Why economics doesn't explain China's FTA decision

Lowy Interpreter

Malcolm Cook and I have been debating why China has been willing to bless Tony Abbott with an FTA when Mr Abbott has so strongly opposed Beijing's political and strategic interests and aspirations in Asia.

Why has President Xi met Mr Abbott's stick with such a juicy carrot, especially when Beijing has been so quick to use the stick itself on other neighbours? (Sam raised the related and important question of why China uses the stick at all when it has so many carrots to offer, to which I have offered an answer separately.)

Malcolm's explanation is that the economic benefits to China of the FTA simply outweigh the costs to China of Australia's position on strategic questions. He does not dispute that those strategic costs are significant, because he concedes both that China is serious about creating a new order in Asia, and that Australia's attitude to this is important to Beijing. He just thinks the economic advantages to China of a FTA with Australia are big enough to counterbalance them.

I'm not so sure. I think it is more likely that Xi and his colleagues believe that wider economic opportunities and kind words will seduce Australia away from its alignment with China's strategic rivals, and encourage us to be more willing to accommodate China's ambitions for regional leadership.

Of course it may be that we are both right to some degree. But it remains important to judge the relative weight of each factor in China's approach to Australia, because the implications for our position in Asia and our future policy depend a lot on which of them predominates.

Malcolm's argument that economic factors predominate in Beijing's decision rests on judgments about the scale of the perceived economic benefits of the new FTA to China. That is hard to judge at this stage, of course, but we need to be careful not to take last week's euphoria at face value.

The evidence suggests that FTAs actually make very little difference to trade flows or GDP growth. Our Government's only word on this is a 2005 DFAT-sponsored study, which was the source of the much-cited figure of US$18 billion boost to Australia's GDP from an FTA with China. Here is what that study said about the impact, had there been an FTA between Australia and China over the past decade:  

In terms of average annual growth rates between 2005 and 2015, the FTA is estimated to increase Australia's real-GDP growth by 0.039 percentage points; and increase China's real-GDP growth by 0.042 percentage points.

Yes, that's right – four hundredths of a percentage point. In other words, the impact on GDP for China, as for Australia, was estimated to be utterly negligible, and there is no reason to believe that the deal that has now been done will have a significantly greater effect. Indeed the Productivity Commission's 2010 report on FTAs strongly suggests that it won't. It concludes that FTAs in general do nothing at all to boost trade or growth.  

But are there other economic benefits? One view is that China values an FTA with Australia to drive reform within China, which might indirectly boost growth. One cannot dismiss this out of hand, but it does seem on the face of it very improbable. The CCP seems to have no trouble driving reform on its own, and if it needs help from outside, why Australia? China has already signed FTAs with many advanced and prosperous countries which pose it no strategic problems. How does adding Australia to the list help?

So from the available evidence there doesn't seem much reason to think that economic motives have been uppermost in Beijing's decision to cuddle up to Tony Abbott. The fact is that this FTA, like others, is much more about politics than economics, in Beijing as well as in Canberra.

And one cannot help but notice that Beijing seems to have secured precisely the political outcome I think they were aiming at. Tony Abbott did, at least while Xi was here, show himself much more open to China's vision of Asia's future than he has ever been before, and he did so in direct defiance of Barack Obama's very plain and stern warnings just two days before Xi spoke in Canberra.

Time will tell whether this proves to be anything more than a passing blip. Tony Abbott may well revert to his previous strategic alignment against China at the next opportunity. If so, it will be instructive to see how China responds. That would perhaps tell us more about its motives and purposes.

In the meantime, it is easy to understand the attractions of Malcolm's interpretation of events. It would be nice to think that Australia's economic weight and sophistication is such an irresistible magnet for China that we can dictate the terms of the relationship and compel it to accept without demur whatever strategic positions we choose to adopt.

Be we would be unwise to assume that this is what is happening. It is at least as likely that the boot is on the other foot, and that China's economy is so important to Australia's future that Beijing can set the terms of the relationship — either by carrot or stick or both — and persuade us to look more kindly on China's aspirations for regional leadership.

Originally published by The Lowy Institute publication The Interpreter. Republished with permission.