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No need to take a softly softly stand on China

John Lee

LAST October, Tony Abbott raised some eyebrows in declaring Japan to be Australia’s “best friend in Asia”. Then in November, Foreign Minister Julie Bishop pulled few punches in criticising Beijing’s newly declared air defence identification zone in the East China Sea that covers a group of islands administered by Japan but is also claimed by China. And in a speech late last month to a Washington think tank, Bishop argued that the US and not China was Australia’s single most important economic partner when one combined trade with investment between the two countries.

If such logic is applied, then Japan rather than China emerges as our single most important economic partner in Asia.

The Coalition’s diplomatic approach towards China and its analysis of Australia’s economic interests and relations in the region is sure to come under persistent fire. Such criticism will be founded on the popular narrative that a rising and economically dominant China is fundamentally changing strategic relations in Asia, and that the Coalition ought to accept reality and pursue a far more softly softly approach to China’s rise. But closer reading of some economic facts, and regional trends, suggests that it is this popular narrative and not the Abbott government’s approach to China that ought to be reassessed.

Let’s begin with the economics. China has emerged as the largest trading partner of many countries in Asia including Japan, South Korea, Vietnam, Malaysia and Australia. It is the largest trading partner of the US and India in Asia. Could it be that Bishop’s methodology of including investment in addition to trade to assess importance is just a convenient sleight-of-hand to underplay China’s economic dominance?

Not so. Trade is important. But it is a series of short-term, and in the best case, recurring and increasing transactions that hopefully benefit both parties. But once the transaction is completed, the relationship ends. Exporters do not inherently care who they sell to, and importers are not inherently interested in who they buy from as long as the transaction is fair and reliable.

An investment relationship is very different in the eyes of governments and firms. From the firm’s point of view, foreign direct investment is an investment of considerable capital, manpower and the firm’s brand and reputation in a foreign jurisdiction and political-economic system for a substantial period, meaning that it is a far better indicator of economic integration and intimacy than trade. Getting out prematurely invariably will entail a significant sunk cost and loss of the firm’s and management’s reputation. Any private or government-owned firm – generally in step with its own government’s advice – needs to be confident about the economic opportunities available in that country. It’s also a vote of confidence in the present and future stability, fairness and trustworthiness of that political-economic system, and an indication of faith that the firm’s equity, interests and promised commercial access will be protected by the host government.

So let’s look at some numbers. China makes up just more than 3 per cent of all Australian stocks of foreign direct investment. Compare this with the US and Japan, which make up more than 24 per cent and 11 per cent of Australian FDI respectively.

Then take a look at some so-called “strategic swing states” in Asia. In Indonesia, Chinese FDI makes up just more than 1 per cent of the cumulative total, compared with 27 per cent of FDI coming from Japan. In Thailand, stocks of FDI from Japan and the US is 38 times and 11 times larger, respectively, than from China. In Malaysia, Japan and the US are behind 15 per cent and 4 per cent respectively of all FDI, compared with a minuscule 0.5 per cent from China.

Even the booming bilateral trade numbers Asian states have with China conceal the fact more than half of it is “processing trade”, where parts are shipped in and out of these countries, with the final product destined for consumer markets in advanced Western economies. In other words, the buying power of Americans and Europeans remain the dominant driver of trade between China and its major Asian economic partners.

The upshot is that the feared strategic leverage that China can exercise from its perceived economic dominance is way overstated. Even when it comes to commodity providers such as Australia, any attempt by Beijing to restrict imports of Australian iron ore, for example, would merely enrage its powerful steel mills and other giant firms, and cause immediate, damaging and politically dangerous disruption to its economy. This is the reason iron ore exports to China broke records even as the diplomatic relationship between Canberra under Kevin Rudd’s tenure and Beijing from 2009-10 reached a generational low.

Finally, in an environment in which not a single significant regional power has realigned with Beijing and away from Washington, as the popular narrative would have it, lowering expectations that China can gradually seduce or else coerce Australia away from the latter’s traditional strategic alignments – which the Coalition government is doing – makes sense.

In fact, breaking from the regional pack and raising false expectations in Beijing that Canberra is ready for strategic change is the greater danger, and only will end up enraging Beijing and annoy other regional security allies and partners.

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