More than a mine, more than a market - history, empathy, economics in the China relationship.
NAB Australia-China Business Week
Sydney, 5 September 2014
## Check Against Delivery ##
The Prime Minister asked me to represent him today at this most important conference. He sends his greetings and is sorry he cannot be with us today as he is, as you know, in India.
In the 12 months since taking office the Abbott Government has worked hard to broaden and deepen our ties with China.
Notably Prime Minister Tony Abbott led a high profile delegation to Shanghai in April for Australia Week in China. He was accompanied by Trade Minister Andrew Robb and Foreign Minister Julie Bishop, five state premiers and a chief minister, and more than 700 representatives from Australian businesses and other organisations, including many CEOs. He also attended the Boao Forum where he gave the keynote address and met with the Australia/China Senior Business Leaders Forum.
The current focus of our economic relationship is progress towards a free trade agreement with China. This week we have had a 20-strong negotiating team in Beijing for the 21st formal round of negotiations on the FTA since John Howard first floated the idea nine years ago.
Finalising an agreement by the end of the year is still a realistic objective and a very high priority of our Government. From Australia’s point of view, we will continue to strive for the best possible deal on agriculture and access to Chinese markets for Australian services.
If agreed the Chinese FTA will have a big impact on our economy.
Since the New Zealand-China deal came into effect in late 2008, New Zealand’s share of Chinese imports have tripled. This reflected a nine-fold increase in the value of New Zealand milk-powder exports to China, a ten-fold increase in the value of timber exports and a seven-fold increase in lamb and mutton exports1.
Already, there are signs of the potential here, particularly for Australia’s primary producers. A north coast farming cooperative, Norco, is already exporting milk to Shanghai and attracting prices of around $9 a litre. It is exporting 16,000 litres of milk a month to China; within 12 months it is hoping to export around 20 million litres a year2.
A free trade agreement would coincide with the broader shift to a services based economy in China. In 2013, for the first time services accounted for the biggest share of Chinese GDP at 46% with industry at 44% and agriculture 10%3.
Not only will this result in more opportunities for Australian businesses, but it will result in a different type of engagement. Rather than the multi-billion dollar deals negotiated in the resources sector, transactions in the agriculture and services sectors, for example, involve many more parties and many more smaller transactions.
Even more so than resource companies, they will need to have a much keener sense of the Chinese market and a deeper affinity with Chinese culture and business practices.
To give you a sense of the opportunities here for small and medium enterprises, the recent Australia Week in China - which was heavily backed by our Department of Foreign Affairs and Trade - saw a raft of commercial deals signed between Chinese and Australian companies, worth around AU$894 million in value. They included Australian companies in sectors as diverse as meat, dairy, medical technology, aged care, building and construction, education, and financial services.
Doing Business in China and Broadening the Relationship
At a personal level I am proud to be part of a Government that is working hard to improve and enlarge our relations with China. It was twenty years this month that we established, with the Zhangjiakou City Government and the Hebei Province Geological Bureau a contractual joint venture, Hebei HuaAo Mining Industry Company Ltd, to explore and develop a promising lead zinc deposit at Caijiaying near the town of Zhangbei in Hebei Province.
That was the first sino-western joint mining venture in China, now listed in London, and last year produced 788,000 tonnes of ore and 461 million RMB of revenue employing 700 local people.
Although it is a long time since I was a shareholder, I am very proud that we were able to establish that mine - not simply because it was the first of its type, but because it has contributed to the growth and prosperity of China, bringing together Australian and Chinese expertise in every relevant field. One of my colleagues at the time, geologist Dr Zhou Bo, is I am very pleased to say still actively involved as a director of the project.
Naturally this conference will focus on the Chinese economy, its growth prospects and the impact on two way trade and investment. But too much of the description, the appreciation, of our relationship is transactional, indeed one-dimensional.
As Consul General Li has reminded us, China is our largest export market, accounting for 36 per cent of Australia’s exports in 2013. Iron ore accounted for 55 per cent of those exports by value, while services - mainly in tourism - accounted for around 7 per cent of exports. Chinese investment in Australia is similarly weighted towards resources. In the six years to 2012, 79 per cent of inbound Chinese investment was in mining, a further 12 per cent was in oil and gas4.
