The Business Council of Australia’s (BCA) Jennifer Westacott has published a rather Panglossian view of Australia’s free trade agreement (FTA) negotiations in locked-BS, which she argues are unambiguously in Australia’s national interest:
The government’s conclusion of a free trade agreement with Korea is the first down-payment on an ambitious but achievable trade agenda that is clearly in Australia’s national interest…
As a medium-sized, open economy, Australia has long relied on trade and investment to support our economic growth and prosperity. The figures are well-known: one in five jobs in Australia is related to trade, and numerous international studies have shown that trade liberalisation is a strong engine for job creation and higher wages.
A combination of the government’s commitment and pragmatism in advancing trade negotiations, alongside relatively favourable political and economic tailwinds from a number of key trading partners, offers a rare window for Australia to conclude several important agreements that will give us a loosely formed free trade network with our key north Asian partners…
By this time next year, we could have concluded preferential agreements with our two largest export markets – China and Japan – as well as the Trans-Pacific Partnership Agreement (which alone brings together 12 countries, accounting for 40 per cent of global GDP, and includes five of our top 10 trading partners)…
The quicker we can conclude free trade agreements with our largest trading partners, the sooner all Australians will benefit from increased access to Australian goods, services and investment from some of the world’s biggest markets.
While FTA’s have the potential to offer modest trade benefits, they are by no means a slam dunk, and the Government should exhibit caution in pursuing them on both equity and efficiency grounds.
Importantly, an FTA with a trading partner that is not the lowest cost producer risks creating “trade diversion” – effectively a situation whereby the importing country shifts its buying from a more efficient, lower cost country whose goods are subject to a tariff towards the less efficient and higher cost FTA partner whose goods are not subject to a tariff. In such circumstances, the importing country loses the tariff revenue, whilst its consumers do not fully benefit from a price reduction, potentially making them worse-off.
In order to explain, consider the below stylised example.
Country A imposes a 10% tariff on motor vehicles and, prior to the FTA, imports these vehicles at a cost of $20,000 from the World, taking the total import cost to $22,000, and earning its government $2,000 per vehicle in tariff revenue.
Country A then negotiates an FTA with Country B, who is less efficient at producing motor vehicles, and can produce a virtually identical car for $21,500.
After the FTA is concluded, Country A shifts its car purchases from the World to Country B. As a result, the total import cost of motor vehicles into Country A falls to $21,500, providing consumers with a benefit of $500 ($22,000 less $21,500). However, the government loses $2,000 in tariff revenue, making Country A worse-off overall.
Obviously, this is simple stylised example only, designed merely to highlight one of the potential costs of FTAs via trade diversion. But these efficiency costs can be real, especially when FTAs are negotiated with parties that are not world’s best producers in goods and where high tariffs exist (e.g. clothing and footwear).
As a general rule of thumb, FTAs will provide greater benefits when they involve complementary economies – that is when the exports of one country coincides with the imports of another – which lessens the potential costs from trade diversion. Thankfully, a quick examination suggests that FTAs with China, Japan, and Korea would contain considerable complementarity. The three countries are Australia’s biggest export markets (mostly commodities), whereas their comparative advantage lies in manufacturing goods where Australia is largely uncompetitive (e.g. low margin manufacturing, electronics, etc).
Another cost associated with FTAs is the complex rules of origin (ROO) that are typically attached to such agreements. ROOs are designed to stop imports coming from third party (non-FTA) countries via an FTA partner, in order to circumvent tariff requirements. The ROOs, which can be either based on value-added requirements (i.e. the percentage of value-added by the FTA partner) or product specific (i.e. individual rules for each individual product imported), can raise administrative costs for businesses (including complying with paperwork requirements) and custom services in administering and auditing the ROO, undermining the benefits from the FTA.
In general, the costs associated with complying with ROOs will be greatest where there is a large number of FTAs each with different requirements, resulting in a “spaghetti bowl effect” of increasing complexity.
Given the apparent high degrees of complementarity with Korea, Japan and China, FTAs with these nations would appear beneficial for Australia. But as always, the devil will be in the detail.
A big risk is that in setting a one year deadline to conclude negotiations, the Abbott Government could forgo quality. The Australia-US FTA is a case in point, whereby the Howard Government accepted a sub-standard deal for political reasons, which saw large chunks of agriculture carved-out, draconian price-based safeguards protecting US horticulture (see Annex 3A), as well as complicated product ROO numbering hundreds of pages.
The Australia-US FTA also highlighted other potential hazards creeping into modern FTAs: the inclusion of non-trade provisions, such the extension of patent and copyright terms, which will increase costs for Australian consumers over the longer-term, as well as (rightly or wrongly) relaxation of foreign ownership restrictions.
As argued previously, great dangers also lurk beneath the proposed Trans-Pacific Partnership FTA, which risks establishing a US-style regulatory structure that hands considerable power to US pharmaceutical and digital firms, at the expense of Australian sovereignty and consumer welfare.
There is also the current negotiations with China, which are quite likely to run aground on political tensions arising over the Abbott Government’s strong shift to US foreign and strategic policy and the Government may be tempted to give away more than it should to overcome the resistance.
The bottom line is that the Abbott Government’s FTA agenda offers modest trade benefits if executed well. However, they could equally result in poor outcomes if the Australia-US FTA approach is adopted, and deals are signed for political rather than economic reasons, without due regard for longer-term consequences. Motherhood statements by the BCA only serve to gloss over these truths.
