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The Impact of China's continuing Economic Boom on Australia and the Region Dr Alan Thomas, Australian Ambassador to China Thursday 29th July 2004, The Park Hyatt, Melbourne Today I've been asked to talk about China's continuing economic boom and its impact on Australia and the region. The rise of China as a global economic power is one of the most remarkable transformations in modern history. It is even more extraordinary when one considers that a similar process of industrialisation took approximately two centuries in Europe, one in the United States, but is occurring in less than half a century in China and relatively smoothly. This is a bit of a sensitive issue in some quarters. China's growing strength and influence is giving rise to a range of reactions among its neighbours. Over recent months a new description has been discussed in Beijing ("heping jueqi") which has been translated as China's "peaceful rise". Even the English translation has led to internal debate, with some Chinese commentators suggesting that "rise" is too muscular and strident a term. They don't want to be seen as a danger. They have suggested softening it by adding the words "and development" (but leaving the Chinese original unchanged!). Others have queried the need for the adjective "peaceful". I think this terminology debate has yet to be finally settled. Perceptions may be important. But the reality is clear enough. China's emergence as a great power is an undeniable fact which we are all coming to terms with. It will have consequences for geopolitical and economic relationships within East Asia and beyond – similar to the way a century or more ago the world needed to accommodate the emergence of the United States as a dynamic economy and then a world power. China is now following a similar path. It has long been a member of some of the world's most exclusive clubs: a nuclear power and a permanent member of the UN Security Council, and more recently a player in space. But now China is also in the WTO, is a leading player in the ASEAN+3 grouping and is more and more involved in the arms control and counter-terrorism agenda. China has become the chief facilitator of the Six Party Talks on the Korean nuclear issue. It probably won't be long before the G7 – sorry G8 – will have to change its name again. There will of course be implications for Australia and other countries. On the evidence to date, these consequences are most likely to be positive. China's increasing level of development is reducing poverty and is building more prosperity and stability within its borders. This can only be a good thing. China's growth is also pushing forward business and other exchanges in the immediate region and beyond. And throughout Australia – in terms of the Federal and State Governments, the business sector, schools and universities, primary producers, tourist operators, community groups of all types – we are gearing up and working as hard as we can to mesh in with this remarkable economic transformation, in a way that benefits both our countries. The rise of China as an economic powerhouse has occurred much faster than I think anyone expected. China's GDP in 2003 was about US$1.4 trillion, making it the seventh largest economy in the world, and the second largest measured by purchasing power parity. It is the world's largest recipient of foreign direct investment. Its contribution to world economic growth is also second only to the US's. China's development is driving world demand for energy, minerals and agricultural products. It is rapidly moving up the ranks to become one of the world's largest trading nations. Its share of world trade has grown to about 7 percent; almost triple what it was a decade ago. It is currently the world's third largest importer. Over the next few years if China's reforms stay on track, its economy (measured by GDP at market exchange rates) could expand to approach the size of Germany's by 2010 and rival Japan's by 2030. At the Embassy in Beijing, we think that China is capable of growing at between 7-9 percent for at least the next few years, and this will bring substantial benefit to both Australia and the region. Of course, there are short and long-term risks that need to taken into account. A down-side of closer regional enmeshment is that any sizeable shock to the Chinese economy would be transmitted quickly to suppliers in the region, and put at risk some of their investments in increased capacity, for example in resources and energy. There has been a great deal of concern this year, including in Australia, regarding overheating of China's economy. China's official economic growth rate for the first quarter of this year reached 9.4% year on year. Some say the real figure may be as high as 12-13%. The Chinese Government is certainly concerned about overheating in sectors such as steel, concrete, aluminium and real estate. It wants to smooth out economic cycles to the greatest extent possible. Our assessment is generally optimistic. We see that the tightening measures introduced since last year are working. A range of production and monetary indicators are slowing. The risk of a hard landing is low due to a range of factors. Most importantly, consumption continues to grow strongly, driven by urbanisation and the Government still has the ability to intervene