That’s enough for familiar statistics.
Rather I want to talk about the deeper texture of our relationship, our shared historical experience and the prospects for the future direction of the relationship.
Deeper People-to-People Links
Australia has become, in just a generation or two, the most diverse and successful multicultural nation in the world.
In the 1950s, around 10 per cent of our population was born overseas; today almost 28 per cent are5.
Our most valuable natural resource in our country is not the minerals under the ground, but the people who walk on top of it.
Australia is not only more diverse than any other Western country, we have almost a million people living in Australia who are of Chinese descent6 and Mandarin is the most common language spoken outside of English7.
More than 600,000 people in Australia speak Chinese at home compared to 2.8 million in the U.S., a country of around 15 times our population8. The United Kingdom has slightly more than 234,000 people who speak Chinese languages9. Although the German census doesn’t count the number of foreign language speakers broken down by language, they have around one Chinese born resident for every five in Australia10.
As I have written before11, the Chinese language is hard to learn. Its ideographic writing system requires a formidable feat of memorisation to achieve even basic literacy. But as Geoff Raby famously observed shortly before he retired as Ambassador to China, proficiency in the Chinese language does not always guarantee a good understanding of China or the Chinese.
A deeper understanding of China history and culture is of enormous importance in the further development of our relationship at a national and indeed at an enterprise or personal level.
Australia is one of the top destinations for Chinese students, with around 150,000 of them currently enrolled at Australian universities and other institutions. And thanks to the Government’s New Colombo Plan, more Australians will be studying in China. Already 34 of our universities have exchange agreements with institutions in China and China has very quickly become the second most popular destination for our students studying abroad12.
History looms large as we reflect on centenary of World War I, the seventieth anniversary of D Day and next year the centenary of the Gallipoli landings and the seventieth anniversary of the end of the the second World War.
And all too often, uneasily we turn the pages of those histories reflecting on the similarities between those times and our own today.
Australians pay close attention, naturally, to the history of the War in the Pacific where Japan swept the British out of Malaya, the Dutch out of the East Indies and the Americans out of the Philippines.
Australia was under direct attack. Darwin was bombed, Sydney was shelled. 22,376 Australian were taken prisoner. More than a third of them did not survive their captivity.
Great Britain’s island fortress of Singapore was over run. The Royal Navy’s Prince of Wales and Repulse were sunk.
The Empire of Japan had driven the British Empire out of East Asia. Australia was alone and looked to American for leadership and protection.
And America did come to our aid and we have been the firmest of allies ever since - an alliance bound by kinship, shared values and a long history of loyalty, solidarity and courage.
But there is one chapter in those histories which is all too often unread even where it is written at all.
For China the war with Japan had begun in 1937 and for four years she fought alone. Japan had 680,000 troops in China at the time it launched its offensive in the Pacific - four times the number it deployed to sweep through South East Asia until they were stopped at our doorstep in the jungles of New Guinea13.
Had China been defeated and become a collaborating puppet state, like Vichy France, not only would Japan have been able to fling vastly greater resources into the war against Australia, but it would have been able to invade Siberia in 1942, as Hitler asked, when the Red Army was almost smashed by the Nazi offensive in the West.
We may not have succeeded in resisting Japanese aggression without the tenacious heroism of our Chinese ally.
The Soviet Union, reeling in the face of the blitzkrieg, may not have been able to survive a two front war at its moment of greatest weakness.
The central role of China as our ally in the Second World War is barely remembered in Australia today. But it will never be forgotten in China.
We should never forget that China’s war against Japan was not just their war, but our war too - and without China we may not have won it at all.
As a Government we are focussed on the opportunities in the Chinese relationship and, as I have said, they go well beyond the commercial or economic.
But there are, naturally, risks to the outlook.
Deng Xiaoping opened China to the world and began a process of liberalising product markets. He was careful to focus on the main game - raising living standards at home - and did not seek to disturb the strategic order in the region. His policy was “hide your strengths, bide your time.”
And for many years thereafter China was remarkably conciliatory in its relations with neighbours. Most notably in 2004 it settled its border with Russia and effectively ratified the seizure in the 19th century of vast areas of Chinese territory by the Czars in the unequal treaties of Aigun and Peking.
