a counter balance to China. 

If China’s objective is to reduce America’s military presence and strategic influence in the region it would be resolving all these disputes swiftly and peacefully with a view to reassuring its neighbours that they had nothing to fear as China’s military power comes to match its economic might.

There are some signs that President Xi is rethinking China’s maritime strategy along these lines, but a lot will depend whether and to what extent he can control the various Chinese maritime security actors which have, in the past, been pushing their own agendas[5].  And it will be harder to reassure Asian neighbours about China’s growing military in 2015 than it was in 2009.

2015 is also the seventieth anniversary of the end of World War II and commemoration could stir bitter memories, especially between China and Japan. President Abe will need to show a masterful contrition that tacks elegantly between Chinese, and Korean, grievance on the one hand and Japanese pride on the other. 

Increasing interdependence of the global economy and technology-enabled flows of ideas are countervailing forces to the various tensions I have outlined here and could well reduce the chances of miscalculation, mistake, and conflict.  But they bring with them new challenges for countries like Australia and America. 

Convergence, globalisation and high-wage democracies

These are the most exciting times in human history - the pace and velocity of change and the opportunities so presented are literally without precedent. The technology of connectivity has raced ahead of our own imagination as to how to use it, not to speak of our understanding as to how to govern it. Already most people in the developed world are connected to the Internet 24/7, before long most people everywhere will be and,  increasingly, billions of things too.

At the same time, rising incomes and living standards across many less developed economies (but particularly in emerging Asia) are multiplying the potential market for every commodity, every manufacture, every service, and every technology. Within one to two decades there will be more middle class consumers in Asia than anywhere else. As developing nations catch up with developed, as economies converge and the globe integrates, competition has become truly worldwide. Surf shops in Santa Monica must compete with online sales from Shenzhen factories. Workers must compete too. Highly skilled jobs, highly sophisticated production lines and highly valued intellectual property are no longer the preserve of high-wage developed countries. 

The economist Michael Spence points out that globalisation was long seen as having a benign impact on the distribution of income in advanced nations, but no longer:  “As the developing countries became larger and richer, their economic structures changed in response to the forces of comparative advantage: they moved up the value-added chain. Now, developing countries increasingly produce the kind of high-value-added components that 30 years ago were the exclusive purview of advanced economies. This climb is a permanent, irreversible change.”[6]

Spence’s work suggests that between 1990 and 2008, 97 per cent of the 27 million jobs created in the US were in what he categorises as the non-traded sector, 40 percent of them for example in government and health care.  In the stagnant traded sectors, increased opportunities at the top of the value chain for highly-paid and highly-skilled workers – engineers in Cupertino or creatives in Westside Los Angeles – are offset by much larger decreases in routine jobs, as these functions relocate to emerging markets[7]

While US firms in sectors such as finance or technology generate more value-added than ever, most is from complex tasks such as management, design and engineering.  This literally rings true –it’s written on the smart phones many of you are carrying: “Designed in California, assembled in China.” 

Meanwhile improved communications and information technology are exposing previously protected sectors in most advanced economies to competition: not just call centres or low-level software, but semi-professional and professional services – the likes of financial analysis and accounting, editing and sub-editing, technology and business process consulting, graphic design and video special effects[8].

How should governments in high-wage high-cost countries respond?

Let me preface this discussion by noting it is wrong to ascribe all or most of difficulty that most of the advanced democracies currently face making fiscal ends meet and achieving structural reform to increased competition from emerging economies.  On the contrary these problems are in large part of our own making. 

But realistic governments in advanced economies can’t be blind to the impact of convergence, technological catch-up, and growing competition across a range of sectors from the skilled, productive workforces and sophisticated, innovative producers we see in emerging Asia and elsewhere.  Every year the list of trade-exposed sectors gets longer. These forces are exacerbating the fiscal and demographic problems democracies already face with their high incomes, high costs, high tax burdens, high levels of regulatory intervention, and generous social welfare programs. So too in many cases, unrealistically high expectations among voters and politicians alike as to the sustainability of the status quo.  Many of the policies and premises of the past are already unsustainable. 

So amidst a all this, how do countries like Australia and the US maintain our wage levels, our social safety nets, our first world economies?

Answers are easy to describe, hard to execute.