quickly if activity slows faster than expected. Another risk factor often cited is China's financial system. In 2001, Gorgon Chang, in his book The Coming Collapse of China, predicted that a financial crisis could be set off within about five years. We think a banking collapse is very unlikely, given buoyant economic growth, strong bank liquidity and a government committed to banking sector reform with considerable financial resources standing behind the big banks – the big four and the second tier banks. In the longer-term there are concerns regarding the sustainability of China's current economic model. It is only natural that as Chinese citizens become wealthier, so too will their demand for consumer items that improve their living standards: cars, refrigerators, air conditioners, computers, and other electrical appliances. The resources required to manufacture and to power these consumer items, the additional pollution and environmental waste, creates an environmental challenge on a global scale. Resource constraints will make it difficult for China to continue high rates of growth under its current economic model, characterised by manufacturing and export-led growth. But how does the Government change the mind-set of "growth at any cost" that has been the guiding principle for the last 20 years? The choice between short-term local development and employment and long-term sustainable economic management is difficult anywhere in the world. Making markets function more effectively, through sound pricing mechanisms, will be essential. There are signs that the Government is moving in this direction. The Central Government is also developing a new measure, known as Green GDP, to measure the sustainability of local governments' economic management. We have also seen increasing references to "human centred" development, emphasising greater investment in health, education, science, the environment and culture. This sort of "balanced" development will be essential if China leadership is to overcome one of its most politically challenging problems – the growing income gap between rural and urban areas, the East Coast and the Western interior. Morgan Stanley estimates there are now 236,000 millionaires living in China. But according to the World Bank, about 16 percent of the population, or 203 million people, still live in abject poverty, defined as income under $1 a day. Even more staggering, 47.3% of the population, 615 million people, lived on under $2 a day. Whereas Shanghainese enjoy a GDP per capita of USD$5625, in Guizhou, the poorest province, the figure is just UDS$757. There are two groups of particular concern. The first is the rural population, which accounts for roughly 700 million of China's 1.3 billion population. Perhaps the majority are underemployed and about 50 million are landless labourers. Productivity rates are low, the tax burden high, and competition from global trade is increasing. In the next 15-20 years it is estimated that at least 180-200 million will be leaving the land in search of employment in China's towns and cities. The second group is laid-off workers from state-owned enterprises (SOEs), mainly concentrated in the North-East industrial rust-belt. SOEs are shedding about 5 million jobs per year. Most economists predict that the economy needs to maintain between 7-9 percent GDP growth to keep these various social forces in check. Aside from these very formidable economic and environmental challenges, there is the question of China's administrative structure and its ability to accommodate the consequences of rapid economic and social change. Can such a centralised and unitary political system cope effectively, given the increasing complexity of Chinese society and the growth in living standards and people's expectations? This growth will not be even over different parts of the country, leading to possible strains on the "one size fits all" system of governance. The authorities will come under varying degrees of pressure to be more accountable and responsive including establishing a dependable rule of law with an independent judiciary. Can a one-party state do this? History provides us with no precedents. China's leaders acknowledge the validity of these concerns, and are taking steps to tackle administrative shortcomings and corruption, and increase consultative mechanisms, including within the Communist Party. But these measures are largely top-down attempts to adjust the existing mechanism and make it operate better. It remains to be seen whether these measures will be sufficient. There is no doubt that China's strong growth and large economy has caused rapid changes in patterns of production and trade flows within East Asia and between the region and third country markets. A recent publication by the Department of Foreign Affairs and Trade Economic Analytic Unit entitled China's Industrial Rise: East Asia's Challenge addresses this very issue. The conclusion of the report is that, on balance, China's industrial rise was a positive sum game for the region and Australia. It also points out that in this rapidly evolving environment those economies with rigid policies and weak markets will gain less than those with open and flexible economies like Australia. This is a predictable conclusion, but it is very important nonetheless. The report addresses two concerns: firstly, that China's