What China Wants by Sam Olsen
What China Wants Podcast
Episode 27: The Great China-Australia Trade Spat

Episode 27: The Great China-Australia Trade Spat

Unpicking the truth with Dr Naoise McDonagh

Hello and welcome to Episode 27 of What China Wants, looking at the recent trade issues between China and Australia.

Not the best of times for Australian wine exports to China. Source

Stewart and Sam are joined by Dr Naoise McDonagh from the University of Adelaide, who has a particular focus on economic coercion and sanctions.

Some highlights from our discussion:

  • Until recently China andAustralia had a good relationship, including a 2014 visit by Xi Jinping to Canberra that was warmly received. A free trade agreement was signed, and China went on to account for more than a third of Australian exports.

  • But things began to worsen in 2018 or so, as Australia became worried about increased Chinese posturing, for example over the South China Sea. Canberra was the first country to ban Huawei on security grounds.

  • When the Australian’s called for a Covid enquiry in 2020 this took the relationship down even further, and China brought in large scale punitive import tariffs and bans.

  • But Australian losses weren’t that great as they found other markets, on the whole.

  • A consequence of this icing-over of the relationship is that Australia is increasing its security relationship with China’s rivals, including the US, the UK, and Japan.

  • Despite the tension, the chance of a massive economic decoupling between China and Australia without war is slim because of the depth of need for each other. But the relationship is changing.

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As always please do share, comment, and subscribe. We’ll be back soon with more What China Wants.

Many thanks for listening.


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Here is the transcript:

Stewart Paterson: Hello, and welcome back to What China Wants with me, Stewart Paterson, and I am joined as always by Sam Olsen. Good morning, Sam.

Sam Olsen: Good morning, Stewart.

SP: So we have talked a lot about the economic relationship between the West and China, and the rising use of geo-economic policies to try and influence the behaviour of nation states. We have tended to look at it through the prism of China's influence attempts on European and American nations. But today, we are joined by Dr. Naoise McDonagh, from the University of Adelaide and the School of Economics and Public Policy. Naoise is an expert in China's geo-economic policy, particularly obviously, towards Australia, with a core interest in studying economic coercion, sanctions and security-driven investment screening. Welcome, Naoise.

Naoise McDonagh: Thank you very much, Stewart, pleasure to be here.

SP: So Naoise, our audience, they might not be quite so up to date with China-Australia economic relations. So I wondered if I could just kick off by asking you to set the scene somewhat, by describing to us the sort of depth and nature of China-Australia economic relations as they stood a couple of years ago?

NM: Yes, so Stewart, their relationship is built on very deep complementarities. If we go back a decade, in 2009, so China had been in the WTO for nearly a decade, it was on its precipitous growth path. And in 2009, China surpassed Japan as Australia's largest export market. So total exports in 2009, were AUD 42 billion, this is quite substantial. And so, we see China is already changing relationships in the region by this time. The relationship just gets stronger and stronger from that period, so the political relationship is actually quite good. In 2014 Xi Jinping visits the Australian Federal Parliament, he gets a great welcome, he delivers a speech in the parliament. They signed a memorandum in 2014 for free trade agreements. So that's China-Australia FTA, ChAFTA as we call it down here, that entered into force in 2015.

From there, the relationship continues to go from strength to strength, the resource boom in Australia takes off with iron ore and coal. China is just hungrier and hungrier for these building block resources, and Australia is able to provide them at a very high rate of productivity. And so by 2020, total goods and services to China are hitting AUD 159 billion, this is 35% of all of Australia's exports in 2020. If you compare this with Japan which is sitting at 12% in second place, the Republic of South Korea is at 5.8%. If we take total two-way trade in 2020, it is AUD 245 billion. This is one third of all of Australia's trade with the whole planet. The US is a distant second at AUD 280 billion, and Japan comes in at AUD 66 billion. So you really see the scale of this relationship, how it's developed from 2009. All the way along, it is the resources that have underpinned this, they are the main component of all this, they are a massive component of Australian national wealth.

