Worsening AU-China relationship could threaten economy, smash trade

Australia's trade with China is at a crossroads. Source: Getty

The Morrison government’s decision to team up with the US and the UK and build and acquire nuclear powered submarines in Australia has offended the Chinese administration.

After the submarine decision was announced, Chinese Foreign Ministry spokesperson Zhao Lijian described the agreement as “extremely irresponsible”. Chinese media said that Australia was now an “adversary” of China and we should “prepare for the worst”.

This commentary was not widely reported in Australia, but it is disconcerting from many angles, including for what it might mean for Australia’s export market.

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This latest tension follows the blow up last year where the Morrison government ham-fistedly led the call for an international inquiry into China’s handling of the coronavirus. This clumsy diplomacy saw China impose a series of economic sanctions, including imposing hefty tariffs, on Australian exports of barley, wine, timber, lobster, meat and coal.

As a result, coal exports to China have fallen to zero.

The submarine decision is likely to see the Chinese administration impose more trade restrictions either explicitly, or implicitly by sourcing imports from countries other than Australia.

Australia’s trade with China

China accounts for over 35 per cent of all of Australian exports. This dependence is extreme. Japan is the second largest export partner taking just over 10 per cent of all exports.

Just 20 years ago, China accounted for a tiny 5 per cent of Australian exports.

Australia’s trade links with China have been a critical factor supporting what was, until recently, a tremendous two decade period of sustained economic growth and rising national income. Without the support from Chinese demand for Australian products, our economy would be around 5 per cent smaller than it is today, with even incomes and higher unemployment.

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The economic relationship with China has, until now, been a success story with few parallels in Australia’s economic history.

All that is in jeopardy driven by clumsy and damaging diplomatic failures.

According to data from the Australian Bureau of Statistics, Australia is running an annual trade surplus of over $100 billion with China. The top two exports are iron ore and natural gas which add up to well over $150 billion of annual revenue.

Australian producers of these commodities have a distinct advantage in supplying Chinese importers including a low cost of production and an ability to supply reliably and in huge volumes to satisfy ever growing Chinese demand.

As the diplomatic spat unfolds, there is a heightened risk China will turn to other producers of iron ore, natural gas and other export items important to Australia.

Also read: New China threat facing the Aussie economy

If those alternative producers are able to supply China with all that it needs, Australian exporters will be in deep trouble.

It has already happened to the coal market, where Chinese sanctions against Australian producers were implemented over a year ago.

According to the head of Research at Westpac, Robert Rennie, Australia accounted for 46 per cent of China’s imported coal in early 2020. This has fallen to zero and now China sources 42 per cent of its coal from Indonesia and a further 31 per cent from Russia.

While it is unlikely such an extreme fall would be evident with iron ore exports as Australia is the world’s dominant producer, alternative markets are expanding in Brazil and India and China has invested heavily in exploration and new mines domestically.

A threat to the economy is 2022 and beyond

It is unclear the extent to which Australia’s export boom to China will be impacted by the escalation of the diplomatic ructions unfurled by the submarine decision.

But if the experience with coal, barley, meat, wine, meat and lobsters is anything to go by, there must be a genuine risk that the hit to the export market and economy more generally will be significant.

And just when the vaccination take up rate was inspiring optimism about opening up the domestic economy before year end, there are dark clouds over the export side of the Australian economy which may yet extinguish what was an upbeat outlook.

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