By Ben Power.

Main photograph by Lew Robertson.

Australia is currently locked in tense negotiations with China over a free trade agreement (FTA).

New Zealand has already seized a competitive advantage over Australia after it pioneered an FTA with China back in 2008.

The Australia-China negotiations have been prolonged and experts are divided over whether the current round of negotiations will lead to an agreement between Australia and China.

But amid the intense focus on a possible liberalisation of China and Australia trade, some are asking whether FTAs are the panacea they’re made out to be: do they deliver the major trade benefits politicians promise?

The answer is they do deliver benefits, particularly at the industry level – New Zealand’s dairy industry has arguably been a major winner from its China FTA – but those benefits are not quite as large as expected. There are also downsides.

So many FTAs are being signed by countries around the world that the competitive advantage they bestow on signatories is waning, and some are now calling for countries such as Australia and New Zealand to increasingly focus on other policies to boost export competitiveness.

“We are coming to the end of bilateral FTAs,” says James Laurenceson, deputy director of the Australia-China Relations Institute at Sydney’s University of Technology.

New Zealand’s dairy industry has arguably been a major winner from its China FTA.

The trend towards “bilateral” agreements has been driven by a number of factors, not least their political attractiveness. Prime Ministers love nothing better than announcing a free trade agreement: it makes them look like they’re achieving something.

The drive to sign bilateral agreements has followed the effective collapse of multilateral agreements through the World Trade Organisation.

“Multilateral has ground to a halt,” says Davie Pearce, executive director of the Canberra-based consultancy the Centre for International Economics (CIE), adding the process has stalled because it’s so complicated.

“You have to have the agreement of all parties. Very small countries, no matter how small their trade is, can derail agreements.”

Trans-Pacific Partnership

The Trans-Pacific Partnership (TPP) has been a long time coming, and is still not finalised. The TPP is a proposed FTA between 12 countries in the Asia-Pacific, including Australia, New Zealand and the US. Talks began in 2005 and were meant to have been wrapped up in 2012 but, frustratingly, still drag on.

With the failure of multilateral agreements, countries naturally turned to striking deals with individual countries.

“If you want more liberal trade, the only other option is to pursue bilateral agreements,” says Laurenceson.

Both Australia and New Zealand have been actively striking FTAs.

Australia has FTAs with New Zealand, Thailand, Singapore, Malaysia, Chile and the US, which account for 26% of its international trade.

There has been a flurry of activity this year with an FTA signed with Korea in April and Japan in July, though these agreements are not yet in force.

Australia is also engaged in three bilateral FTA negotiations with China, India and Indonesia. The big one is China.

“It’s not clear at all there will be a resolution,” says Mark Melatos, a senior lecturer at Sydney University’s School of Economics. “At least not this time around.”

But Laurenceson predicted the G20 meeting in Brisbane (underway as Acuity went to print) was likely to be a focal point for an FTA to progress.

“It’s very hard to see how Australia and China would miss the opportunity when Xi Jinping was in Australia for the G20,” he says.

“I suspect it will be a case of the two leaders getting together to sign some documents but DFAT officials being left to ‘tie up some loose ends’.”The process is inevitably complicated by politics, Laurenceson adds.

“For example, Australia wants better agricultural access to China. The problem is that half of China’s population still lives in rural areas and farmers tend to be at the lower end of the income distribution. We’ve seen how difficult opening up agricultural markets has been in other countries, such as Japan and Korea, as well.”

The ANZ FTA

New Zealand and Australia’s pioneering FTA was signed back in 1983.

“That’s where they learnt a lot about those things [FTAs],” says Jason Young, a lecturer in international relations at Victoria University of Wellington, and a research fellow at the New Zealand Contemporary China Research Centre.

New Zealand also has agreements with Hong Kong, Malaysia, Thailand and Singapore, and is in talks with India and Korea.

Young says New Zealand is a small economy, but also very externally dependent. Trade (imports and exports) accounts for 60% of the country’s economic activity, particularly since (like Australia) it liberalised its economy in the 1980s and 1990s and dropped barriers to trade and tariffs.