So, so far, so good, this is all great you think. But there are problems that are starting to brew from around 2018. China has kind of risen at this point, it is becoming geopolitically more belligerent, it is trying to set its own path in the region as a hegemon. Australia is alert to this. It is the first country in the world to ban Huawei - this is in 2018, for the 5G security risks. Already, this starts to deteriorate the political relationship. By 2020, the relationship is breaking down further, the issues in the South China seas are problematic. Australia's alliance with the US on a security relationship is becoming more problematic for Beijing. And then of course, there is a call for an independent COVID inquiry in Australia. So, this is the breaching point, the kind of asymmetry between booming trade relationships and a steady and consistent breakdown in the political relationship.

SO: So Naoise, just in terms of the politics you were just mentioning there, what people might be interested to know is where was this sort of change in politics been driven from? You mentioned the breakdown in the relationship there, but who was doing more of the running? Was it the Australians who were trying to change things on a political level and being pushed back on by China? Or do you think the Australians were reacting to what China was trying to do? The reason I ask about that is, do you think that this is a political relationship, which is, in effect, broken by what has happened in the last few years? Or do you think that actually it is more posturing from either side that can actually be repaired?

NM: It is definitely a reaction on the Australian side and within the region. Everyone is reacting to a more geopolitically self-assured China. This changed around 2017-2018. The diplomatic stance within China changed, there was a shift in the political narrative that it was time to be more geopolitically active, to move away from this kind of Deng Xiaoping terminology of 'bide your time and hide your might' which was the dominant discourse in China during its WTO early period of growth and development. Then China started to build up the resources and become more active, standing up as a geopolitical great power in essence, which is what China's self-image is of. It feeds off of its past as the Middle Kingdom and a historically great power, and Beijing now feels that it is its time to actually become that again.

So it was in the South China Seas, it has been pushing back, it has its nine dash line. People may not know about this, but it pulled out a map it claimed, showed, historically, that China owned a big portion of the South China Seas, including parts of it that are otherwise given by the United Nations Law of the Sea to other littoral states, such as the Philippines, Vietnam, and so forth. So it basically claimed the whole South China Sea. This is very threatening, massive military buildup over the last 10-15 years. Of course, small states always get fearful when big states engage in large scale military build-ups and start claiming territory.

So it is definitely a reaction, and China is counter-reacting, because it doesn't like Australia making a point to push back on Huawei, to push back and say you need to obey the United Nations Law of the Sea for example. In China's view, and this is what we see in the analysis of its system, it had, in a way bestowed many gifts on Australia through its trade agreements, buying all these resources, and it kind of expected, I think, a more pliable Canberra. But Australia is looking out for its national interests and inter illegitimate.

SP: So Naoise, you have painted this great picture of, a deep economic engagement, then this this level of political pushback against sort of 'Chinese rejuvenation', for want of a better word. Can you just describe to us then what form did the attempts at economic coercion take that China tried to push on to Australia? And what was the public reaction to that? Could you in any way, shape or form say that these geo-economic policies have worked from a Chinese perspective?

NM: Stewart, so I think let's take the tools used, the sanctions applied in the first instance. China has a well-established playbook in this regard. It has been using what we would call informal sanctions for last decade, quite regularly against different countries, normally for political reasons - so they are economic measures for political reasons. And in the case of Australia, essentially what it did in 2020, it first indicated, and this is common publicly, the Chinese ambassador to Australia indicated that, and I quote, "maybe the Chinese people will no longer want to consume Australian wine or beef", big quantities of each being exported. This was the first indication when we heard about it, there might be a call for an independent inquiry.

This is a pattern I have seen elsewhere with China. It flags up these coercive tactics, then the call for the inquiry was made, so they followed through. Essentially what they did was they targeted eight key commodities, and they chose commodities that would do the least amount of damage to China's economy and impact maximum political damage to Australia's economy. In particular, they were looking at agricultural exports, because the coalition government at the time has a strong base outside of the major cities, and in the agricultural areas. It also avoided completely things like iron ore because it is completely dependent on Australia for iron ore. So things like coal, copper, wine, beef, barley, and some types of wood and rock lobster - that comes from South Australia where I am based.

