Speak truth to China without shouting
As a middle power, we have to be realistic how much we can stand out in the region. We have to calibrate whether it is in our national interest to be the regional tall poppy.
The Chinese warships in Sydney Harbour in early June highlighted some of the complex issues that Australia faces in dealing with China.
The context, the reaction and the images spoke to key elements of Australia’s exquisite dilemma. There was the backdrop of the intense naval contest between the United States and China in the South China Sea that could have involved those very warships in Sydney. There was the unhappiness of Australia’s China hawks over the visit that exemplified the difficulties Canberra faces in balancing its number one “friend” with its number one “customer.” And there were the pictures – of Chinese sailors loading up with Australian baby formula – that hinted at the tensions between the commercial opportunities and the social challenges posed by the Chinese.
Despite these dilemmas, the good news is China will not implode. It will continue to be a major driver of Australian economic growth and a source of large financial flows; but also a geopolitical challenge.
No debt crisis is looming
Yes, China has a debt problem. But the problem should be seen in context – relative to other economies – before rushing to conclusions of an imminent financial implosion.
China had, as at 2017, total debt equivalent 250 per cent of GDP. But that’s much the same figure for the US. China’s private sector non-financial debt was around 180 per cent of GDP. Stripping out household debt of around 45 per cent of GDP, corporate debt was 135 per cent of GDP. That is high. By contrast, US non-financial corporate debt was around 70 per cent of GDP. But note that a lot of Chinese corporate debt is quasi-government, sitting on the balance sheets of State-Owned Enterprises (SOEs). Because the Chinese government debt to GDP ratio is low to begin with – at 45 per cent of GDP at end 2017, compared to more than 100 per cent for the US government – reclassifying those SOE debts will give you a less frightening picture from a debt default perspective. In looking at Chinese debt, it is useful to consider the State’s balance sheet.
China has been running current account surpluses since the mid-1990s, which means it is not dependent on external funding for its economic activity. Chinese savers fund the Chinese economy. So, economic life continues even if it faces a foreign capital strike.
It has accumulated approximately US$3.1 trillion in foreign currency reserves as a result of these surpluses. That is around 22 per cent of its GDP, compared to the international average of around 15 per cent. This gives it a liquidity buffer; lowers crisis risk; and provides substantial resources for crisis mitigation. Still, those reserves are only 11-12 per cent of M2 money and can be quickly depleted in a capital flight. So, it has capital controls to mitigate that risk.
China borrows largely in its own currency. Its external debt is only around 14 per cent of GDP. The debt experience of peripheral European Union countries versus the US and Japan is the difference between debt denominated in foreign currencies versus debt in your sovereign currency. It is also the difference between controlling your own currency (e.g. US and Japan) versus having no control over your currency (e.g. Portugal, Italy, Greece, Spain).
And China’s high savings rate (47 per cent in 2017) and low bank loan to deposit ratio (0.7) limit the risks of domestic funding stress.
At 13.5 per cent, the People’s Bank of China’s Reserve Requirement Ratio level is still high by international standards. It has more policy ammunition on this front than the United States, where the equivalent ratio is 10 per cent.
China also has more fiscal policy ammunition than the US, with an official estimated budget deficit of 2.8 per cent of GDP for 2019, compared to 4.7 per cent for the US. However, Morgan Stanley analysts estimate there are another 150 basis points in China’s budget deficit to GDP ratio, after adding off budget items. But that would still leave China’s “augmented budget deficit” to GDP ratio to 4.3 per cent – lower than the US$ estimate.
Slowing the inevitable
China’s slowing growth will have knock-on effects on the Australian economy. But the far bigger disruptive forces are the business opportunities created every year despite that slowing, and China’s likely use of those opportunities to achieve its geopolitical objectives.
Even with 25 per cent tariffs on all its exports to the US – assuming a resultant loss of 160-170 basis points of nominal GDP growth – China will still exceed the US economically, in US dollar terms, by the early 2030s. Those tariffs will slow that inevitability, but by only a few years.
That growth will likely be overwhelmingly driven by consumption, rather than by investments and net exports as in the past.
Assuming a moderate shift in the household consumption expenditure share of GDP from 40 per cent to 45 per cent by 2030, the consumer market would have grown from US$5.3 trillion to more than US$12 trillion. It would have grown consumption by five times the size of the Australian economy in 2018.
While China’s economy is changing, around 60 per cent of Australia’s exports to China remain iron ore and coal. Despite the publicity surrounding a few success stories, we have made few inroads into China’s consumer market.
The regular media reports of Australian consumers fuming over daigou buyers cleaning out supermarket shelves of baby formula begs the question of why there are such surrogate buyers all over Sydney and Melbourne suburbs to begin with? The younger generation of Chinese consumers are digitising their spending habits rapidly, making it easier to reach them online. Yet there are these ubiquitous daigou stores. What has the Australian distribution chain missed?
Even as we puzzle over how to penetrate the Chinese consumer market, the nature of that market is rapidly changing. Chinese consumers are becoming older, wealthier and more sophisticated. Meanwhile the younger Chinese consumer – the Little Emperors of China’s past one-child policy – are coming of age and becoming very much more demanding.
And we will see this in services as well. China Outbound Tourism Research estimates 180 million outward trips from China this year, rising to 400 million by 2030.