“It wanted others to do it, too,” Young says.

New Zealand and Australia’s pioneering FTA was signed back in 1983.

He also says that when the UK entered the European Union, New Zealand lost special trade privileges to a market that in the 1950s and 60s made up around 80% of its trade. It had to find other export markets, but that was difficult because of high trade barriers, particularly in agricultural markets. New Zealand saw bilateral agreements as a way of removing some of those obstacles.

Importantly, in 2008 New Zealand became the first country to sign an FTA with China, which has given it a competitive edge over the likes of Australia in industries such as dairy.

Young says New Zealand’s size helped because China sees New Zealand as a safe step –  it is an advanced, western liberal economy, but small.

“If they get something wrong, the fallout is smaller than if they signed with another country,” he says.

Still, Young says policymakers “have been very nimble seeing those opportunities and being able to achieve those agreements”.

Pay off

But for all this activity, are bilateral agreements paying off?

There is a benefit of not being isolated. “There is always a risk everyone else does them and you’ll be left out with no one to dance with,” says Melatos. “The rest of the world doesn’t stand still.”

Melatos says bilateral agreements also create insurance against further protection being launched against you.

“It’s illegal for countries to introduce protection against you, especially if you have those FTAs set up.”

But Melatos says analysing the costs and benefits of FTAs is hard, particularly because they occur slowly: it can take 20 years to reduce tariffs or change the rules. “It’s hard to know for sure what the value is until you have got to the end of ten years,” he says.

It is clear FTAs create closer economic relationships between countries. The benefits are going to be there, he says.

“It’s just going to take a long time for them to come through.”

The CIE’s Pearce has delved into the impact of FTAs on Australia in a detailed report, The Impact of Free Trade Agreements on Australia. He agrees it is hard to say in a general sense what an FTA generates in terms of benefits to countries.

“Most of our analysis shows there’s a net positive, but there’s a few trade-offs along the way,” he says.

Pearce’s modelling found that FTAs that include Australia increase Australian exports, production and GDP relative to what would have been the case without the FTA. At the same time, Australian exports suffer when other countries strike FTAs that don’t include Australia.

Melatos says FTAs stimulate trade, “but probably not as much as you might have thought, initially”.

Industry booster

Melatos says that, while the macro benefits might be uncertain, FTAs can have bigger effects on individual industries. He points to the impact on New Zealand’s dairy industry of the country’s FTA with China.

“That expanded their trade in dairy,” he says. “For them there has definitely been a lot more trade in dairy.”

Victoria University of Wellington’s Young agrees the China FTA has benefited the country, particularly its dairy industry.

“The answer is yes,” he says.

“There is evidence that New Zealand’s agriculture, particularly the trade with China, has grown by huge amounts post-2008.”

"Generally we consider trade liberalisation to result in mutual benefits for both partner countries and associated industries."

According to Pearce’s report, Chinese imports of dairy products have grown significantly since 1995 and in particular since 2008, with the growth driven by imports from New Zealand after the FTA was signed. But it also coincided with melamine contamination in Chinese dairies which meant quality imported products were preferred.

In 2007, New Zealand provided 39% of dairy imports to China; that had increased to 63% by 2012. Australia provided just 5%.

Executive Director of the Dairy Companies Association of New Zealand (DCANZ) Kimberly Crewther says it is difficult to quantify the benefits to the NZ dairy industry of a particular FTA.

“Generally we consider trade liberalisation to result in mutual benefits for both partner countries and associated industries,” she says.

“Tariff reduction creates an opportunity to trade more readily, as does the improved alignment between trading partners on technical related matters, and the improved business relationship for trade often spills over into increased two-way investment.”

New Zealand's benefits

In the case of the New Zealand-China FTA, Crewther says the New Zealand dairy industry has had a tariff preference which has supported its position as a supplier in comparison to other potential import sources.

“This has enabled the New Zealand industry to play a significant role in responding to China’s growth in demand for imported dairy products in recent years,” she says.

Crewther says the FTA has also supported an increase in two-way investment in the dairy space.