They were targeted, and initially, export revenue fell by about AUD 5 billion from July 2020 to February 2021, compared with trade as usual. So, this is a pretty extensive amount of trade losses for Australia. We had a research paper here at the Institute for International Trade in the school for Economics and Public Policy. We extrapolated out that these annualised losses would be a notional AUD 23 billion. That's 1% or thereabouts of Australian GDP. So again, you think, "Wow, this is very big." Now for some individual sectors, this was initially a very devastating blow. But what we found out over time is that actually the notional losses were far bigger than the real losses. And so if you want, before we talk about the impact, I could perhaps go into that a little bit Stewart, what do you think?

SP: By all means, because we often hear about these policies but quantification of the impact, or accurate quantification of impact is actually quite hard to come by. I do think that our profession has not necessarily covered itself in glory, in terms of actually being able to explain to policymakers and the general public, what the economic welfare losses through sanctions, or a breakdown in trade relationships, generally actually amount to.

Australia has shrugged off most of China’s trade punishment. Source: FT and Lowy.

NM: Yes, so as I said, the notional losses are very big, but markets are actually very adaptive. Who would have thought that, right? So these are private sector firms involved, and so essentially, there is a very good paper on this by three Australian scholars titled "Market adjustments to import sanctions: lessons from Chinese restrictions on Australian Trade 2020-21". So they looked at this whole period, and essentially they asked, under what conditions do high levels of export concentration in a single market generate political vulnerability to economic coercion?

Now, this is a question that has relevance to the whole world, because China is the largest trade partner now for about 120 or 130 countries, for a majority of world countries. So how vulnerable was Australia, and what was the actual impact? So essentially, they are saying that there was three ways that the markets and Australian businesses adapted. There was trade reallocation, so sell products to alternative markets; trade deflection, so you get around sanctions by using intermediaries; and then just product transformation - there, you just have to alter your product enough so it is not covered by the sanctions.

That is simple enough in principle, but there are a few more criteria, which I will just go through. So reallocation, that will work if there are tight global markets in particular. So think about coal, there is X amount of global demand for coal, there is X amount of supply. So the minute China says, "we're not taking Australian coal anymore", that does not change the nature of the global market, and in fact, creates trade shuffling. Essentially, what happened is the price of coal went up in China because it does not have the same options for supply. Indonesian coal exporters started sending coal to the higher market, it created a gap in India and Australian coal sellers sold at a lower price but still sold their coal into India, so you get trade shuffling. This also happened with Australian copper, China started to draw on Chile for copper, which opened up gaps in the US, the EU, and Japan. It also happened with barely and all of a sudden there were gaps in the Middle East, so you get this trade shuffling effect.

SP: And Naoise, just for our American listeners, of who there are many, this would be fairly similar, I suspect as to what happened with the soybean sanctions during the Trump administration - although not necessarily sanctions, but the tariffs that China put on the farmers there. A global commodity, supply and demand conditions have not changed as a result of the geo-economic policy, so there is a clearing price, and it is just that different people are going to be buying produce produced from a different source of origin as it were.

But obviously, during the soybean crisis, what seemed to happen was a massive culling of the sort of hog stock in China at the same time, which meant that soybean prices collapsed, not because necessarily of the economic sanctions, but because of a dislocation in the market, and this could have led to some misinterpretation as to the impact of the actual Chinese policy there. So is Australia perhaps offering a bit of a counterbalance to the narrative that was put forward at the time, regarding American soybean prices?


NM: No, that is absolutely right. And so, along with the trade reallocation, then you have the deflection. Rock lobster was a massive export from South Australia, but it had become a very non-substitutable demanded good in China because it has a quite unique taste. So, when that got sanctioned, imports from China went down to zero, exports to Hong Kong suddenly ramped up 200%. All of a sudden, there was a massive draw-in from Hong Kong, and this ended up being smuggled into China because the demand still existed. Now that also would rely on how well it can be enforced, and how well a border can secure itself from smuggling and so forth. In this instance, there was a good possibility, and so a lot of the rock lobster went into China anyway.

