Commentary

Hon Tim Groser:
Minister of Trade:

2 July 2014

Address to the NZ China Centre Conference.

Thank you for this opportunity to address the NZ China Centre at my old Alma Mater, Victoria University.

I of course understand there are other pathways to relative professional success than tertiary qualifications. But having a great education from an excellent University is certainly one of them. I have never forgotten that. Nor have I forgotten one or two of the key Professors of this University who helped me so much as a young man.

Back to China. So we have just passed - one year ahead of schedule - a milestone that frankly I thought was quite a stretch when Prime Minister Key and Premier Wen decided on it in Beijing in 2010: to double our two-way trade by 2015. Well, copy that: we put a positive tick beside that goal last week. Apparently, our Leaders will not allow us to take a breather- the Prime Minister and the new President of China, President Xi have now decided to lift the bar again. The goal now is to lift two-way trade to $30 billion by 2020.

By the way, our extraordinary success with China, which has both a political and a commercial side to it, is being noticed and admired - maybe even envied - around the world. In Mexico City, about ten days ago, and on my way to representing New Zealand at the Heads of State meeting of this new Trade Grouping called the Pacific Alliance, I was holding a seminar on global trends in trade with my host, the Mexican Minister of the Economy and a former Professor of Economics, Dr lldefonso Guajardo.

This subject came up from the floor in the Q&A. When I gave the questioner the basic data on our exports, the Mexican Minister said NZ's exports were greater than Mexico's total exports to China. Mexico is the 14th largest economy in the world and has 118 million people.

Take a bow, New Zealand Inc. It has taken a lot of people and a lot of hard work over a number of years over successive Governments to get us to this excellent position. We are now seeing the benefits in terms of increased export income (and thus lowering foreign borrowing than would have been the case), more jobs, and higher economic growth. If we stick to what we know works in terms of foreign policy, trade policy and the domestic economic policies that underwrite this huge success, the future is even brighter.

This very success is, however, giving rise to a number of people asking a question - namely, are we in danger of creating too much trade dependency on China?

Personally, I think it would be harsh to brush this aside by saying some people can only ever look at a glass as half-empty. It is a fair question that deserves a fair answer. It is especially so in the light of the defining event of our trading economy in the last 50 years: the body-blow we suffered when the UK, which then absorbed 50% of our total exports, entered the then EEC, triggering a whole series of difficult adjustments by NZ. As a country, we know the hard way about trade dependency and the risks it involves.

However, as I go through my analysis of the issue, just bear in mind one central fact. The world is utterly different today than it was in the 1970s. The front and centre of the problem faced forty years ago by New Zealand trade negotiators like me, and particularly the people I learned my craft from, was we had too much product for export and too few market opportunities open to us. The world just shut us out.

Today’s trade policy ‘problem’ – if indeed ‘problem’ is the right word for it – is the opposite: we have more opportunities than we could ever exploit. In terms of our agri-business exports, we can only feed around 40-50 million people. The new trade agenda in front of us – and TPP is the biggest game in town here – is about risk diversification and giving our companies more choice still.

It is not just, to use American basketball parlance, ‘defence’ (ie risk diversification) but ‘offence’ as well - we want to strengthen the hand of our export sales managers’ when they look at alternative markets for the world class suite of goods and services their company and NZ has to offer. If you don’t have choice, you don’t have a negotiating position – you have a set of requests.  I remember one veteran Australian trade negotiator telling me as a young NZ negotiator in Canberra that ‘New Zealand negotiates through a veil of tears’. It was meant to intimidate me so I just said ‘You’re right. But aren’t we good at it’.

Well, we are also good – very good – at the new game where, thanks to our successes married to economic development in the emerging economies, we are in an entirely different and utterly more favourable position. In addition to the two ‘jewels in the NZ trade policy crown’ of CER and the China FTA, we have an FTA with Hong Kong, a comparable agreement with Taiwan (another world first), a comprehensive FTA with the whole of ASEAN (AANZFTA) that was finally ratified by Indonesia, the largest ASEAN economy, in 2011, an FTA with Chile, P4 (or Pacific Four – the Foundation stone of TPP) and several individual FTAs with individual South East Asian countries. And we are still benefiting enormously from the Uruguay Round set of Agreements that 20 years ago brought some discipline to export subsidies and stabilised a number of market access issues important to New Zealand.