expanding exports of assembled high technology products will damage middle and high income East Asian economies such as Japan, Taiwan and South Korea; secondly, that its rapid expansion of more traditional labour intensive manufactures threatens developing economies of South East Asia. Closer analysis of regional trade flows, however, shows that fears of a "hollowing out" of the region's manufacturing industries are unfounded. On the contrary, China's industrial boom is benefiting the region. China has become an engine of growth for the region. Over the past five years it has been the fastest growing market among the major East Asian economies. Its imports have grown by more than 15 percent annually. A few amazing statistics, if I may: China now produces 20% of the world's refrigerators, 30% of its televisions and 50% of its cameras. These figures, though impressive, should not alarm us. To produce more technologically advanced products, China mostly assembles imported components. For developed economies, therefore, the rise of China presents opportunities for exports of specialised, advanced components and capital equipment. This compensates, at least in part, for losses in labour intensive manufacturing sectors in those economies. There should be additional compensation in the form of growth in services. Consumers are also benefiting from cost competitive Chinese consumer goods. And regional businesses benefit from access to China's competitively priced production inputs. China is also increasingly interested in bilateral and regional trade arrangements. In part we can see this as a response to the "China threat" syndrome – concerns that China is gaining at the region's expense, both through hollowing out the region's manufacturing industries and by attracting a disproportionate volume of Asian inbound foreign direct investment. As discussed earlier, these concerns are misplaced. China has made a very deliberate diplomatic effort to cultivate ASEAN-China relations. Premier Wen recently described China as a "friendly elephant". While China has not eliminated the perception of a "China threat", there has certainly been a perceptual change in recent years much more inclined to accept China as a pragmatic, benign power, which presents the region with economic opportunities. It is against this backdrop that China has placed such a high priority on negotiating an FTA with ASEAN. It has also completed a Closer Economic Partnership Arrangement with Hong Kong, and announced it will start FTA negotiations with New Zealand, Singapore and South Africa. Other mid term possibilities for FTA negotiations include Australia, Chile, and most recently, the Gulf Co-operation Council (includes China's big energy partners – Kuwait, Oman, Qatar, UAE, Saudi Arabia and Bahrain). Long-term FTA partners include Japan and Korea as part of a "plus three FTA". China's growing interests in regional arrangements can be attributed to a number of factors. Firstly, China wants stable political and economic relations with its neighbours and to project its political influence in the region. Secondly, China wants to use its FTAs and its general push for "fair trade" to increase the prospects for sustainable development. It is concerned that trade diversionary effects from other regional arrangements, such as EU enlargement, and overseas protectionist measures directed against China, such as anti-dumping, threatens to slow the growth of China's external trade, thereby slowing the pace of China's industrial transformation, reducing job growth and increasing social pressures. Thirdly, China wants to increase trade and investment with the rest of Asia to balance risks in its US relationship. China has been working hard to strengthen its relations with the US. But the China-US relationship is going to be tested on many fronts – and the lead up to the Presidential elections in the US will amplify those voices concerned with job security and structural adjustment in labour-intensive industries. China's currency peg against the USD, WTO compliance and protection of intellectual property, are other hot issues. Both sides will need to work hard to limit the potential for misunderstandings and continue to emphasise pragmatic over politicised approach to disputes. Due to the combination of the above factors, in the next few years we expect to see China intensify its efforts to negotiate FTAs and closer economic partnership arrangements, particularly within the region. It will not be an easy or smooth process. Negotiations with ASEAN, for example, have been protracted and difficult, given the very different interests of the 11 economies. Overcoming sensitivities in agriculture and political distrust will require a patient and steadfast approach. But in time, if China continues with its economic reforms and sustained economic growth, it is plausible that an East Asian hub based on interlocking FTAs will emerge. Australia-China Bilateral Relations: What the Future Holds In the final part of my speech I'd like to turn to Australia-China relations. How well placed are we to meet the growing opportunities created by China's sustained economic growth? China is now Australia's third largest overall trading partner, with 2-way trade in goods and services trebling since 1996, to $23.3 billion in 2003. This is incredible when one considers that bilateral trade was only $69 