The other one that we have seen in the Australian case, Stewart, was the transformation. This, again, will work best if you can quickly and quite easily turn a particular product into an adjacent product category - I will give an example in a moment - without any massive kind of reorganisation of production or our major costs. So in this instance, logs, wood timber logs, were basically banned from Australia, and they could quickly and easily be turned into wood chippings, which were not banned. And so again, the was not such a big impact, and so the logs were actually able to be transformed.

Now, I will say that there was a particular product that was hit hard, and this is premium wine. The premium wine market got hit with anti-dumping tariffs. So this was not an informal sanction, this is actually technically WTO-allowed sanctions. So the Chinese claimed the Australian wine was being sold below market prices. Australia can challenge this in the WTO, it would take many years. So they put on 200% anti-dumping tariffs, and that killed off the premium wine trade very quickly. This was bottled wine, and China was a really good premium wine market for the Australians, they were getting top dollar prices they cannot get anywhere else in the world. They had opportunities to bulk sell it in 24,000 litre cartons, but there were issues there, then with quality and brand, as this could impact their brand so they did not really want to do that. So that has been a big hit for the winemakers, they will actually have to put in the hard yards and build markets globally to be quite frank.

SO: Wasn't the fallout of that a massive increase in premium wine sales from Australia into the UK? Didn't that help to deflect some of the impact from China?

NM: I did not hear that it was on the scale that they were getting in China, but I may not have the top figures on that one. I do not think it was replaceable at that scale.

SP: I think that is actually just Sam's bias there. I think he was doing his best to try and make up for the...

NM: ... a personal stockpile.

SP: Yes, exactly.

SO: I was trying to help, yes. On a more serious note, one of the things you mentioned there was about Hong Kong. And what Stewart and I have spoken about previously on this podcast is the potential for Hong Kong to act, to restore is traditional role as a gateway to the West from China, if things start to go a bit more pear-shaped in terms of Western-Chinese relations.

What I mean by that is that if there were big sanctions between America and the UK, and Europe etc. with China, and things got shut down in terms of normal trade between China and the West, would Hong Kong still be allowed to act as an entrepot? And one of the reasons we think that might be on the cards is the fact that they have not so far implemented the counter-sanction laws in Hong Kong. But just in terms of a dry run on things, when Australia was hit by these tariffs, did trade with Hong Kong remain unaffected? And can you see, therefore, that Hong Kong might continue to act as that bridge between China and Australia specifically?

NM: Yes, that is a good question Sam. Definitely, the sanctions did not apply, for example, in the rock lobster case, we could see they could import them at any number they wanted, and then they were being smuggled or re-exported as another type of product. Hong Kong is still in this grey zone kind of place. In many ways people say, look, it's just another province of China now, and I think that is true in terms of the political repression, but it still has its slightly different status in terms of the sanctions did not apply to Hong Kong, it still has that kind of semi-entrepot status. I do not think that is anything you can rely on, and I think if China wanted to, they could quickly turn that off in a particular instance, that autonomy, if they really wanted to turn the taps.

SP: So Naoise, if you are looking at this from a Chinese perspective, they implemented these economic policies, these geo-economic policies if you like, to try and influence Australia's stance towards China. Would you say that they have worked in terms of how has the political attitude, both amongst elites in Australia and amongst the populace as a whole, changed towards China? And can we attribute any of that sort of dynamic in political attitudes to the geo-economic policies that China implemented?

NM: Look I think we find in this case, as we often find in many historical cases, that sanctions tend to bring countries together, they make them more psychologically determined and resilient often. This has been the case in Australia, there has been an absolutely strong and resilient bipartisan agreement between the main political parties on the need to continue their strategic deterrence actions - that is building relationships with Japan, India, a resilient supply chain initiative, for example, with those two countries, their military alliances, their relationship with the US.

They are building actually quite a deepening military relationship with the Japanese as well. They have recently signed a reciprocal access agreement, the Chinese do not like that. Federal Defence Forces recently announced a type of commitments that really mimics the language used in Australia's ANZUS agreement, which is Australia, New Zealand and the United States, which is a self-defence type of agreement, and a commitment to engage when there are risks in the region. So they have continued with all of those.