I am not describing our negotiating agenda here – TPP, the Pacific Alliance, other current negotiations. The Trade Agreements I have just referenced are all done and impacting positively on our country. But we the Oliver Twist of trade policy. We are hungry for more. When we say ‘We are Ambitious for New Zealand’ it is more than a good political bumper sticker. We mean it.

Defining the 'Dependency' Issue

There are two associated 'dependency' issues which should be considered before we get to the main course, but I don't think we need to spend a lot of time on them. The first is what is called 'indirect dependency' on China. That is, that adverse developments in China would impact on Australia and our other major trading partners and thus indirectly on New Zealand. The second, though hardly front of mind, relates to 'dependency' on imports, given that China is our largest source of imports and these will be an important part of the supply chain for thousands of our businesses.

The issue of indirect dependency is an issue, particularly when you take into account what I call ‘the triangulation’ of the NZ-Australia-China economic relationship. It arises because of  the intersection of two facts:

•         Australia is actually a larger market for New Zealand exports today than China when you take into account our exports of services to Australia and add that to our exports of merchandise exports. So anything that affects the Australian economy adversely will, by definition, affect New Zealand. Putting all hackneyed trans-Tasman jokes aside, purely for economic reasons a strong Australia is fundamentally in New Zealand’s interests.

•         Australia is far more exposed than New Zealand to a downturn in China, given the vast size of its mineral exports to China. The long-signalled shift in emphasis by the Chinese authorities from investment-led to consumption-led growth (this long predates the fascinating reform directions of the Third Plenum) is already affecting 'hard' commodities' and this is Australia's export strength.

So, there definitely is a danger of 'indirect dependency' here, especially through the triangulation of the NZ-Australia-China economic relationship. But consider the following.
There are rather large practical limits to what we can do about this. Even further diversification of our export effort (which is central to this Government's trade policy) does not avoid the problem. An astonishing 124 countries now count China as their number-one trading partner. If China slows down or worse, all our export markets slow down. Period.  We would be adversely affected even if we did not sell a single dollar of goods and services directly to China.

At market exchange rates, China is expected to pass the US in terms of economic weight around 2020. We used to say 'When the United States catches a cold, the world starts to sneeze'. Correct. Just add the words 'or China' to that phrase and we are where New Zealand always was: a small economy whose economic fortunes will always be affected by global downturns in the major economies of the world. On this question of 'indirect dependency', I am tempted to say 'yes, but tell me something I don't know'.

What is important for New Zealand is to maintain a flexible set of economic, market oriented policy instruments to adjust to external shocks, wherever those external shocks come from. And those signals need to impact immediately on economic actors' decisions - not five years too late when officials and politicians have finally woken up to the fact that the comfortable world around them has changed and this demands policy readjustment. That includes sticking with a flexible exchange rate, avoiding returning to misplaced subsidies in the hope that they provide 'certainty', having competitive energy pricing, good infrastructure and so on. Having a 'competitive economy' is a good shorthand way of putting it.

One of the reasons - though by no means the sole reason - why the disappearance of the UK, a far more dominant market for NZ then than China today- hit us so hard was because we had economic policies in place that came straight out of the manual for a 'Command Economy'. Those hopeless domestic policies vastly complicated the adjustment we had to undertake. Of course, I recognise that there is a whole bunch of people out there who don't get this and are offering New Zealanders a fast policy ride back to the future. Well, to those folk, I would encourage them to reflect a little more deeply, if they are politically capable of it.

We can deal quickly with the second issue - are we becoming too dependent on imports on China? First, recall that ultimately there is only one point in exporting to any country - to provide the foreign exchange to import or, if you have more than you need to pay for your current imports, invest the foreign exchange earned.

