Saturday 14 Dec 2019 | 02:36 | SYDNEY
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About the project

Trade wars, populism, and geopolitics. The world is quickly becoming more fraught as complex forces threaten to disrupt and reshape the global economy in profound ways. In this context, the Lowy Institute launched the Global Economic Futures project aimed at better understanding this rapidly changing global economic landscape, where it might take us, and the key choices to be made.

The project examines the future shape of the global economy especially given rising tensions between the world’s two largest economies – the United States and China – and the possible implications for, and changing roles of, major regional economies, including Australia, India, Indonesia and others.

Experts

Roland Rajah
Director, International Economy Program
John Edwards
Senior Fellow
Stephen Grenville
Nonresident Fellow
Mike Callaghan
Nonresident Fellow

Latest publications

Economic diplomacy: Free trade disputes, WTO appeals, DFAT on China

Empty bench

It has been one of the most forecast developments in geo-economics, but the World Trade Organisation is about to finally suffer the crippling blow of its appeals process coming to a halt. On 11 December, the trade court will no longer have enough judges to issue the binding rulings that have been a foundation stone of globalisation, due to the Trump Administration's two-year veto of new appointments.

So far, this deficiency has not made an impact on global markets the way rumours of US–China trade row settlements (or not) have been doing for weeks. But its much broader impact on how global trade may now be conducted – i.e., as an opportunistic free-for-all – could add to any negative sentiment surrounding no US–China deal.

The world economy has survived the fact that trade – a traditional driver of global growth – seems to have stopped expanding. But if trade disputes between important countries such as the one that has occurred this year between Japan and South Korea (with little attention paid in Australia) become the norm, the world economy may not be so resilient. 

Introducing the FTD

The term FTA may so familiar that it has almost transcended acronym status. But its legitimacy still generates angst among trade economists because, in reality, free trade agreements can be anything but that with their exclusions, long implementation timeframes, and trade-diverting impacts.

So perhaps it was inevitable that someone would coin an acronym to encapsulate the new reality that trade disputes may now be more common than agreements. Enter Jayant Menon, the chief trade economist at the Asian Development Bank. 

“The proliferation of FTDs is more pernicious than the proliferation of FTAs that preceded it.”

“FTAs are being replaced by the proliferation of free trade disagreements (FTDs). Unlike FTAs, FTDs are not easy to measure or define — they cover a wide range of actions and inactions. They may be difficult to quantify, but they are real,” he says at East Asia Forum.

He suggests this process is almost inevitable when one emerging power starts to overtake another, and he notes that at about 60% of the US GDP (at market prices), China is now about where Japan once was amid trade disputes with the US.

“Trade wars are easy to start but hard to end. Not only can they escalate quickly, but they can spread to new issues, sectors and regions, as well as ignite new wars. The proliferation of FTDs is more pernicious than the proliferation of FTAs that preceded it,” Menon says.

Tribal warfare

The shifting power balance between economic determinists and security hawks in the national government over how to manage the rise of China has been a recurring focus in this column.

But thanks to an Australian Financial Review report by John Kehoe of a recent Australian Government Economist Conference, we have some rare insights into the fluidity involved.

The Department of Foreign Affairs and Trade’s economist Jenny Gordon is reported as saying: “We’re [economists] about trade-offs, and the difference on the geopolitics side is they’re less able to think about trade-offs. We live in this trade-off world, and they [national security officials] tend to live in this more absolute world.

“The conversation we need to have is to get them to think about trade-offs a bit more and get us economists, conversely, who tend to think ‘the markets will work and China has a vested interest in trading’, [to reconsider our thinking]. Something has to give.”

Meanwhile, the Treasury deputy secretary Meghan Quinn, who oversees international economic diplomacy, offered a relatively rare concession in this context that economists can overlook the role of non-financial incentives in international policy making.

“We do tend to be trained about incentives in a monetary form. But there are actors out there that have a different framing on what the final objective is,” she is reported as saying.

Return of the trade ninjas

The last time Japan asserted itself on the regional trade scene, it was all about making sure the old Trans-Pacific Partnership (TPP) survived in a smaller form – without US President Donald Trump’s America.

This time, it seems to the be the opposite – making sure the Regional Comprehensive Economic Partnership (RCEP) doesn’t arise in a smaller form under the dominance of China. That means bringing recalcitrant India back into the fold.

Japan’s Deputy Minister for Economy, Trade and Industry Hideki Makihara told Bloomberg: “We aren’t thinking about that [RCEP minus India] at all yet. All we are thinking of is negotiations including India.”

Japanese Prime Minister Shinzo Abe with Indian Prime Minister Narendra Modi during an official visit to India by the Japanese PM, September 2017 (Prakash Singh/AFP via Getty Images)

That will be welcomed in Australia, because the RCEP had been seen as a better way to engage India in a least some trade liberalisation after the serial false hopes for a bilateral trade deal going back to 2014, when the two national leaders promised an agreement within a year.

Japanese ministers have been making an unusually intense series of visits to India in recent days, paving the way for Prime Minister Shinzo Abe’s likely visit in mid-December.

Japan already has some steely form on this front, having vetoed China’s efforts to have RCEP move forward as an ASEAN Plus Three deal (Southeast Asian countries plus China, Japan, and South Korea) when India stopped progress. But that would have also excluded Australia.

Australia’s BRI no. 2

The rebadged Export Finance Australia’s (EFA) status as the Federal government’s new go-to agency for muscling up to China has been underlined by its latest call to action in supporting the Papua New Guinea budget.

The suggestion that the former Export Finance Development Corporation was becoming the cash cow for Australia’s entry into geo-economic competition (See Economic diplomacy: Australia’s BRI, aid revamp, and integrating Asia) was overtaken within days by the announcement its national interest account would be used to lend PNG US$300 million.

Using EFA’s national interest account means the government can provide the loan support to PNG without a direct impact on the federal budget bottom line.

Nevertheless, the move is a major reversal of the decision in 2000 to stop providing direct budget support to PNG in favour of more targeted and controlled program aid.