Arguably the first challenge is to get the message out there – watchfully monitoring and carefully, clearly explaining that the emerging challenges posed by globalization, convergence, and rapid technological change are all forces that are not going to go away or able to be somehow resisted. 

Governments therefore must remain relentlessly focused on the challenge of maintaining economic prosperity and competitiveness.  It means acknowledging if popular programs are unsustainable or undermine these economic objectives. Many would add it means taking unpopular decisions, I would rephrase that by saying it means taking decisions which may not be popular but will be accepted because the public understands why they have to be taken. 

Leaders must be decision makers, but they must also be, above all, explainers and advocates, unravelling complex issues in clear language that explains why things have to change and why the Government cannot solve every problem. 

As many mid level manufacturing and administrative jobs have been competed away - whether by other nations or new technologies - we have seen slower growth in middle class income, most notably here in the United States. 

It is vitally important, both as a matter of social justice and political reality, that structural changes are seen as being fair across the board. That means not only must tough decisions be justified, but that the burden of adjustment is not borne disproportionately by one part of the community. They key to this is not simple wealth redistribution (as many on the Left would assert) but rather ensuring that good jobs are available to as many as can work. As our former Prime Minister John Howard used to say "the best form of social welfare is a job." 

To prosper, with full employment,  in the new world individuals and companies alike need to be smarter, more adaptable, more competitive, more productive, more innovative and more technologically sophisticated.  That challenge is well understood by Californians, whose technological imagination has in large part created the modern world.

But governments can’t bestow these qualities on individuals or companies, any more than they can magically wave new job-creating industries into being or vanquish the competition emerging in so many sectors from so many sources. 

What they can do is invest effectively in enablers of a sophisticated, adaptable economy – in beneficial areas such as skills and training, education, research and economically justified infrastructure.   

In the crucial area of education and research, encouragement for excellence is important – but perhaps even more important is ensuring less able students gain the strongest possible skills and grounding, given they are most vulnerable to being left behind by the economic shifts underway. 

Australian schools and universities should be matching the performance of the world’s leading systems – yet according to one widely used measure, the OECD’s PISA study of comparative performance in secondary schooling, it is our failures in teaching the least capable, least advantaged students in our community that force us to settle for the mediocrity of middle of the pack, where the same measure also places the US.

 In the US, of course, any weaknesses in secondary education are overshadowed by the world’s strongest and most flexible and market-driven universities and colleges, which are a crucial catalyst for the most innovative parts of the US economy. 

The Australian government is currently proposing reforms to give Australia’s universities similar flexibility and scope for specialization. 

Those opposed to these reforms decline even to acknowledge the role that successful, diverse, market-driven universities with strong links to industry play in the US and a few other countries in driving technological advances, originating intellectual property that can be commercialised and taken to market, and generating startup ventures.   

When we look at the role played in the Californian (and US) economies by the likes of Stanford, Berkeley and CalTech, it is hard to believe these reforms are being so strenuously resisted.

What else can governments do?  They can lead by example – for example in their own use of IT, or their own innovation in service delivery or other operations.  Last week the Prime Minister and I announced the establishment of a Digital Transformation Office whose mission it will be to ensure that citizens can engage with their Government on the end to end digital platforms just as they do their banking, their shopping and so much else besides.

Governments can also influence culture, by recognizing certain types of success and with their communication.

But perhaps most importantly, governments can get the basics right – by pursuing policies that encourage macroeconomic stability, by balancing budgets, by investing capital prudently and efficiently, by avoiding public sector activities that the private sector can do better, and by ensuring open and competitive markets.  One of the few factors which virtually all economists who have analyzed the ‘East Asian miracle’ agree contributed significantly to the remarkable growth the four tigers achieved from the 1960s to the 1990s was the success all four governments had in getting fundamentals right.

Governments probably need to do all of these things.  The pressure being exerted on what we traditionally think of as domestic policies by the economic rise of less developed economies (and, I might add, by technological advances) are unlikely to abate – in fact there is reason to expect they will grow. 

Free trade and openness

As well as doing the right things, governments must avoid doing the wrong things.  This in particular means rejecting protectionism and other populist remedies.  As economists have demonstrated over a long period, these harm rather than help prosperity.  Australians conducted a controlled experiment on this between 1901 and the early 1980s, and we can verify that it doesn’t work out in the long run. 

If we believe ever-closer global economic integration is one means of ensuring the current shift in relative economic influence remains peaceful, that is further reason to eschew populism, and support a renewed commitment to economic integration, open borders and the free flow of goods, services, capital and ideas. 