When the New Labour government came in, in the very recent federal election, they have continued the same policies. They have changed her tone, they communicate differently - some say the last government was very poor at its communication strategy, and that needlessly created frictions - but the new government has kept the same policies in place. The order of the day, Stewart, has been what they're calling 'strategic patience'. We are not going to back down on any of the issues that China has raised when it sanctioned Australia, from Huawei through to its different alliances, and they have not backed down on anything.

Actually, I do not know if you have heard about this in the UK, but at a certain point, about a year ago, China released this infamous 10 point list of what Australia had to do to get back in the good books for the relationship, including clamping down on it media, clamping down on its independent politicians, controlling them, telling them what to say as if it was a single party, authoritarian political system. And this was completely just like, this is the wrong approach you would take with any democracy and least of all Australia. So they have maintained their policies, they are stricter on their foreign investment reviews with Chinese companies, and they are not backing down. In the end, actually, so the relationships has gone down, down, but it seems to have stabilised at this low point in recent weeks. And China has even said they are willing to talk now without preconditions. They have not lifted any of their sanctions, but they are willing to talk now.

Would AUKUS have happened without increased Chinese posturing in Australia’s near-abroad? Source

SP: Just within the rest of the region, one of the observations that we have made on this programme before has been the reluctance of particularly ASEAN nations, but just generally in Asia, there is a strong and perhaps understandable reluctance to sacrifice economic welfare for the purpose of what some people see as a sort of futile resistance to China's hegemony within the region. Can you point to any evidence in the rest of the region that Australia's bold stance here where they have really gone on the front foot in terms of not capitulating on anything, has started to rub off on other countries in the Indo-Pacific region?

NM: I think the deepening relationship with Japan is a reflection of the fact that Australia is seen to be someone that you can rely on, that they will hold true to what they say. I think this is a very, very important relationship. It has been a long-time important trade relationship, but the political relationship has become very important in recent years. The India relationship is really blossoming, and they made a kind of limited trade type of agreement. It is not really a full free trade agreement, but they made some concessions economically to boost that relationship. The political relationship is very strong, and they are working towards a Free Trade Agreement, which is something very hard to do with India. So I think, again, India sees Australia as a reliable partner, someone you can work with in the region who can help you as a deterrent power-balancing scenario.

Because everyone in the region is afraid of China becoming too powerful. Now, a lot of the other countries they are all trying to walk that narrow strategic line. They are trying to be on friendly terms with China, but nobody wants to see China get all its own way in the region. I definitely think Australia sets a good example in that way, that you can take the coercion on the chin. In the end, it did not cost as much, but they did not know, we did not know that at the start. Those big losses, initially, is what we thought was going to happen. So I think being willing to ride it out, looking at the ways markets can adapt, I think the nations in the region are looking closely at that example, the politics of it and the economics, I think it is a really interesting case study.

SO: So do you think that if relations do continue to sour between China and the West, do you see a moment where the economic side the economic relations becomes untenable between Australia and China, and actually, there is a forced decoupling between the two? And if so, what would the impact on Australia be? I mean, surely they cannot find new trade partners to make up for what they would lose with China, right?

NM: Look, anything can happen, it is all about probabilities. What is the probability of something happening outside of war? I do not think there will be a full decoupling with any nation that has a large trade relationship with China. That is just my own thinking on it. Even with the Russia situation, that did not happen until it was a full-scale invasion of all of Ukraine, they were allowing Russia to take bits and pieces. In the China situation, that is not the issue unless they try to take Taiwan. So, I do not think that relationship will be full decoupling, neither with the US, neither with Australia. The economic interests are so deeply ingrained and tangled.

I think, what we will have ongoingly over the next decade, and hopefully the war scenario does not come true ever, strategic decoupling of high technology and critical minerals that are really strong geopolitical leverage - for example, lithium critical minerals needed for green technologies. So you have got to have reshoring and friendshoring to some extent. You will have that strategic decoupling, but you are going to have pragmatic realism. The Midwest in the US wants to export its agricultural products, China needs them. So they are going to continue. Same in Australia - iron ore, again, iron ore is the great story here, it is about half of the trade exports to China at any given moment from Australia, are iron ore, worth tens of billions, and this is a massive component of Australian wealth.