The PNG announcement follows the government decision a week earlier to use EFA as one of the main vehicles for a plan to create an Australian rare earths industry and reduce the world’s dependence on China in this sector. 

The agency got $1 billion in new callable capital in the Pacific Step-up to become Australia’s provider of alternative finance for infrastructure and other projects that might otherwise go to China’s potentially trillion-dollar Belt and Road Initiative (BRI).

China-US trade war: For all the bark, not much bite

It is now nearly 17 months since the Trump administration began collecting 25% tariffs on the first tranche of Chinese imports to the US – time enough to evaluate the economic impact the trade war so far.

That impact? Surprisingly little.

It is certainly true that comparing the first nine months of 2018 to the first nine months of 2019 (the latest available data), goods exports have fallen in both directions between China and the United States – China’s exports down 13%, and US exports down 15%, compared to the same period in 2018.

But compared to both countries’ GDPs, the impact is trivial. The direct full-year impact through net exports (exports minus imports) could be slightly above 0.3% of China’s current US dollar GDP, and slightly less than 0.25% of US GDP – in China’s case a negative effect for GDP, and in the US case positive, but the impact of the greatest trade war in our lifetime is not much, either way. The effect of lower bilateral trade on GDP is overwhelmed by other changes, including faltering business investment in the US and continued economic rebalancing in China.

Long before the trade war, some supply-chain processes were moving from China to Bangladesh, India, or Vietnam, a response to rapidly rising wages in China. The trade war has not brought a major acceleration of this trend.

It also is not clear that the decline in either side’s exports to the other this year is the result (entirely or even mainly) of the new tariffs or other trade war measures. Much of the change might have happened regardless – 2019 has been a bad year for trade. US goods exports to Germany and Mexico are also down on last year (though by less than the fall in exports to China), as are US goods exports overall.

Much of the decline in US exports to China is accounted for by a dramatic fall in soybean shipments. China imports soybeans mostly to feed pigs, and the abrupt decline coincided with the mass slaughter of China’s pig herd in response to a swine fever epidemic. Political decisions no doubt augmented the cut, but they would have fallen anyway.

Around half of the decline in China’s US exports is accounted for by information and communications equipment – mainly in mobile phones and computers, most likely due to weak iPhone and computer sales in a saturated US market. Penalty tariffs cannot be the cause of the decline in these Chinese imports, because thus far mobile phones and computers are not subject to them.

Pre-emptive purchases of Chinese imports before the tariffs took effect probably exaggerates the GDP impact of changes in exports and imports in 2019 compared to 2018. This is evident in the sharp rise in China’s exports to the US in 2018, compared to 2017. Those extra exports in 2018 may have been at the expense of exports in 2019. Comparing the first nine months of 2017 to the first nine months of 2019, the change is smaller and the GDP impact about half of that between 2018 and 2019.

The overall impact of additional tariffs on bilateral trade and on the economic growth of the protagonists so far has been less than many expected – though some of the early econometric model exercises also predicted modest impacts.

According to the White House, some of the measures against China were aimed at disrupting supply chains in China, forcing them to move elsewhere. “Their supply chains are cracking very badly,” President Trump claimed on 13 November.

If this were true, one would expect flows of foreign direct investment into China to falter. They have not. Foreign direct investment into China rose markedly in 2018, compared to 2017. On the most recent OECD numbers, it has continued to increase, while total global foreign direct investment flows have fallen.

Long before the trade war, some supply-chain processes were moving from China to Bangladesh, India, or Vietnam, a response to rapidly rising wages in China. The trade war has not brought a major acceleration of this trend. The oft-cited case is Korean mobile phone giant Samsung, which this year announced plans to close its last China mobile phone factory. But Samsung first moved to Vietnam in 2005. Before announcing its plans, its share of the China mobile phone market had fallen to 1%.

There have been few other high-profile departures from China. Supply chains, once established, are resilient and long lasting, according to IMF research. Furthermore, US penalty tariffs on China are explicitly intended as bargaining chips. Corporations would be reluctant to make an expensive move knowing the tariffs might well come off as part of a deal. For many of these businesses, the China consumer market, now with an annual spending increase bigger than the US or any other economy, is a good reason to stay in China. And even if the US tariffs were expected to remain for a while, the US market accounts for less than one fifth of China’s goods exports.  

More broadly, some in Washington push for “decoupling” the US and China economies. That does not seem to be working either. As the OECD points out, sales in China by China-based majority-owned affiliates of US corporations continue to outpace US exports to China, as they have for many years. Though instructed by President Trump to “immediately start looking for alternative to China”, American businesses are unwilling to leave the huge and growing China market to their competitors.  

If the US goes ahead (as threatened) with additional tariffs in December, the effect on China’s exports to the US may be more substantial. The new tranche includes cell phones, computers and other consumer goods. China imports generally account for a higher share of these goods than for the goods now subject to penalty tariffs. If the US persists with software and hardware denials to Huawei and other Chinese technology businesses, they will be hurt.

Economic diplomacy: Australia’s BRI, aid revamp, and integrating Asia

The big boost

When Prime Minister Scott Morrison put the South Pacific at the centre of his foreign policy priorities last year, the relatively low-profile Export Finance Insurance Corporation was suddenly thrust into the strategic limelight.

But last week’s foray into a form of state capitalism by the government to create a rare earths industry and reduce dependence on China has underlined how the now snappily rebranded Export Finance Australia (EFA) is becoming the go-to agency in the era of geo-economic competition.

The agency got $1 billion in new callable capital in the Pacific Step Up to become Australia’s provider of alternative finance for infrastructure and other projects which might otherwise go to China’s potentially trillion-dollar Belt and Road Initiative (BRI).

Australia’s failure to develop its bountiful rare earths endowment as a commercial but also strategic asset as China has cornered the market over the past decade is a classic case study in how China dependence has now turned into a China panic.

