Defence industry could help rebalance the US–Australia economic relationship
1 Jun 2023|

President Joe Biden’s offer to have Australia counted as a ‘domestic’ economy under the US Defense Production Act may give a badly needed boost to the flagging economic relationship between the two countries.

The US bought only 3.3% of Australia’s merchandise exports in the year to March, its lowest share since 1934–35 at the height of the tariff war in the wake of the Great Depression. Before that, its share had not been lower since 1912.

Singapore (population 6 million) bought more Australian goods over the past year than the US (population 330 million). The US, which was our second biggest market behind Japan until 2004, now ranks seventh.

The decline of the US as a trade partner and its refusal to join regional trade groups like the Comprehensive and Progressive Agreement for Trans-Pacific Partnership gives weight to arguments that Australia’s future lies in Asia and the need for a modus vivendi with China.

The US share of Australian imports has held up better—it remains the second biggest supplier after China—but there, too, its share has halved from 20% to 10% over the past 20 years.

Although the US remains by far the largest foreign investor in Australia, this increasingly looks like a legacy of the post-war expansion of the US multinational corporation that’s running out of steam.

US companies have pulled a net $19 billion out of Australia over the past four years, according to the Australian Bureau of Statistics. The value of all US investment in Australia has declined 16% since 2019.

This is possibly driven by the gap that has opened between US and Australian company tax rates in the wake of tax cuts under Donald Trump’s administration. Australia’s company tax rate of 30% is internationally uncompetitive when the US rate is 21%.

US investment figures, which are compiled on a different basis, also show US firms unwinding investments in Australia. They show that the level of US investment in Australia has barely changed in the past decade, rising from US$165 billion in 2012 to only US$167 billion by 2021.

The US stake remains much greater than Australia’s share of the regional economy would suggest. US companies hold 17.5% of their investment in the Asia–Pacific in Australia, though that’s down from 25% a decade ago.

Australian companies continue to invest in the US. Their holdings of $193.1 billion now exceed the US stake in Australia of $184.3 billion, according to Australian Bureau of Statistics data.

One obvious explanation for the decline in the relative importance of the US in Australia’s investment landscape is that it has no need of Australian iron ore, liquefied natural gas or coal—the big-three commodities that have driven the rapid growth of Australia’s trade with Asia, and with China in particular.

There has also been a change in the nature of the US global business. The technology giants like Amazon, Facebook, Uber and Google don’t have to be physically located in Australia in order to sell their services here.

Australia doesn’t have to enjoy a close economic relationship with its principal military ally, but it would help persuade the Australian public of the benefits of the alliance if there were greater mutual economic gains.

Although Australia’s trade with the US is relatively small, particularly from a US perspective, it shows some interesting trends that may point to the potential for growth as activist industry policy enjoys a renaissance on both sides of the Pacific.

Australia’s biggest exports to the US are gold and beef, but following that come pharmaceutical products, measuring and analysing instruments, medical instruments and aircraft parts. Each of these categories also features in Australia’s imports from the US.

Last year, Australia imported $2.4 billion in US aircraft and parts, and exported $745 million. It imported $1.8 billion in US pharmaceutical products (excluding medicines) and exported $1.2 billion to the US. There were imports of $1.3 billion in measuring instruments and exports of $784 million. Similarly, Australia imported $1.3 billion of medical instruments from the US and exported $750 million.

Each of these products involves advanced manufacturing and their trade between the US and Australia points to an important trend under globalisation in which countries trade similar goods with each other. Under classical trade theory, trade prospers from the difference between countries; hence, Australia exports resources to Japan and China and imports manufactured goods.

However, globalisation and the reduction in transport as a share of total costs have fostered trade within industries, with micro-specialisations in different niches within a single industry or even within corporate groups. The design work done for the global Ford group in Australia is an example of the latter.

The trend of reciprocal trade can be seen in the services sectors. While the US doesn’t feature in Australia’s big travel and education sectors, it is by far the biggest market for Australian business services, telecommunications and computer services, financial services and intellectual property. In business services, for example, Australia’s sales to the US were worth $3.1 billion last year, while imports of business services were $4.5 billion.

Industry policy can foster this reciprocal trade. For example, around 70 Australian companies make parts for the F-35 fighter jet. Pharmaceutical companies that benefit enormously from Australia’s Pharmaceutical Benefits Scheme have an incentive to export their products here.

There has long been a push for greater local content in defence procurement, and the government is now pursuing a $32 billion plan for the local manufacture of missiles.

The lesson of reciprocal trade is that Australia would gain by developing a specialisation in the manufacture of missile components where it could achieve economies of scale in collaboration with the major defence contractors and could build exports. Self-sufficiency is an entirely legitimate national security goal, but economics are on the side of specialisation in parts of the process and the increasing returns to scale.

The initial aim of the Biden administration in pushing for Australia to be recognised as a domestic company under the Defense Production Act is to open the way for Australian producers and processors of critical minerals to benefit from US markets and subsidies.

This is classic trade theory, leveraging Australia’s strengths in commodities which are not matched in the US. It is of considerable value to Australia if it supports the development of an industry that becomes a principal supplier to the energy transition, just as our iron ore, coal and LNG have supported industrialisation in Japan and China.

However, there’s potential for the collaboration with the US to support the further development of a wider spread of services and advanced manufacturing industries and trade.