These are issues where the Australian Government has been able to make significant progress, as I noted earlier.  The three free trade deals concluded by Andrew Robb in the past year account for around 40 per cent of Australia’s international trade[9].  If we add these to pre-existing Free Trade deals signed by Australia with economies including the US, New Zealand, Singapore, Thailand, Malaysia and Chile, more than 60 per cent of our international trade is now covered by such agreements. 

The three recent agreements are very good trade deals – and vitally important for Australia as our economy shifts away from a boom in mining investment and heavy reliance upon commodity exports to more broadly based growth.

One of the great errors of Australian policy in the past decade was to mistake the very elevated prices for commodity exports which we saw at the peak of the China-driven resources boom as a permanent shift in our terms of trade, rather than the temporary result of a particularly resource-intensive phase of China’s development and a resulting period where for certain resources supply badly lagged demand. 

Supply (including a large expansion of capacity in Australia in the case of our key resource exports) eventually caught up and growth in demand slowed.  Prices for resources remain much higher than in the 1990s, but much lower than they were at the peak. 

The Australian economist Saul Eslake persuasively argues that perhaps no other country is more exposed to a single export market than Australia to China.  Around 78 per cent of our exports go to Asia, where most economies are closely integrated with China, while 36 per cent go directly to China[10].  There’s little prospect of the Chinese economy resuming such resource-intensive, infrastructure-led growth in the near future.  So as China rebalances, Australia too will need to readjust.

So one of the most positive parts of the FTA with China is that it will see trade barriers removed over a decade in several areas where Australia has a strong competitive advantage – including key agricultural products like dairy, beef, wine and seafood.  Australia also has a surplus with China in services of almost $7 billion a year, and services too are covered by the deal.

The three deals of the past year align with a trend in the Asia-Pacific toward an ever-growing number of bilateral and multilateral agreements.  A study by the East-West Center shows that in 2000 there were only 4 free trade deals in place among APEC members – but a decade later there were almost 40, with even more concluded since then[11]

The many agreements in place should make a broad-based and enduring regional agreement easier to negotiate – but the crucial element needed is leadership.  This is why the Trans Pacific Partnership process, which involves economies accounting for 40 per cent of world GDP, is so important.   

Most of us in this room understand the large economic gains achievable from freer trade.  One study puts the gains from the TPP for all 12 participants at $223 billion a year[12].  But I also want to dwell on what we might describe as the indirect gains from liberalised markets.  President Obama touched on this in his recent speech in Brisbane, where he noted the purpose of trade is not simply to secure resources but to build partnerships that raise living standards, give entrepreneurs the opportunity to flourish and empower individuals[13]

Engagement and exceptionalism

Australia’s trade liberalisation ties in with a much broader story of engagement and increasing openness to our region.  So let me conclude by reflecting a little on Australian exceptionalism.

Australia is a diverse and prosperous society with high wages, a very high standard of living, and a generous (but in the main carefully targeted) social safety net.

Over the past 70 years Australia welcomed millions of immigrants from more than 200 countries, and in doing so become arguably the world’s most successful multicultural society.  Three in every ten Australian residents were born outside our borders; only two, much smaller,  developed countries have a higher proportion of foreign-born residents, and none have populations of equivalent diversity[14].

This diversity has been achieved, for the most part, with social harmony and economic inclusion – unemployment rates, for instance, are virtually identical among migrants and native-born Australians.

Like Americans, Australians do not define national identity by reference to race, religion or a particular culture.  Rather, our identify is grounded in a shared commitment to common civic values – democracy, the rule of law, engrained scepticism toward government, lack of deference to authority, and above all a peculiarly Australian brand of egalitarianism often summed up as “the right to a fair go.” 

Much like the wider Asia Pacific – from Tasmania to Tianjin, Chuhotka to California, Sydney to Santiago – Australians are increasingly diverse.  This is a valuable asset in a world where economic activity is ever more widely dispersed – it isn’t an exaggeration to say that our greatest riches are not under the ground, but walking upon it. 

Across the region there is a lot riding on political reform. I have mentioned China, India and Japan, but in Indonesia new President Jokowi is tackling structural reform including, as Xi is, entrenched corruption. Myanmar is facing the first free election for many decades and Thailand too is in the midst of a difficult transition to a stable democratic government.