Since then, however, China has been disputing maritime territories with Japan over the Diaoyu/Senkaku islands and with the ASEAN nations in the South China Sea. I note that I make no judgement at all about the merits of those competing claims. Our interest is simply in their peaceful resolution.
A real risk is that an incident at sea escalates, drawing in the United States with unpredictable consequences.
In my view we should expect China to become more assertive in its own region. It is, or shortly will be, the largest economy in the world. Its rise is to be welcomed. But it is vitally in our and China’s interests that its rise is peaceful.
Many Chinese scholars have compared this muscular maritime diplomacy as comparable to America’s declaration of the Monroe Doctrine in 1823 which asserted that further European intervention in North or South America would be resisted by the United States.
It is not an apt comparison. East and South East Asia are not composed of former colonies struggling to remain free, but includes many large and powerful states, including Japan, with considerable economic and military strength. They, like China, have all benefited from decades of a Pax Americana.
All policy must be judged by its outcome. If the objective of Chinese regional diplomacy is to weaken American influence with the nations of the region, it is not working.
The counterproductive consequence has been to drive China’s neighbours not only into increasing their defence spending but into closer alliance with the United States.
China’s better strategy would be one that builds trust with its neighbours and settles disputes pragmatically, as it did with Russia in 2004.
Another major risk to the outlook is the consequences of the long overdue rebalancing of the Chinese economy being undertaken by President Xi Jinping.
For many years China has practised a form of financial repression that has transferred wealth from households to state owned enterprises, encouraged property speculation and malinvestment, suppressed consumption and produced growing income and social inequality.
For lack of a better alternative Chinese households entrusted their savings to state-controlled banks which returned negative real interest rates, and proceeded to on-loan those deposits to state-owned enterprises, often engaged in property development, at negligible, arguably negative, real interest rates.
This constituted a significant transfer of wealth from thrifty households to all too often inefficient state owned businesses. . Michael Pettis has estimated its magnitude at as much as 5 to 8 per cent of GDP annually.
Just as cheap and abundant labour encourages firms to engage in labour-intensive production, so the availability of what in real terms was ‘free’ money exaggerated incentives to invest. If funds can be borrowed from friendly bank managers at rates well below the nominal growth in GDP, almost any project passes muster.There is abundant evidence of malinvestment in property and infrastructure - the inevitable consequence of free money.
As research by Anne Stevenson-Yang from J-Capital research shows in the five years to 2012, China added 5.9 billion square metres of commercial floorspace, which is the equivalent of 50 Manhattans. To put the Chinese real estate construction boom in perspective, in 2012 China built around 20 million units, or around 2 billion square metres of residential floor space; at its peak the U.S. built 2 million homes a year14. As Bill Gates recently blogged, China used more cement in the three years to 2013 than the U.S. used in the entire 20th Century15.
Reform Is Taking Place
The good news however is that after many years of the Chinese Government declaring it would do something about this financial repression, reform, under Xi, is finally happening. The official lending rate has risen to 7.5% and just as importantly nominal GDP growth has dropped to under 8% in the first quarter of this year.
China will see slower growth, but with higher real interest rates the growth that does continue will be focused on a more productive use of resources.
There is considerable concern (we need look no further than today’s Financial Review), about the impact of slower growth in investment will have on demand for iron ore and coal. Both commodities are at five year lows. Coal also faces the consequence of China aggressively moving to cleaner sources of energy - many analysts argue China will shortly cease to be a net importer of thermal coal.
The challenge for the political leadership is how to ensure that household income and consumption can grow faster than GDP, with the consequence that there will be slower growth in investment and especially construction activity but do so without unacceptable increases in unemployment.
A Chinese economy with a higher share of consumption (say 50% plus ) will have a larger services sector which is, of course, much more labour intensive than the capital intensive heavy industries and infrastructure projects which have been so advantaged in the past.
This re-balancing is being supported by wage growth; whether China has passed the Lewis turning point or not, the endless supply of cheap labour from the countryside is both diminishing and proving less suitable for the higher skills required in a more sophisticated economy with a greater share of services.