“For example, Fonterra has made investments in China, while Shanghai Bright and Yashili have invested in New Zealand.”

Australia’s wine industry has also benefited from FTAs, including its FTA with the United States, but by exactly how much is also uncertain.

“It’s always difficult with these things to say when there’s been an increase in sales to a particular market to allocate that benefit to a particular cause,” says Steve Guy, general manager of regulatory advice at the Australian Grape and Wine Authority.

“I wouldn’t like to say it’s the FTA agreement with the US to explain our strong showing there. We welcome that agreement nevertheless.”

Guy says there was a clearer outcome from Australia’s FTA with Thailand. At the time of negotiations, the tariff on imported wine was 54%; that falls to zero at the start of next year.

“Our competitors, at least some of them, are still facing 54%, including Europe,” Guy says.

“Thailand is probably the best example where we have been able to achieve a significant advantage, which has certainly been reflected in our sales to Thailand.”

But, Guy says that FTA tariff reductions aren’t a panacea. Wine sales to Thailand face other problems including political unrest and possible moves to introduce graphic health warnings on alcohol labels.

Australia's benefits

Australian wine will win from an FTA with China, according to Guy. China is Australia’s third-largest market for export wine, but it imports more expensive wine than any other country. China slugs packaged wine with a 14% tariff, which hits high-quality Australian wine hard. Of course, New Zealand wine doesn’t face the tariff, but Guy says that overwhelmingly the market in China is for red wine.

“New Zealand primarily exports white wine. They were in there first [with the FTA] but they can’t get the optimal benefit.”

Guy says that, while as with the US FTA, the outcomes can be uncertain, the wine industry always welcomes and supports the government striking FTAs.

When it comes to an FTA with China, “we definitely would be encouraging and welcoming an announcement from the government that those negotiations will be concluded”, Guy adds.

But FTAs aren’t all upside. Pearce says a downside is what’s dubbed “trade diversion” – if a country lowers tariffs against one supplier (country A) but not against another (country B), then you could get a situation where the country ends up buying the product from country A, even though country B is the cheapest supplier.

"Downsides of FTAs may include administrative costs, keeping track of where imports come from, and dealing with complicated rules of origin issues."

“Whether this happens depends on the tariff rates being changed,” Pearce says, though he notes that, for Australia, most FTAs seek access into export markets, so trade diversion is not a major issue.

Other downsides of FTAs may include administrative costs, keeping track of where imports come from, and dealing with complicated rules of origin issues, Pearce says.

Both Pearce and Laurenceson believe Australia will benefit from an FTA with China. Pearce’s modelling found it would boost Australian exports to China, particularly for goods such as cotton and wool.

“Yes, we’ll benefit,” Laurenceson says. “Any time you lower trade barriers to create trade opportunities benefits will flow. And this is magnified by the fact that 36% of our goods exports go to China. That’s more than the share of our next five largest customers combined. Of course, bilateral deals are never as good as multilateral ones – even with China being an important trading partner, 64% of our exports will be unaffected.”

Benefits on borrowed time

So overall, FTAs have benefits for countries and certain sectors, but those benefits might be on borrowed time. If everyone starts striking bilateral agreements, then countries lose their competitive advantage. Melatos says a map showing bilateral trade agreements has been described as a “messy spaghetti bowl” because there are now so many. “If everyone else is doing it, the pay-offs are certainly going to be less.”

“Once China is done we’ve more or less done as much as we can in the bilateral space,” Laurenceson says.

But nations like Australia and New Zealand can’t turn to multilateral agreements, says Laurenceson.

“The appetite [for multilateral] is probably quite low. If the appetite was strong the WTO would have accomplished more over the past decade. I wouldn’t be getting too excited about the prospect of another round of big WTO liberalisation.”

So what do countries like Australia and New Zealand, who have unilaterally cut protection, do?

“All you can do is try and make your outputs as competitive by other means,” Laurenceson says. “You can’t rely on tariffs being cut to make your products more competitive in China.”

This article was first published in the December 2014 issue of Acuity magazine.