All of these challenges and currents of change, dynamic and unpredictable, will be helped to a better resolution by strong and continued American engagement in the region. The Obama Administration’s pivot to Asia is a vitally important stabilising, reassuring factor in the peaceful development of our region. 

And this, I should add, means a lot more than fleets and planes. The United States has been pre-occupied for many years with the wars in the Middle East and Central Asia and the need for its attention to those troubled regions will be, I fear, enduring. 

But the main game, the highest stakes, the most to win or lose is in the Asia Pacific. That is the new centre of the global economy and America, a Pacific nation, has as much skin in this great game as any of us in Australia. 

The scarcest resource is not military might or dollars. It is the time and attention of our leaders. As this conference recognizes, it has never been more important for America’s leaders, above all, to be engaged, aware, committed to the Asia Pacific.  

 


[1] Liberalisation of the Indian economy commenced in 1991.  Between 1993 and 2011 annual growth in GDP averaged 7 per cent, but from 2012 to 2014 the annual average declined to 5 per cent.  IMF (2015) 'WEO Database'

[2] In 2013-14 China, Japan and South Korea accounted for 40 per cent of Australia’s two-way trade in goods and services (55 per cent of exports and 25 per cent of imports). Dept of Foreign Affairs & Trade (2015) 'Trade in Goods & Services'

[3] The speed of the current shift in relative economic production is unprecedented.  In 1990 Western Europe and North America produced 49 per cent of world GDP, but by 2030 their share will fall by almost half to 26 per cent according to forecasts by Willem Buiter at Citigroup (whose estimates broadly match those from several similar recent exercises in modelling convergence). Emerging Asia (i.e. Asia excluding Japan) produced 14 per cent of world GDP in 1990, but will triple its share to 44 per cent by 2030. Buiter & Rahbari (2011) 'Global Growth Generators' London, Feb 2011.

[4] Angus Maddison (2006) ‘The World Economy: Volume 2, Historical Statistics,’ OECD Publishing, 2006, p.641.

[5] See Linda Jakobson “China’s maritime security actors” Lowy Institute December 2014          

[6] Michael Spence (2011) ‘Globalization and Unemployment,’ Foreign Affairs, Jul/Aug 2011.  http://www.foreignaffairs.com/articles/67874/michael-spence/globalization-and-unemployment

[7] Michael Spence & Sandile Hlatshwayo (2011) ‘The Evolving Structure of the American Economy & the Employment Challenge,’ Council on Foreign Relations, Mar 2011.  http://www.cfr.org/industrial-policy/evolving-structure-american-economy-employment-challenge/p24366

[8] “Twenty-five years ago, business services such as information technology (IT) maintenance and support were not traded internationally; now Internet connectivity and innovative software permits many of these services to be performed remotely at lower cost, often in another country.”  Spence & Hlatshwayo (2011) p.9. 

[9] Dept of Foreign Affairs & Trade (2015) 'Trade in Goods & Services'

[10] Saul Eslake (2014), ‘Australia and its Commodity Cycles’ Nov 7 2014, available  online

[11] ‘The Trans-Pacific Partnership and Asia-Pacific Integration: A Quantitative Assessment”, pp.4-5 available online here: http://www.eastwestcenter.org/sites/default/files/private/econwp119_2.pdf

[12] Petri, Peter A., Michael G. Plummer and Fan Zhai, (2013) Adding Japan and Korea to the TPP 7 March

[13] President Obama: “The purpose of trade is not simply to extract resources from the ground, but to build true partnerships that raise capacity and living standards in poor countries; where small business owners and entrepreneurs and innovators have the freedom to dream and create and flourish; and how well a country does is based on how well they empower their individual citizens.” http://www.whitehouse.gov/the-press-office/2014/11/15/remarks-president-obama-university-queensland

[14] As of June 2014, 6.6 million (28 per cent) of Australia’s 23.5 million residents were born abroad. Among OECD nations only Switzerland (29 per cent) and Luxembourg (43 per cent) have a higher ratio of foreign-born residents.  The equivalent proportion in the US is 14 per cent and in Canada 21 per cent.  Australian Bureau of Statistics (2014) ‘3101.0 - Australian Demographic Statistics’, June quarter 2014. UN Department of Economic & Social Affairs, Population Division (2013) 'International Migration 2013'

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