In August it also stepped up separately with $90 million in backing for a radar manufacturer to build a factory in Canberra, in what was the first output from another role it got last year in administering the new Defence Export Facility.

But the announcement of a series of measures to make Australia a significant player in the production and processing of the rare minerals used in a range of high-tech products showed how EFA is being drawn further into strategic planning.

Even before the agency has turned a sod in the competition to offset China’s commercial ambitions in the Pacific, Trade, Tourism and Investment Minister Simon Birmingham said EFA “would now place a greater focus on critical minerals projects and related infrastructure, including projects that supply defence end-use applications”.

Australia’s failure to develop its bountiful rare earths endowment as a commercial but also strategic asset as China has cornered the market over the past decade is a classic case study in how China dependence has now turned into a China panic. But as David Uren writes in this cautious endorsement of an EFA role in rare earths development, using Chinese development capital might still be less risky for Australian taxpayers in what is a volatile commodities play.

However, even though Chinese companies already own some Australian rare earth prospects, letting them lead Australia’s push to become a powerhouse in this sector might be a step too far in the current strategic environment.

Trade, Tourism and Investment Minister Simon Birmingham (Photo: G20 Argentina/Flickr)

As for the original Pacific Step Up, EFA still appears to have a fairly blank slate on what to support, which is probably wise, given the way politicians and commentators are prone to jumping at Chinese shadows in the Pacific.

The agency’s chief executive, Swati Dave, told a recent Senate estimates hearing agency staff had been to Indonesia and Papua New Guinea developing a pipeline of projects, but nothing had been delivered yet. She nominated water, telecommunications, electricity, and transport as likely sectors for EFA support.

With growing demands on her cash box, Dave is implementing a much more rigorous process inside EFA for assessing the real value of proposals, especially in terms of employment in Australia.

And as for the power of the extra $1 billion on her balance sheet, the former commercial banker told the estimates hearing:

That’s important, particularly when we are dealing with other partners in the region, because it helps us to be more relevant in whatever finance we are supporting.

But as the rare earths initiative shows and the latest mooted aid review hints at, there are likely to be further new government priorities in the era of geo-economic competition.

Doing more with less 

With Australia’s $4 billion development assistance program apparently facing a new review amid a tight overall government budget, the recent experiments in the Pacific with non-grant assistance such as loan guarantees and labour migration will likely be much in focus as alternate models.

Indeed, to that end, the recent Senate Estimates hearings featured an interesting discussion about whether the shift to development lending rather than standard grant money in the Pacific Step Up was based on any evidence that lending produced better results than grants.

Disaster relief supplies in Indonesia, December 2018 (Photo: Timothy Tobing/DFAT)

The $2 billion Australian Infrastructure Financing Facility for the Pacific (AIFFP) has been crafted so that $1.5 billion is conventional lending and can’t be classified as Official Development Aid, where Australia’s global ranking is falling. However, it also does not hit the budget bottom line (and the politically precious surplus), but instead gets added to government debt. The remaining $500 million will fund grant aid, including pre-existing climate-change related spending. However, it may also be used to “concessionalise” the lending to make it cheaper for the borrowers while at the same time extending the reach of Australian aid.

Department of Foreign Affairs and Trade officials confirmed that the AIFFP had been based on a feasibility study which found that financial instruments including loans, equity, and guarantees could expand Australia’s development aid footprint with less budget cost than grants.

They also argued this approach to development finance had long been used by multilateral lenders including in cooperation with Australia – which seems to be a pointer to what might emerge from an aid review.

Integrate or bust

The completion of the Regional Comprehensive Economic Partnership (RCEP) trade deal negotiations this month (even without India) has only served to underline how Asian countries have been pushing ahead with trade deals amid the global slowdown in trade growth.

The Asian Development Bank’s latest annual assessment of Asia’s economic integration notes how all free trade deals that came into force globally in 2018 involved Asian countries.

It says that regional economic integration – which RCEP is intended to facilitate – is a critical element for maintaining strong growth in the region amid unresolved trade tensions, weakening global demand, and policy uncertainties.

And while Asia’s trade volume growth eased to 4% in 2018 from 7.3% in 2017, regional trade linkages remain robust and work as a buffer against external challenges.

But despite regional integration being underlined by the way Asia’s intra-regional trade share is now at 57.5%, the more striking figure in the report is the way Asia has now cemented its position as the world’s leading supplier of foreign direct investment (FDI).

The region now supplies just under 50% of all the world’s FDI, with Japan supplanting the US and China as the leading source of this capital.

Book review: China, the US, and the big break

Book review: Paul Blustein: Schism: China, America, and the Fracturing of the Global Trading System (CIGI Press, 2019)

Paul Blustein has produced an enviable bookshelf of behind-the-scenes reportage on international economic institutions, both as a journalist (for The Washington Post and The Wall Street Journal) and as the author of books such as The Chastening (the International Monetary Fund’s role in the 1998 Asian crisis), Off Balance (the IMF and the Bank for International Settlements during the 2008 crisis), and Laid Low (the European crisis of 2010). His insider sources – especially in international bureaucracies – provide veracity, verve, and colour.

His latest book, Schism, examines how the World Trade Organisation failed to adapt to China’s emergence as “manufacturer to the world”, with its economic system fitting awkwardly into the existing multilateral framework. Superimposed on these initial tensions, US President Donald Trump’s bullying tactics have thrown a spanner into the mechanism of global trade.

The story begins with the drawn-out process of China’s admission to the WTO, finally achieved in 2001 after years of arm-wrestling negotiation with the US, which acted as gatekeeper for WTO entry. China, under the guidance of reformist Premier Zhu Rongji, made many concessions to adapt to the WTO framework and to placate America’s concerns that China’s size, coordinated decision-making, state-owned enterprises, and subsidies would enable it to compete too effectively.

Blustein doesn’t doubt that it was appropriate to admit China (what was the realistic alternative?) and that the US bargained hard and effectively. He cites the tough tactics used, including all the usual tricks that Trump would later claim as his unique expertise.