But Chinese tourists will increasingly demand the literal road less travelled. They will seek premium experiences in new locations, further from home – that is, also further than Australia. And they will want those experiences in more comfort and with more convenience.
Cultural challenges to managing in Asia
Beyond infrastructure and quality facilities, Australia needs people with language skills and cultural familiarity to drive its business engagement. And that’s for everything from selling tourism to consumer products.
Yet, there were only 4,000 students in the whole country doing Chinese at Year 12 in 2015. Stripping out those with Chinese ancestry, there were less than 400.
Yes, but don’t we have all these Asian migrants in our midst who can drive our regional business engagement? Not quite; not at senior levels of management.
Asian-Australians make up approximately 12 per cent of the population. But as former Labor government minister Gareth Evans recently pointed out, Asian-Australians are grossly under-represented in leadership positions. He drew on the work of the Australian Human Rights Commission’s 2018 “Leading for Change” report, which found that Asian-Australians accounted for only 1.6 per cent of “chief executive officers or equivalents.” Looking one level down the management chart, the report found Asian-Australians made up only 3.3 per cent of non-chief executive, “C-Suite” senior managers.
Beyond management, there is the boardroom. A quick survey of ASX 100 companies indicates that Asians made up only around 5 per cent of the boards.
While addressing gender diversity in our boardrooms, we should also improve cultural diversity, if for nothing else but our own commercial interests. If the argument is there aren’t suitable Asian-Australians who want to sit on the boards, companies can look regionally as Treasury Wines, Orica and Westpac have.
We can also do a lot more to engage broadly with Asian foreign investors, who can offer deep insights into China and the rest of Asia. They are within our midst and are often willing to share, if we bother to engage.
People are the underappreciated Chinese export
With rapidly growing wealth and intensifying pressures from urbanisation, more skilled and monied Chinese will seek migration to Australia. According to data from the Global Wealth Migration Review, Australia is the top destination in the world for high net worth migrants, with China the biggest source country of departures.
That should be welcomed. Population and productivity are the two biggest drivers of economic growth. And with their money and business skills, these wealthy migrants should boost our business engagement with China, and generate jobs for Australia, provided the money that flows in is channelled into productive businesses, which utilise their commercial expertise and networks.
But this can also be socially disruptive. It might also contribute to income/wealth inequality and other imbalances. So, within a racially non-discriminatory framework, this phenomenon will require regular balancing against other categories of migration – family reunions, skilled migration, and humanitarian intakes – to achieve what reflects an Australian vision of an equitable and diverse society.
China’s geopolitical power will grow with its economic power. China is not the only country in history to use its economic clout to further its broader international interests. It has used its economic power against those who have crossed it and will very likely continue to do so.
The most prominent recent example is South Korea, after its deployment of the Terminal High Altitude Area Defence (THAAD) anti-missile defence system. Beijing constricted the tourist funnel and rallied a boycott against the food, beverage and retail conglomerate supermarket chain Lotte.
Of course, Australia has to stand up for its broader interests, notwithstanding possible economic blowback. Countries do not trade out of charity but out of mutual comparative advantage. But equally, they don’t form strategic alliances out of charity either, but out of hard-headed consideration of security interests.
China’s demand for steel and energy will continue to grow, albeit at more modest levels, as a result of continued urbanisation and higher incomes. Just as importantly, there will be greater demand for our iron ore and coal from emerging Asia ex-China, particularly India. That should maintain a reasonably healthy balance between demand and supply over the next decade.
So, China – as irritated as it might be with Australia from time to time on geopolitical matters – will have to continue buying iron ore and coal from Australia for a long time to come.
But our economic connection with China also includes tourism and education. And China can turn the taps on and off more easily in those areas, causing disruption and pain, short of total disengagement, which is unlikely to happen.
Thirty one per cent of all international students in 2018 were from China, followed by India at only 13 per cent. Chinese students contributed $11 billion to our export income in 2017-2018. And the growth from that income from China has been accelerating.
Similarly, the Chinese are our biggest source of tourism dollars by a wide margin. They spent $10.4 billion in Australia in 2017 compared with visitors from the US at $3.8 billion.
These sort of figures underline how we need to diversify more urgently to moderate our vulnerability.
But there is something else we can do to reduce volatility in our business relationship with China.
Between the two extremes of loudly criticising China and capitulating to Beijing’s expansionism in the South China Sea and other actions, there are middle paths which may make more mundane the day-to-day business of doing business with China. Dull is good.
None of the above is to suggest a geopolitical inevitability about China being Number One. Being the world’s largest economy, from sheer population size, is not the same as being the dominant world power. But such binary calculations are not useful from a business perspective anyway. We shouldn’t confuse “greatness” with “business.”
Australia should also pay attention to the regional dynamics. The attitudes towards China are still fluid, but lately less combative.
As a middle power, we have to be realistic how much we can stand out in the region. We have to calibrate whether it is in our national interest to be the regional tall poppy.
Without sacrificing our sovereign rights, we should be able to speak truth to power, without shouting it. We can state our positions, defend our interests, and support international conventions, without theatrics.
And what is the worst that could happen if we did not loudly echo every anti-China sentiment out from the US?
To repeat, nations do not trade out of charity. But neither do they form alliances out of charity.