And here, as our number one source of imports, China continues to perform a huge positive role in providing New Zealand households and businesses with an increasingly sophisticated range of highly competitive goods and services that they buy from China. Presumably, New Zealanders and companies buy from China only because they believe China offers the best value for their money.

But if, at the margin, China became uncompetitive for whatever set of reasons, there is no real risk here to New Zealand. There is a global market out there we can turn to. It would just cost us a little more at the margin . No, this issue is not about any 'dependency' on China as a source of imports.

The Growth of New Zealand Exports 

Three things have powered the extraordinary growth of New Zealand exports to China: economic development of China, liberalisation of China's economy through their joining the WTO and the bilateral NZ/China FTA, and the enormous efforts NZ Inc. has put in to leverage off the opening of the China market in recent years.

Sustained economic growth in China and the rise of disposable income is the most important by far. I won't quote any numbers. You all know them and have your own favourite 'China statistic' to quote. The only observation I would make is this: it took decades of growth of income in China before it made an economically significant difference to this small trading partner of China's that is New Zealand.

This is worth keeping this in the back of our minds, since I am optimistic we are going to see a whole variety of 'mini-China' stories play out on New Zealand as the extraordinary growth story in the emerging economies plays out, starting with economies like Indonesia, Brazil, Mexico, Turkey, the Gulf States, the Philippines and others. The biggest question of all is obviously India.

But development takes time before it has a large measurable impact on New Zealand. For the moment, our export story is very much a 'China story'. But we live in the era of 'hyper-globalisation' where the Petersen Institute has estimated that over the period 1990-2010, over 70 countries grew their per capita incomes at an annual rate well exceeding the rate of growth of US per capita income.

The second factor is of course the opening of the Chinese market through trade negotiations. Having hundreds of millions of consumers with disposable incomes ready to buy the sophisticated suite of goods and services that New Zealand can produce is not much use if you don't have access to them because of their trade barriers. Those very vocal New Zealanders whose views we read every day on this matter and who oppose every trade agreement I and other New Zealanders have tried to put together, including TPP, don't get this and they never will. I don't know how they think New Zealand is supposed to earn a living in the world.

The first decisive move in terms of our getting far better access to the increasingly well-off Chinese consumer was the conclusion of 12 years of negotiation in Geneva that allowed China to become a Member (technically, 'resume' membership) of the WTO. New Zealand was the first country to conclude bilateral WTO negotiations with China. At one level, therefore, this had nothing to do with our FTA: it is one of our 'four firsts.', as the Chinese leaders put it. But at a political level, it had a lot to do with our FTA. The Chinese did not forget this, and this was one of the political building blocks behind the FTA.

Finally, there is no difference between 'Foreign Policy' and 'Trade Policy' for New Zealand. Get it right, they complement each other. Get one of them wrong, and it is like waving the wrong flag at a bull, so to speak.

The second decisive move was the signing of the FTA in 2008. This was a huge achievement and we today have a literally unique set of agreements in place: a comprehensive FTA with China, a comparable agreement with Hong Kong in place since 2010 and since 1 December last year, a comprehensive economic cooperation agreement with Taiwan.

Our exports to Taiwan have exploded since December, which is hardly surprising since duties were eliminated on entry into force on a very significant set of tariff lines. So if you think of the greater China economic zone, New Zealand is currently better placed than any other country in the world to get access to its consumers.

However, I have always said that an FTA, or an agreement like it by any other name, does not in itself put a dollar on the table, if you don't make efforts to use and leverage it. From the Prime Minister down, Ministers have put enormous effort into leveraging that effort in recent years - have a look at the visas in my passport as one sign.

And it is obviously not just Ministers: our companies and our institutions have lifted their game - sometimes a little late, in my view. We have established the NZ China Council, chaired by the Rt Hon Sir Don McKinnon. NZTE, which has been given considerable new financing, is adding 6 staff to the 62 staff already on the ground in China. MPI is in the process of moving from 1 to 7 staff in China. Divisions working on China in New Zealand are being strengthened. It is a work in progress. Our footprint in China will presumably look quite a bit different ten years from now.