American politics often intruded into the extended timetable, with Congress’ characteristic intransigence always threatening agreement. Tiananmen in 1989 further delayed agreement.

After 2001, things didn’t work out as America expected. Some (but by no means all) expected the accession would be a catalyst for shifting the Chinese economy towards the American model in both economics and politics. More importantly, few expected China to be so spectacularly successful in exporting manufactures. Looking back, this success was attributed to China’s currency manipulation, intellectual property (IP) theft, forced IP transfer, subsidies, state interference, unfair labour practices – in short, everything except the reality that a very large low-cost manufacturer had entered the market with dynamism and entrepreneurial determination.

The loss of manufacturing jobs was more a result of technology than of Chinese imports (Photo: Thomas Hawk/Flickr)

The “China Shock” was painful for US manufacturing. Early analysis showed that the loss of manufacturing jobs was more a result of technology than of Chinese imports. But in time, it was recognised that some geographic areas had been unable to adapt. In the heat of this revisionist debate, not much account was taken of the many opportunities opened up by the China trade, including in overseas investment. The rise of supply-chain production took away some American jobs, but allowed others to compete in world markets by shifting components of low-skill production overseas, leaving the higher-skilled (and lucrative) value-add to be done in America.

That said, there is no doubt that the China Shock was painful and politically decisive in Trump’s election in 2016. The transition was also painful for China, but it was a crucial element in the transformation which has taken 800 million people out of poverty.

Blustein dismisses the importance of the Trans-Pacific Partnership: America’s departure was a minor loss to the cause of global trade.

The post-2001 period saw American hostility escalate over time. Under George W. Bush, there was still hope that China might be changing “in America’s image”. Barack Obama increased the pressure on China, with the use of “safeguards”, vigorous anti-dumping actions at the WTO, and an effective end to “currency manipulation” – the renminbi undervaluation. Xi’s elevation in 2012 modified the direction of China’s economic development, reversing Zhu’s shift towards private markets.

Then came Donald Trump, with his fixation with the bilateral imbalance and inflated view of his bargaining ability. Some complaints were irrelevant (e.g., the bilateral imbalance), while others were immutably intrinsic to China’s sovereignty (state capitalism). Other issues such as subsidies and state assistance were more prevalent in China, but America is hardly without sin in this regard. As for intellectual property, the system has been distorted by abuses (trivial patents, evergreening medical patents).

Blustein dismisses the importance of the Trans-Pacific Partnership: America’s departure was a minor loss to the cause of global trade. He asserts that it was never intended to contain China.

The detailed “tick-tock” storytelling enlivens what might be a dull narrative. What did Trump and Xi eat at the 2018 APEC Buenos Aries dinner? Grilled sirloin, if you’re wondering. But this is just decoration – the book has strong analytical substance and sound conclusions. Even at this late stage, Blustein argues that Trump should work with traditional US allies to restore the role of the WTO, the vital centrepiece in the indispensable multilateral framework.

We might make more sense of the conflicting views (even among the Americans, let alone between the Americans and the Chinese) if we identified three different mindsets among the protagonists.

First, textbook economists see trade in black and white. Free trade maximises each country’s welfare, even if it requires some internal redistribution to achieve equity. Tariffs harm everyone, including the country imposing them. Bilateral imbalances are irrelevant. Comparative advantage allows countries to benefit from their legitimate intrinsic advantages, such as low labour costs. Subsidies benefit the recipient and harm the subsidiser. Most developing economies (and Japan) have used competitive exchange rates during the catch-up phase. The free-market trading system is largely self-regulating, requiring very little intervention or regulation to achieve optimal outcomes.

The second group accepts the benefits of international trade but also believes that an individual country can gain a bigger share of these benefits by tough tit-for-tat bargaining. Tariffs might be a valid tactic of this bargaining process. The whole of the WTO bureaucracy and the tortuous post-war “trade-rounds” have operated on this basis.

The third group identifies overriding security concerns and would be prepared to limit trade – perhaps even seeking decoupling – in order to minimise the security threat from China.

The diverse and contradictory arguments, motivations and actions can be better understood in these terms: no consistent rules can satisfy these divergent mindsets. The WTO has serious deficiencies, and few of the members behave as they should. But for all its imperfections, this multilateral approach has been a key element in the huge increase in global living standards since the Second World War.

Jokowi’s curious plan for Indonesia’s capital

After winning a second and final term, Indonesian President Joko Widodo announced, “I have no burden now. I’m not thinking about next elections… so I will do whatever it takes for the country’s sake.” Just a month later, Jokowi, as Widodo is known, declared that Indonesia’s capital city would move 1300 kilometres away from Jakarta to East Kalimantan, on the island of Borneo.

This was hardly the kind of ambition most were hoping for in a second Jokowi term.

Such a move has been discussed perennially and has never eventuated. But this time, Jokowi seems serious. At an eyewatering cost of Rp 466 trillion (about $48 billion), government functions will shift to Indonesian Borneo, while Jakarta remains a commercial hub.

Jokowi risks wasting his political capital and energy on a symbolic project of dubious merit, while forgoing key election and policy issues such as health, education, and investment.

Proponents see the move as a way to help address Jakarta’s many woes – including traffic congestion and the fact that the city is rapidly sinking – while making government less Java-centric and bringing it closer to the people.

But moving the capital won’t fix Jakarta’s problems. Only 180,000 civil servants and 141,000 government vehicles of the city’s 10 million inhabitants and 17 million registered private vehicles are set to leave for Kalimantan in 2024. Moving so few will alleviate little pressure from the megacity. As outlined succinctly by economists Paul Burke and Martin Siyaranamual earlier this year, Jakarta isn’t going anywhere – and neither is its pollution, illegal well digging, and traffic.

From Kalimantan’s perspective, building a new large city also has major implications for the environment and the region’s indigenous Dayak Paser people, who potentially face further displacement and marginalisation. Though hosting a new city will create more jobs in the area, few from East Kalimantan will be well-placed to win formal government jobs, compared with experienced bureaucrats shipped in from Jakarta.