So I think pragmatic realism, I will just give you an example there, actually, Sam. So very recently, this is only a few days ago, it was announced as a joint venture between China's Changxing, lithium miner, and an Australian miner in Western Australia. They also have deals with a Chilean miner and with a US firm so Australia has got all those three big lithium players actually now in Western Australia.

And actually, the Chinese firm has a lot of valuable knowledge. They have been doing the lithium, the high-grade processing for the last decade, so China dominate that whole supply chain. So in this instance, the Australians will probably get the knowledge transfer from the Chinese side. I do not know exactly how that deal is structured, what the ownership ratios are yet, but that is pragmatic realism and I think we are going to see more of that. There was no big kick-off, of course, nobody was saying this is this is a major strategic or national security risk. It was just reported on it, and it's happening.

SP: So Naoise thanks very much indeed for these wonderful insights. But you know, as an Australian looking at what is going on in Western Europe and the United States, do you have a sense that we are behind Australia, both in terms of the degree to which we felt the sharp end of China's geo-economic toolkit, but also perhaps more importantly, in learning how to respond to attempt to economic coercion? And what do you think that our takeaway in Western Europe and America should be from Australia's experience?

NM: I think this depends a little bit on, for example, the scale of the relationship and the symmetry or asymmetry between the players. So for the US, I am not sure there is much they need to or could learn from the Australian relationship, because the US is the big partner and China is the junior partner, even if it is a closing gap, that is still the way it is in that relationship. So the US can and will do things and think differently, in how it deals with China than Australia would. And so I am not sure there would be too much that would carry there.

And then so the UK is bigger economically than Australia, but it does not have the same relationship anyway, in terms of export dependencies. So, I think you have to contextualise that somewhere to say, well, what can they learn from it? Because the whole idea was with Australia, in particular, the asymmetry, the export asymmetry is so big, they are going to have to buckle, they are going to have to give in, the coercion is going to work. And it didn't. So I guess if you were to say in countries that have a smaller asymmetry, there is definitely no excuse for them to cave in to economic coercion. So I guess I would contextualise it and say it that way. So the individual countries in the EU, and also the UK, they will have a different type of relationship to China. But I guess..

SP: Perhaps Germany might be the most apposite one here where you have a small number of companies like BASF and Volkswagen, which, if you like, the car industry and the chemical industry in Germany might be the equivalent of your coal and iron ore miners in terms of their dependency on China. And obviously, Germany has had a certain amount of success in exporting to China. Unlike your iron ore producers, though, obviously, Made in China 2025 is all about eating the Germans' lunch, in terms of cannibalising their industries, taking their intellectual property, and generating indigenous industries in China that can compete head on with the Germans and make them irrelevant to China. So they have a similar sort of dependency, it's not as extreme obviously, as Australia's. Yet we seem to be seeing significant reluctance in Germany to actually view China in the way that Australia now seems to be viewing China.

NM: Yes, I think that is right, Stewart, and absolutely, I agree. I think in Europe, everyone looks at Germany as being the one that is most vulnerable, most hooked into China, and least willing to make the cognitive shift from Merkelism - Mercantilism as many call it and I do not think that's unjustified - to make the cognitive shift to say, "we have to really strike out for our national interest in certain key strategic economic relationships". Australia was incredibly brave and forthright in banning Huawei, they knew there would be a massive backlash. I do not see anything like that happening in Germany, or that type of courage to say "these are our strategic relationships. We need to batten down the hatches here and here" and they just seem very overly concerned about China's response.

We have seen recently with the Hamburg port issue that was in the media. Six German ministries came out against it, it is phenomenal, and the Chancellor continued to push it through. It is almost obscene that that happened the way it did and so he's having his visit to China. We know that Olaf Scholz, the Chancellor, he could have kicked that back that decision and left until he came back. He did not want to spoil the visit. But I think there is a stronghold still in the German Merkel era, group and cohort who just don not want to update, I think, their geopolitical framework.

SP: Naoise McDonagh, thank you very much indeed for joining us on What China Wants. It is much appreciated, and we would love to have you back on again at some point in the future to take this discussion further, but thank you very much indeed for your time.

NM: Absolute pleasure, thanks very much for having me on.

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