There seem to be two views on China’s prospects. One holds that there will be a medium term slower rate of investment especially in property, and hence demand for iron ore and coal, but that because of the rapid rate of urbanisation, with a quarter of a billion people expected to move to the cities over the next twenty years, the excess property inventory will be taken up.
Another holds that there will be, and needs to be, a much more significant pull back in investment not least because as financial repression winds down investors will have to find projects that deliver real commercial returns.
The deflation of the property bubble is already seeing big falls in property prices across China, especially in second tier cities where there is less prospect of excess inventory being taken up. This rebalancing, while necessary, has its own wealth effect - negative impact on household spending, offsetting at least for a time the policy objective of increasing consumption as a share of GDP.
Either way it underlines the need for us to to think of China less as a destination for bulk commodities - coal, gas and iron ore - and more as a sophisticated market for high quality, differentiated services - education, architecture, design, legal and financial services and technical services among many others.
Among these shifts, Australia can and should be at the forefront of this transition and can be a huge potential beneficiary of the new Chinese economy.
That is why the shift towards a services economy has been a major focus of the proposed Free Trade Agreement.
Another feature where Australia in general - and Sydney as a hub of finance - can be an early mover is in the internationalisation of the renminbi. As my colleague, Treasurer Joe Hockey, announced earlier this year, our countries’ respective central banks are working to ensure we have an offshore RMB clearing house located here in Sydney, a recognition of the increase in direct trades between the two currencies16.
The recognition by Chinese policy makers of the need for reform,the liberalisation of currency controls and domestic finance, the rise of a Chinese middle class, the shift from investment led growth to one based on consumption are all indications that the story of China’s growth still has a long way to go.
Australian governments and businesses will need to be agile and innovative with the empathy to know that your “same bed” companion has “different dreams”, the imagination to know what they might be and the wisdom to know that you will be together for a very long time.
1 Quoted in Eslake, S., & Joiner, A., (2014), “A Trio of Free Trade Deals”, Bank of America Merrill Lynch, pp.9-11
2 Lynch, J., (2014), “Who’s Buying Milk for $9 a Litre?”, in the Australian Financial Review, available online: http://www.afr.com/p/business/companies/who_buying_milk_for_litre_rZ3idyq8Vc0Cnsh0arYKvN
3 WEF, (2014), “China Update: June 2014”, p.3
4 KPMG & University of Sydney China Studies Centre (2012) ‘Demystifying Chinese Investment: China’s Outbound Direct Investment in Australia,’ August 2012 update, pp.5-6.
5 ABS, (2013), “Australia’s Population By Country of Birth”
6 ABS, (2012), “Cultural Diversity in Australia”, available online here: http://www.abs.gov.au/ausstats/[email protected]/Lookup/2071.0main+features902012-2013
7 ABS, (2013), “Australian Social Trends”, available online here: http://www.abs.gov.au/AUSSTATS/[email protected]/Lookup/4102.0Main+Features30April+2013
8 U.S. Census Bureau, (2012), “Language Use in the United States: 2011”, available online here: http://www.census.gov/prod/2013pubs/acs-22.pdf
9 Office for National Statistics, (2011), “Census”,available online here. Statistics for Scotland’s census are available online here. Official statistics on foreign languages spoken vary slightly on what they measure. For the USA it refers to those 5 years and over and what language is spoken at home. In the UK it refers to those aged three years and over and the main language spoken. In Australia it refers to all persons and language spoken at home.
10 Statistisches Bundesamt, (2013), “Ausländische Bevölkerung”
11 See for instance, my blog online here: http://www.malcolmturnbull.com.au/media/the-asian-century-and-learning-chinese-in-school
12 Bishop, J., (2014), “Australia in China’s century”, available online here: http://www.foreignminister.gov.au/speeches/Pages/2014/jb_sp_140530.aspx?ministerid=4
13 Beevor, A., (2012), The Second World War. 14 Stephenson-Yang, A., (2014), “Consumer Call”
15 Gates, B., (2014), “Have You Hugged a Concrete Pillar Today”, available online here: http://www.gatesnotes.com/Books/Making-the-Modern-World
16 Hockey, J., (2014), “Deepening Financial Ties with China”, available online here: http://jbh.ministers.treasury.gov.au/media-release/014-2014/