It’s also hard to see how moving the central government will help improve governance. The Indonesian system is already one of the most decentralised in the world, with 508 local governments receiving a minimum 26% of the central government’s net domestic revenues and a share of national resource revenues. It’s unclear how moving the locus of central bureaucratic activity will make government more responsive to the people.

Conversely, it is easy to imagine how governance might instead worsen. Forcing civil servants to leave Jakarta’s comforts for what is currently a forest will only make it harder to attract and retain the kind of capable public servants Indonesia needs in the face of stiff competition from the private sector.

Counter-productively, the move may also put even more distance between the country’s central policymakers and the public they are supposed to serve. After all, how will ordinary Indonesians protest en masse as seen recently if they earn approximately Rp 15,000 ($1.50) an hour, and a flight from Jakarta to Kalimantan costs Rp 1 million ($100)? Or perhaps that is the point. Meanwhile, well-heeled crony capitalists will have little trouble making the trip to engage in their own kind of government “influencing” activities.

Indonesian President Joko Widodo (Photo: International Monetary Fund/Flickr)

Of more immediate concern is the opportunity cost the move might impose on Jokowi’s second term. Jokowi risks wasting his political capital and energy on a symbolic project of dubious merit, while forgoing key election and policy issues such as health, education, and investment.

It’s a similar picture in hard dollar terms. Moving will be an expensive and ongoing fiscal burden, both within and beyond Jokowi’s term, which will crowd out more important spending priorities. A worst-case scenario could see large amounts of capital being poured into the move, only to be wasted if the idea is abandoned by a future president.

This all assumes that the project actually gets off the ground. Construction is supposed to begin in 2020, but basic preparatory studies remain incomplete – consultancy group McKinsey was only appointed to follow up government studies on 21 October. A design for the new city will only be decided on after international and domestic design contests end in March 2020. Many of the state-owned enterprises expected to fund and build much of the new capital have already accumulated significant debt as part of Jokowi’s first-term infrastructure drive.

And then one has to consider the delay, opacity, and corruption that often plagues big projects in Indonesia.

Jokowi insisted in July that his government must “look for a new model and new values”. Reviving Sukarno-era plans for a new capital city is a strange way to get there. If Jokowi wants to produce the step change in economic performance Indonesia requires, he should focus on deeper structural reforms – not moving the capital into the forest.

Signs of a deal between US and China, and a rethink

It is not yet agreed, may yet fail, and is anyway unlikely to settle matters, but the impending “phase one” trade deal could be a useful ceasefire in the US economic war with China. Two years on from the US initiation of penalty tariffs on China, it is also a convenient moment to point to a few lessons from the trade war thus far.

The essence of the deal is that the US will suspend the new penalty 25% tariffs on a wide range of consumer imports to be imposed on China from 1 December, and probably also remove or moderate the 15% deal tariffs on clothing, appliances, and some consumer electronics imposed 1 September. In return, China will commit to buying more US farm exports, toughening intellectual property protection in China, and more liberal investment rules for US finance businesses in China. For China, a sweetener in the deal may be permission for Huawei to continue buy US computer chips.

Both sides want a deal. US President Donald Trump needs to have some sort of agreement well before the presidential and congressional contests get seriously underway in 2020. He would no doubt prefer not to impose more tariffs in December, because these will be on consumer goods.

The US has discovered limits to bilateral pressures. It has not sought or found useful allies in pressing China.

For its part, China has every incentive to give Trump something. It needs more soybeans anyway, because its pig herd is rebuilding after an epidemic of swine fever. Earlier this year, its National People Congress rubber-stamped legislative changes to ban forced transfers of intellectual property in joint ventures and to limit discretions in controlling inward foreign direct investment. Having made or foreshadowed these changes, the Chinese negotiators are now free to modify the detail and present them as a package to their American counterparts. Phase one will also likely include a mutual agreement that exchange rates will not be manipulated for trade advantage.

What China must get in return is an agreement about a schedule for the reduction or elimination of existing penalty tariffs, and the suspension of threatened new tariffs. From China’s viewpoint, this is the only point of the negotiation.

If that is indeed the deal, it is pretty much what might sensibly have been expected at the outset of this quarrel two years ago. There never was any chance that China would give ground on the role of the Communist Party or the state in economic management. There was no chance China would agree to drop plans as a tool of economic development. China may be willing to discuss industry subsidies, but only if the US and perhaps Europe and Japan are also prepared to put their subsidies on the table. That is unlikely.

Given the logic of the negotiations so far, subsequent rounds will be all about the further reduction of US penalty tariffs on China in return for China buying more from the US, and carrying out whatever commitments it makes in phase one. Anything grander than that is unlikely.

While a phase-one deal is more likely than not, and a serious phase-two discussion may be postponed at least until 2021, there are already some important lessons in the experience of the last two years.

One is that although the US is a bigger and more technologically advanced economy than China’s, and it imports a good deal more from China than China from the US, not all the cards are in US hands.

As multiple US studies over the last 18 months have established, the costs of the tariffs imposed on China are being borne by American customers, not Chinese suppliers. The tariffs show up as higher prices in US stores, which is why China’s exports to the US have fallen. They are essentially a tax imposed on American consumers, the revenue from which is then distributed as support payments to American farmers hit by reduced Chinese purchases.

US Trade Representative Robert Lighthizer (L) and US Treasury Secretary Steven Mnuchin (R) with Chinese Vice Premier Liu He (C) as he arrives for trade talks in Washington, 10 October 2019. (Photo: Saul Loeb/AFP/Getty)

It is certainly true that the US trade deficit with China has narrowed and Chinese exporters are hurt by the reduction in sales. Yet it is also true that US exports to China (which has imposed counter-tariffs) have proportionately dropped more than China exports to the US.

While US tariffs have affected China’s exports to the US, China’s exports overall are well up  on 2017, before the trade war began.