It is however beginning to pay off. From 1992 to 2007, merchandise exports to China increased by an average compound annual growth rate of 12%. From 2008 to 2012 that rate more than doubled to 28% per annum. Last year, exports increased by a mind-boggling 45%. Note incidentally that this was during a period when Chinese growth was 'slowing down'.

That growth rate has to slow. If you extrapolate our current rates of export growth, within a few years we would be exporting more than 100% of our exports to China - a literal impossibility. With respect to our main agri-business exports, we will sooner or later hit supply constraints.

I have been a sceptic for some time of the conventional wisdom around the 'what happens if China's growth rate slows' school of thought. First, because it is not a question of 'if' - China will slow down. No country, with the singular exception of the City State of Singapore, has done otherwise from the Industrial Revolution onwards. Second, because it seems to me to miss the point.

What matters to China's trading partners is the increment of GDP growth, not some abstraction called a 'growth rate'. Today's China's GDP is around US$10 trillion and the rate of growth is around 7%. Yesterday (metaphorically speaking - say 2005) it was half that - US$5 trillion growing at around 10%. So today, the annual increment of growth is around $700 billion, far larger than the $500 billion GOP increment seven or eight years ago when China had double-digit growth.

Sectors 'Most At Risk'

I recently asked MFAT's Economic Division to undertake a more granular analysis of sectors of our export economy that were most 'trade exposed' to China. It is a pretty comprehensive study, so I will draw out only a few of what I think are the key conclusions we should draw from it. Nor will I try to explain their choices of metrics and methodologies. They all look sensible to me. Before joining the dark side and going into politics some ten years ago, I used to do this sort of analysis myself.

There are 18 products that are highly 'trade-exposed' to China (meaning over-weight in trade terms). In 2012, their combined export value was $5.25 billion, comprising 77% of our exports to China that year (which is a lot lower than our 2014 exports).

In 17 of the 18 'most at risk' products, exports grew faster to China in 2012 than the same set of products to the rest of the world. And in some cases we are seeing rapid growth in exports to China associated with declines in NZ exports to the rest of the world.
There is clear evidence of market-switching going on. Crustaceans are among the 'highly trade exposed' categories. Should we be concerned that our exports of crustaceans to the world excluding China fell in 2012? It is not obvious to me why we should be concerned: our exports to China increased 28%. China is simply paying higher prices.

But, you ask, what if China Inc. decides eating crustaceans is 'soooo 2012' and the in-crowd in Shanghai starts eating escargots? What then happens to our crustacean exporters?

Well, I would have thought it was pretty obvious - our crustacean exports (heavily represented by the way by Maori business interests who are going really well in the Chinese market) go back to the other markets and take a price hit. They would not like it, but it is hardly the end of the world.  And since we have a market economy, someone, somewhere in Aotearoa, will think – ‘I wonder if we could export escargots to Shanghai?’

One of the reasons - though by no means the sole reason - why the disappearance of the UK, a far more dominant market for NZ then than China today - hit us so hard was because we had economic policies in place that came straight out of the manual for a 'Command Economy'. Those hopeless domestic policies vastly complicated the adjustment we had to undertake. Of course, I recognise that there is a whole bunch of people out there who don't get this and are offering New Zealanders a fast policy ride back to the future. Well, to those folk, just reflect a little more deeply.

Sheepmeat is another example and of far greater economic importance to our export earnings. When we concluded the Uruguay Round negotiations, and the numbers are ingrained on my mind 20 years on, we bound the figure of 225,000 tonnes of access into WTO law at zero duty. Our exports of sheepmeat to China exploded in 2013 – they grew 95% to a tad under $600 million. As a consequence, we are selling way short of that legally permissible 225,000 tonne figure to the EU. So what do you think would happen to our sheepmeat exports if China Inc., for some incalculable reason, said 'we have gone off NZ sheepmeat'? Well, we are in a University. I will let you work out yourself the answer to today's assignment.

