China: ‘largest trading partner’ isn’t what it’s cracked up to be
2 Jul 2013|
Chinese and Australian flags in Canberra

The insight that for the first time Australia’s largest trading partner—China—is now no longer our primary security partner or even in the Western alliance has now been offered many times as a sign that enormous strategic changes are afoot for Australia and the region. But Australia isn’t alone. China has become the largest trading partner for Japan, South Korea, Vietnam, Indonesia and India. It’s no wonder that an increasing number of commentators believe China’s strategic pull, based on its growing importance as a trading partner, will be irresistible in the near future.

The facts speak for themselves: trade between China and major regional countries has been growing more rapidly over the past two decades than China’s already rapid economic growth. But is trade really as decisive a factor of future economic (and resulting strategic) orientation? I argue that strategists ought to place far more emphasis on foreign-direct-investment (FDI)—generally defined as equity ownership of 10% or more in a foreign business—rather than trade as a better and more powerful indicator of economic intimacy, and importance now and into the future.

Why focus on FDI rather than trade? Consider this scenario. You go to the same newsagent every day to buy your newspaper. Lately, you’ve also been buying your business stationery from the newsagent, making you a major customer and the proprietor very happy. But in the midst of a promising relationship, you have an argument with the town Mayor, who bans you from entering the shopping strip where the newsagency is located.

There are few winners from the Mayor’s rash decision. From your point of view, this is enormously inconvenient since you’ll have to now order your newspaper and stationery from a neighbouring town, leading to increased costs for your business and a delay in getting your daily newspaper. From the proprietor’s point of view, the loss of significant business will hurt his bottom-line and he’ll have to work harder to increase sales elsewhere.

Now imagine that you’re an investor in the newsagency. A breakdown in your relationship with the Mayor—and a resulting ban against you coming anywhere near the newsagency—is much more serious. You can no longer oversee the running of the business, let alone work in it. If things take a turn for the worse, it’ll be difficult to sell your stake in the business. If the Mayor decides to seize your equity in the business, you lose a major asset. It’s in your overriding interest to do whatever it takes to appease the Mayor. At the very least, you’ll be reluctant to invest again in that town until a new Mayor is in office.

In essence, trade is a series of short-term (and in the best case, recurring and increasing) transactions that hopefully benefits both parties. But once the transaction is completed, the relationship ends. With trade, firms don’t generally care who they sell goods to as long as price and reliability of payment is adequate. Buyers care only about price and reliability of delivery. In this sense, trade is indiscriminate and fluid. Likewise, and subject to political considerations such as sanctions, host government receiving the tax receipts from those firms couldn’t care less where the latter make their revenues. For example, Canberra doesn’t care whether Rio Tinto receives the bulk of its revenues from China, or from some other rising giant in the future.

The FDI relationship—in the eyes of both governments and firms—is very different. From the firm’s point of view, FDI is an investment of considerable capital, manpower and the firm’s brand and reputation in a foreign jurisdiction and political-economic system for a substantial period of time, meaning that it is a far better indicator of economic integration and intimacy than trade. Getting out prematurely will invariable entail a significant sunk cost and loss of the firm’s and management’s reputation. Any private or government-owned firm—generally in step with their own government’s advice—needs to be confident about the economic opportunities available in that country. It’s also a vote of confidence in the current and future stability, fairness and trustworthiness of that political-economy, and that the firm’s equity, interests and promised commercial access will be protected by the host government.

Moreover, much of Asia, aside from advanced economies such as Japan, needs foreign capital to develop rapidly—which is why FDI matters at least as much as trade. Note that a massive influx of Chinese capital and aid for ‘nation building’ projects—more so than trade—is the main reason Cambodia believes it has no choice but to enter Beijing’s political sphere of influence. But host governments in the more important maritime Asian economies are reluctant to allow foreign equity (whether it be private or sovereign-owned) into key sectors of their economy unless there’s a pre-established diplomatic relationship and political trust between the two governments—as well as adequate harmonisation of regulatory, taxation, legal and other standards. Why is Ericsson more welcome than Huawei in Australia? It is because there’s far greater political trust and harmonisation of commercial and legal standards between Australia and Sweden, than there is with China—despite our trade relationship with the latter.

The US, EU and Japan—and in many cases Singapore—are far more important and larger investors in other Asian economies than China. For example, take a so-called ‘swing state’ like Thailand which is fairly indicative of China’s relatively small footprint for FDI into significant Asian economies. Cumulative investment there by China is under US$2 billion. This compares to over US$46 billion by Japan, US$26 billion by the EU, US$24 billion by Singapore, and US$13 billion by the US. The same applies to Australia.

Add to the fact that around 70-80% of FDI into China goes into the export-manufacturing sector, meaning that foreign firms there are really just producing products for mainly American and European, rather than Chinese consumers; while 70% of Asia’s trade with China is double counted ‘processing trade’, with the goods produced ending up in Western markets. In other words, even expanding trade with China is built on the voracious consumption habits of Western rather than Chinese citizens.

China’s strategic ambition is intimidating and its potential economic size seductive. But focusing more on FDI and less on trade exposes the perception of Chinese economic dominance and intimacy overtaking the relationship with traditional economic partners. That picture doesn’t yet match material reality or sensible forecasts—in addition to the fact that banning trade from one country, as Beijing has done occasionally with Japan and the Philippines, rarely achieves the intended political or strategic aim. This is just one reason why China’s growing standing as leading trade partner isn’t easily translating into strategic leverage or political intimacy with major Asian states.

John Lee is the Michael Hintze Fellow and adjunct associate professor at the Centre for International Security Studies, Sydney University. He is also a non-resident senior scholar at the Hudson Institute in Washington DC and a director of the Kokoda Foundation in Canberra. Image courtesy of Flickr user Cobain Lu.

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