China’s GDP growth has slowed, but not because of reduced exports to the US, any more than the slowing of US growth over the last year (and by more than the slowdown in China over the same period) is due to the drop in exports to China.

The US has also discovered limits to bilateral pressures. It has not sought or found useful allies in pressing China. Japan and Korea have stayed aloof, and Europe has continued to negotiate amicably enough with China. Even Australia has refused to side with the US against China.

Another lesson is that decoupling is hard to do. Though often portended, there have been few major changes in manufacturing supply chains which include China, and very few significant departures of foreign businesses from China. Its consumer market is now too big, its industrial organisation too efficient and too competitive, for foreign businesses to leave the market to their competitors. At China’s international import trade fair in Shanghai, US exhibitors have taken more space than any other country.

Huawei, the telecoms infrastructure company most prominently targeted by the US, continues to do brisk business worldwide. A year ago, it estimated the losses to its business from US actions at US$30 billion; that figure has now been revised down to less than $10 billion. Like other threatened Chinese businesses, Huawei is developing alternative products to software and hardware currently sourced from the US. It illustrates the point that in cutting off US supplies to China, the US has been losing customers and at the same time creating competitors.

There have been important lessons for China’s leadership. It no doubt much regrets bragging about the ambitions of the now-unmentionable China 2025 plan, a program that was always more rhetoric than substance. Though still intent on reaching the front rank of technological development, China’s leadership may well conclude it is sensible to say less and do more.

Economic diplomacy: RCEP and ASEAN’s new way, plus voting ADB-style

Market day

For two generations, the term “Factory Asia” has neatly encapsulated the essence of the region’s economic success, with components flowing across the region for products mostly ultimately exported to the developed world.

But as Asia embraces its first regionwide trade deal this week (minus India) in the Regional Comprehensive Economic Partnership (RCEP), there is a subtle underlying shift in the language of integration from the old export-oriented factory model to the idea of a more integrated and consumer-driven Market Asia.

Thai business professor Pavida Pananond captured the challenges involved in this shift recently, arguing:

Policymakers must look to a future in which innovation, specialised supply chains, and strong institutions that protect intellectual property rights and guarantee fair competition become the most important aspects of the national competitiveness agenda.

How much the RCEP deal measures up to this standard when it is finally revealed after all the “scrubbing” of contradictions will be the test of the new political rhetoric about the “world’s biggest trade deal”.

While the RCEP is largely stitching together existing bilateral trade agreements, it is still notable that amid global headwinds to increased trade from forces ranging from onshoring to protectionism, Asian countries have pulled off a new agreement.

ANZ economist Richard Yetsenga argued this week that Asia’s business model was broken because it was still too dependent on the old model of (external) trade, abundant labour, and cheap finance.

But as the RCEP negotiators have sought to put in place some important basic plumbing over the last six years, there is growing evidence for the emergence of a Market Asia which is more independent of the global economy.

The most recent is the McKinsey Global Institute’s Future of Asia series which argues Asia is becoming more Asian as intraregional activity grows. For example, the region itself now accounts for 60% of Asian goods trade and 59% of foreign direct investment, and has 74% Asian air travellers and 71% Asian investment in start-ups.

“The region has reached a tipping point at which its scale is of global significance; most types of global cross-border flows today are shifting towards Asia, and flows within Asia are rising,” the latest McKinsey study says.

When the Lowy Institute’s Roland Rajah looked at this earlier in the year in this paper, he concluded: “Whereas previously East Asian production was heavily integrated but still primarily geared towards serving Western markets, today the region appears to be fuelling its own demand.”

Friends in trade (Photo: Kusuma Pandu Wijaya/ASEAN Secretariat)

The Asian Development Bank’s relatively new Asia-Pacific Regional Cooperation and Integration Index shows a continuing but slower pace of integration than these two above studies. But it nevertheless observes that “strengthening (the region’s) intraregional share offers a buffer against the fallout from increasingly inward-looking policies worldwide.”

While the RCEP is largely stitching together existing bilateral trade agreements it is still notable that amid global headwinds to increased trade from forces ranging from onshoring to protectionism, Asian countries have pulled off a new agreement. And this is amongst the most diverse group of economies in the world extending from Japan to Myanmar.

How much goods will now move more smoothly through Market Asia due to the RCEP’s more standardised rules of origin and how much services will flow due to the more limited unification of standards and intellectual property rules remains to be seen. For example, the Association of Southeast Asian Nations (ASEAN) – at the core of RCEP – has allowed non-tariff barriers to rise as it has slashed tariffs to near zero.

But as predictable complaints emerge about RCEP being an opaque and unquantified agreement, Australia’s Productivity Commission has done some useful analysis here.

The ASEAN (new) way

One of the more intriguing aspects from the weekend’s East Asian Summit (EAS) was the apparent show of strength by the normally anodyne ASEAN group towards the two recalcitrant regional powers of the moment.

After having given India a leave pass on making serious RCEP progress earlier in the year so it could get through its April-May election, the ASEAN countries appear to have become fed up with its last-minute new demands and elected to go ahead without it.

At the same time, they delivered a pointed snub to the US, with only three out of ten ASEAN leaders turning up to the sideline US-ASEAN Summit in response to the lowest level US delegation to have ever attended and EAS. US President Donald Trump’s offer of an alternative summit in Washington is likely to be a hard sell.

The question now is whether these same countries are prepared to take such an un-ASEAN approach to dealing with China.

Only three out of ten ASEAN leaders turned up to the sideline US-ASEAN Summit (Photo: ASEAN 2019)

No contest

At least the European and US masters of the International Monetary Fund and World Bank tolerate a brief period of democratic coat trailing by alternative candidates for the top jobs at these institutions when there is a vacancy.

And so, we get a brief pecking order of prominent available financial officials from the emerging market world – and even the occasional mention of a former Australian politician.

But not so the Japanese when it comes to keeping their share of the post–Bretton Woods spoils at the top of the multilateral financial institution pile.

And so, the Asian Development Bank announced last Monday that voting had just opened for the contest to succeed current president and former Japanese finance ministry official Takehiko Nakao, who visited Australia in September. 