We can see the same thing starting to happen to beef. The figures for CY2013 show declining exports of New Zealand to many markets. But they also show an astonishing 374% increase in beef exports to China to over 35,000 tonnes. No wonder Sir Graeme Harrison, the Chairman and founder of our largest export companies, says ‘sheepmeat is interesting, but for our meat industry, the real China play will be in beef’.

There are exports in this analysis where moving back to the next best priced market would be very challenging. Iron ore is one of them. China consumes around two-thirds of the world's tradable iron and unsurprisingly 78% of our iron ore exports go to China. But this is only 1% of our exports to China. This is a huge issue for Australia. It is a much lesser issue for NZ. But recall the earlier point about the triangulation of the NZ-Australia- China trade flows.

Conclusions:

So what general conclusions can we draw here and what policies should we have in place to take some of the risk out of this situation?

The first and most obvious point is that the core external challenge facing New Zealand is to lift our export performance in a sustained way - hence the emphasis the Government places on export markets in our Business Growth Agenda and desire to lift the ratio of exports to GDP by 10 percentile points by 2025. This is the only way to reduce our addiction to OPM (borrowing Other People's Money) and paying our way in the world. As the Prime Minister has said 'We have proven we can spend like a first world country; now we have to prove we can earn like a first world country'. China is the most important part of a solution to that over-arching strategic challenge; it is not part of the problem.

Because of that we should try to export more, not less to China, and the Chinese are ready to welcome this - hence the agreement at the highest political level between Prime Minister Key and President Xi to the new goal of $30 billion two way trade by 2025.

That said, it does always make sense to look at downside scenarios, while not being overwhelmed by them. If China, for whatever reason, had a deep and sustained economic crisis - and we know from the GFC, the deepest downturn for 70 years for developed countries, that even the richest countries can take nothing for granted - we should accept the obvious: a large economic shock in China will negatively impact New Zealand.

If 124 countries have China as their largest trading partner, it is obvious that we would be negatively impacted even if New Zealand exported nothing to China. I recall saying in 1997 at the time of the then Asian Economic Crisis that if your country was not affected by the Asian Financial Crisis it was a black mark against your country. It meant you had wasted the previous ten years and had failed to become integrated with the Page 17 Asian success story. As far as I recall, only one economy remained gloriously unaffected by the Asian Economic Crisis of the late 1990s: North Korea. So what did that mean? We should have learned from North Korea?

The biggest single risk-minimisation strategy New Zealand can follow is to ensure that our exporters - whether they are exporting high technology medical equipment or infant formula - have access to other markets. That, ladies and gentlemen, is what our pro-active trade negotiation and trade promotion agenda is all about.

As always, New Zealand's trade negotiation agenda is agonisingly difficult to bring to a closure: I have never been associated with an 'easy' negotiation. Everything takes longer than planned. Every agreed time-line gets broken. Frustration is the rule, not the exception. It is unlikely you would get the chance, but if you did, ask the gentlemen who was responsible for getting China back into the WTO. That took 12 years. His Russian counterpart (whom I know extremely well) took 18 years- and there was talk In the Dumas of charging him and his colleagues of treason. The worst I suffer from is continual jet lag.

Absolutely the best insurance policy New Zealand can take out is to complete the TPP negotiations and improve our access to the huge markets that would represent – about 40% of global GDP. And this allows me to return to where we started: the real, as opposed to the imagined, lessons of 1973 when our overwhelmingly important export market, the UK, started to turn away from NZ and legally required us to export less, year by year ('Protocol 18' was the name of this policy instrument).

The real problem was not so much the dependency of our export base on the UK (which was around three times as high as the relative share of our exports to China today). The fundamental problems were twofold:

•         We had no alternative markets - nobody had done very much about exploring what might lie east and south of the English channel and what political and other relationships we might need to develop as a consequence;

•         We had rigid economic policies in place designed to try and 'protect' everything but which ended up protecting nobody.

Ladies and gentlemen, we are in a far, far better space today. We should be celebrating, not fretting about, our economic linkages with China.

Jul 2, 2014