million when we established diplomatic relations in 1972. Investment links are also expanding, now totalling $3.4 billion, with growing opportunities in manufacturing, mineral exploration, education, banking and legal services. Looking ahead, we see substantial opportunities for the Australian-China trade and investment relationship. It is conceivable that China will overtake the United States and Japan and become our largest trading partner in the next five to ten years. Despite the many difficulties that beset China's economy, it seems that GDP will continue to grow by at least 7-8 percent a year over the next few years. Australia is uniquely placed to assist China meet its challenge of securing adequate sources of key inputs such as energy and minerals. The 2002 deal to supply A$25 billion of LNG to Guandong Province over the next 25 years was an excellent start to our energy partnership. BHP Billiton recently signed a 25-year deal worth A$11.6 billion to supply iron ore to four Chinese steel mills. We also expect there to be continued strong demand for Australian commodities, such as iron ore, copper, wool, aluminia, barley and coal. Although more than half of our trade with China is based on commodities, there are also substantial opportunities for Australian businesses in manufactured goods, including high-tech manufactures. Consumption among China's emerging middle class – now numbering over 100 million – is expected to remain strong, buttressed by the continued growth in the private economy, urbanisation and rising disposable incomes. This explains why China is now our fastest growing market for services, everything from architectural to film post production. Education is a particular success story. 53,000 students from China are currently studying in Australia, making it the largest source country for students, and a further 30,000 Chinese are undertaking courses offered by Australian institutions in China itself. Many of these students maintain close academic, business and personal connects with Australia. Tourism is another key growth sector. Last year 176,000 Chinese tourists visited Australia and 114,000 Australians visited China. There are also substantial opportunities for services such as banking, accounting, insurance and professional consulting. The Australian Government will continue to work hard to ensure that Australia is well positioned to benefit from China's continuing economic boom. High-level visits are an important way to push forward the relationship. The Prime Minister has visited China four times since 1996. We were also delighted the President Hu Jintao visited Australia during his first year in office. Of course with the election on the horizon in Australia we expect the second half of this year will be quieter on that front, but we expect that whichever party is returned to power, next year will be a busy time for high-level visits. We will also be seeking closer engagement under the Australia-China Trade and Economic Framework, signed on 24 October 2003, during President Hu's visit. The Framework is broad-based and forward looking. It sets the agenda for strengthening bilateral trade and economic relations and covers a wide range of activities in sectors such as energy and mining, agriculture, textiles, clothing and footwear, services, investment, education, ICT, and on policy issues that include food safety and health. As part of the Framework, the two sides have agreed to undertake a feasibility study into the benefits and cost of a possible FTA, as a basis for Australia and China to decide whether to negotiate an FTA. The FTA feasibility study will provide an opportunity to explore the benefits to Australian exporters and service suppliers by removing or reducing trade barriers. The FTA study will explore the potential gains of trade facilitation measures such as co-operation in the movement of business people, customs procedures, technical standards and electronic commerce. The FTA study will also examine any challenges or costs that an FTA might involve. The Australia-China trade and economic relationship has grown dramatically in scale and diversity over the last few years. Over the next 5-6 years, trade and investment is expected to increase strongly, involving more sectors, more companies, traders and investors. But we should not be complacent. We will need to work hard to maintain momentum and focus in the relationship. We are not the only ones to notice China's rise and the opportunities to flow from closer engagements. We have already built a strong foundation, based not only on trade and investment, but through a comprehensive relationship that includes co-operation on regional security, disarmament, counter-terrorism, people smuggling, social security, development co-operation and human rights, to name just a few issues. People-to-people links are also extremely valuable. We are continually surprised at the number of government officials in China who have children who have studied, or are currently studying in Australia. The work of the Asia Society in promoting links between Australia and China is also very valuable in this regard. So I think you very much for your efforts to promote greater understanding and awareness between Australia and Asia. And I thank you for giving me the opportunity to address you today.
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