The catch is only one nomination has been received after a one-month search, and that is Masatsugu Asakawa, now special advisor to Japan’s Prime Minister and Minister of Finance.

Voting is now open for a month for those who find the choice a bit difficult. So much for those Asian emerging-market powers, such as India, who like to call for a bigger share of the global bureaucratic spoils.

Fellow traveller

Indonesia has discovered economic diplomacy as it watches foreign investment flow out of China to its neighbours but not to it – and also amid worries about being next in line for a Trump administration tariff hit.

And so, one of the back stories of the new Indonesian ministerial team under President Joko (Jokowi) Widodo was the appointment of Indonesia’s ambassador to the US, Mahendra Siregar, as vice foreign minister responsible for economic diplomacy.

Siregar is exquisitely well credentialled for the job as a former head of the investment promotion agency, a former minister variously for trade, finance and international economy, and a chairman or director of several companies. And he has been a long-time friend of Australia as a Monash University graduate and member of the Australia Indonesia Centre board.

Mahendra Siregar, Indonesia’s new vice foreign minister responsible for economic diplomacy (Photo: G20 Australia 2014/Flickr)

But what’s most striking about this appointment is the way it shows how the Trump administration’s arbitrary and mercantilist approach to international trade has forced a major economy to structure a senior job largely just to manage US economic risk. This might be a sign of things to come in other countries.

And Siregar may be treading in an extra minefield by being told to report to Jokowi not through his notional boss the foreign minister Retno Marsudi, but via the coordinating ministers who look after economy and business, Airlangga Hartarto, and maritime affairs and investment, Luhut Panjaitan.

Indonesia will have been extra unsettled by the way US Commerce Secretary Wilbur Ross played down the impact of cuts to US import tariff preferences for Thai products during the weekend summit.

Economic diplomacy: Indonesia trade, ASIO business & deglobalisation

Dealmakers

The latest set piece showdown between the Labor Party leadership and its union base over a trade deal – this time with Indonesia – comes with some overlooked historic irony.

It is now more seven decades since the industrial and political wings of the labour movement tussled over Indonesia’s independence struggle, but then the unions occupied the moral high ground over less committed politicians on both sides of politics. The historian of this period Rupert Lockwood described the union-led campaign stopping Dutch naval ships returning to claim colonial control of Indonesia after the Second World War as the “zenith of their capacity to intervene in Australian foreign policy.” He even argued it showed the country was not beholden to the concept of white Australia – despite that took two decades longer to become clear.

This time it is the politicians who have shown the foresight over long term relations with Australia’s closest Asian neighbour with Trade Minister Simon Birmingham deserving credit for giving the Labor politicians the small concessions they needed to deal with the union opposition.

Labor’s acceptance of trade liberalisation in the Hawke-Keating years is probably still its greatest contribution to modern international economic engagement and the party’s credibility in this area would be in tatters if it had turned its back on this in relation to Indonesia.

Good vibes during the Australia Awards Indonesia at the 5th Congress of Indonesian Diaspora in Jakarta, 10 August (Photo: Australian Embassy Jakarta/Flickr)

The skilled labour exchange, working holiday visas and the very modest number of training visas for Indonesians to come to Australia in the trade agreement are a very controlled way of testing the potential for some labour movement compared with what happens in other parts of the world. Unions should be working to facilitate this.

On that note, is unfortunate for the agreement’s implementation that former trade minister Tom Lembong has this week now lost his job as investment minister in the Indonesian cabinet. He more than most Indonesians had the capacity to sell – in both countries – the value of Australia providing jobs training to Indonesians so they can return home better skilled. That might be for future Australian businesses in what is touted to be the world’s fifth largest economy or just providing better services to existing Australian tourists visiting the country.

However, the new Coordinating Minister for Economic Affairs, Airlangga Hartarto, who has followed in his father’s footsteps by studying in Australia and becoming a senior government minister, should now be a useful voice for pushing the Indonesia-Australia Closer Economics Relations Agreement (IA-CEPA) forward in the new government.

The challenge now is to use the economic partnership provisions – which distinguish this agreement from some other trade deals – to make it a so-called “living agreement.”

This study by Poppy Winanti and Kyle Springer, for the Perth USAsia Centre, provides some good ideas on using IA-CEPA as a springboard for much greater institutional engagement between two countries which are moving from a competitive to a complementary economic relationship.

Team player

The Australian Security Intelligence Organisation (ASIO) has used its new annual report to reject suggestions from critics such as former prime minister Paul Keating that its activities are chilling international economic engagement, especially with China. Using very similar language to last year, the agency says in its latest report that it is keenly aware of the importance of foreign investment to Australia’s economic prosperity and supports balancing national security with broader national interest considerations.

The comment comes amid some new calls (see James Curran here and Alan Gyngell here) for the national security committee of the federal cabinet to be broadened so that intelligence agency views are weighed alongside other more diverse, mostly economic, views.

Nevertheless, ASIO still takes the opportunity to warn:

Foreign intelligence services seek to exploit Australia’s businesses for intelligence purposes. That threat will persist across critical infrastructure, industries that hold large amounts of personal data, and emerging sectors with unique intellectual property that could provide an economic or strategic edge.

It is notable that while ASIO has complained it does not have the resources to meet growing requests for advice, its workload advising the Foreign Investment Review Board has being fairly consistent over the four years it has disclosed this activity. It provided help on 275 investment applications last year which was up, but near the four year average of 265.

ASIO’s engagement with the broadly defined business sector does suggest it is facing rising demand for its advice as cyber security intrusions and foreign interference have been getting more attention.

However, ASIO’s engagement with the broadly defined business sector does suggest it is facing rising demand for its advice as cyber security intrusions and foreign interference have been getting more attention over the past decade. Membership subscriptions to its Business Liaison Unit have risen from 778 to 4480 over 10 years.

And it is also intriguing that this year the domestic security agency it has taken on the extra task of helping the Department of Defence – which has its own considerable intelligence capabilities – with foreign ownership, control and influence checks related to defence industry.

Mixed messages

The sharp slowdown in foreign direct investment (FDI) around the world last year has tended to be overshadowed by the much blunter showdown over trade between the US and China. But it has nevertheless been interpreted by some as a similar blow to globalisation.

Financial capital flows around the world overall have generally been weak since the 2008 global financial crisis but foreign direct investment has held up better than other debt and equity movements until last year.

Now the International Monetary Fund has analysed the situation from different perspectives in its latest annual economic outlook and come back with good and bad news.

The 2019 IMF/World Bank Plenary, 18 October (IMF/Flickr)

When it looked at the overall situation with FDI it came to the reassuring conclusion that the standstill is not due to fragmentation (better known as deglobalisation) but rather simply due to the internal accounting operations of multinational companies.

Two forces seemed to coincide. First, US President Donald Trump’s 2017 US company tax cuts removed tax on repatriation of money from abroad and the resultant inflow has offset outward foreign investment. At the same time corporate housekeeping in European low tax investment jurisdictions like Luxembourg – possibly driven by successful global tax avoidance measures – had a similar impact.

And so the IMF concludes:

The sharp decline in global FDI flows in 2018 seems to be explained almost entirely by multinational corporations’ financial operations, with no meaningful collective impact on emerging market economies.

But when the IMF looked separately at the increasing trend toward “reshoring” of manufacturing from emerging markets back home to the US and other developed countries, it said the situation was more worrying for globalisation and overall world growth. It found:

If multinational firms shorten supply chains by producing more goods closer to final consumers in advanced economies, emerging markets could have much less access to the latest technological developments.

This reduction in the technological diffusion that been a feature of globalisation would particularly hurt emerging market countries, but it would also have some negative impact on the developed countries pursuing onshoring.

China, the Pacific, and the “debt trap” question

“Debt trap” diplomacy has been a recurrent rallying cry for critics of China’s Belt and Road Initiative (BRI) and its overseas infrastructure lending activities. Over the past two years, this debate has taken centre stage in the Pacific, with China accused of drowning these tiny economies in unsustainable mountains of debt.

In the vortex of geopolitics, however, objective analysis has been missing from the debate. Our latest Lowy Institute report has sought to fill this gap, drawing upon the unique dataset contained in the Lowy Institute Pacific Aid Map and combining it with other data to provide an evidence-based assessment of the impact of Chinese loans on Pacific debt sustainability and the risks posed in the future.

The problem is not that China’s lending is overly skewed towards countries already at risk of debt problems. Rather, it is the sheer scale of lending, combined with inadequate controls to avoid potentially unsustainable loans.

The Pacific is a central part of the global story surrounding China’s BRI. Our research shows that the small and fragile economies of the Pacific are among the most vulnerable to potential debt problems, while several Pacific countries already appear to be among those most heavily indebted to China anywhere in the world.

Nonetheless, our analysis suggests that China’s lending practices in the Pacific have not be so problematic as to justify accusations of debt trap diplomacy – at least not yet.

According to the regular assessments by the International Monetary Fund, debt sustainability risks are indeed rising in the Pacific, but this reflects a confluence of factors and is more closely linked to the region’s high exposure to disasters, rather than excessive Chinese lending.

Nor has China suddenly become the dominant financier in the region and therefore able to exercise significant leverage over Pacific nations. Traditional creditors (i.e., major domestic banks, Japan, the Asian Development Bank, the World Bank) still play a more significant role, especially if much larger amounts of grant aid are also considered. The exception is in Tonga, where China holds over half of public debt. But this has not exactly been an advantageous position – China has twice agreed to deferring repayments, while getting little in return.

China’s lending terms are also hardly predatory. Whereas its overseas lending in many other parts of the world often comes at market rates, China appears to have been much more careful in the Pacific, with the vast majority of its loans having been concessional enough to qualify as aid, according to the standard of the Organisation for Economic Co-operation and Development (OECD).

Perhaps the most important question is whether China has been lending to countries already facing elevated debt risks. Our research found that in 90% of cases, Chinese loans were made in situations where there appeared at the time to be scope to absorb such debt sustainably. That leaves 10% of cases where Chinese loans looked problematic, but in comparison to other official lenders in the region, this figure would not make China a huge outlier.

The problem is not that China’s lending is overly skewed towards countries already at risk of debt problems. Rather, it is the sheer scale of lending, combined with inadequate controls to avoid potentially unsustainable loans.

Hence, looking ahead, we see clear risks. In particular, our analysis shows that, under a business-as-usual scenario, several Pacific countries (most notably Vanuatu, Samoa, and Tonga) would quickly enter risky territory in terms of their overall burden of debt.

Pacific nations are clearly in the driver’s seat in setting their own borrowing policies. Most have frameworks intended to protect overall debt sustainability, operating with varying degrees of effectiveness.

China also has a role to play. Ultimately, China cannot remain a major player in the region through its current model of cheap loans without eventually fulfilling the debt trap accusations of its critics.

To avoid this, China will need to substantially restructure its approach – in particular by adopting clear sustainable lending rules and, ultimately, focusing far more on grant aid rather than loans.

Positively, China has begun taking debt sustainability more seriously, in particular by signing up to G20 principles and guidelines, which include commitments to key global standards for sustainable lending.

But China is still moving in baby steps. For instance, a new debt sustainability framework released earlier this year by China’s finance ministry remains a “non-mandatory policy tool”. It needs to become a mandatory one for China’s Export Import Bank – which leads China’s overseas lending in less developed countries – and linked to clear lending rules aimed at protecting the debt sustainability of borrowing countries.

Adopting such rules is exactly what the Australian government has done with its own new bilateral infrastructure lending facility for the Pacific, giving more confidence that its activities will remain sustainable.

Clear, sustainable lending rules would bring China up to speed with other official sector lenders. It would also give China far more international credibility that it is indeed acting as a responsible global power.

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