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Diversification: trade mission impossible?

Disruptions to Australian exports of beef and barley combined with COVID-19 and geopolitical shifts have put both China-oriented demand and China-centric supply chains in the spotlight.

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Around 35 per cent of Australia’s goods exports go to China. For some commodities – iron ore, infant formula and liquefied natural gas (LNG) – more than half of Australian exports go to China. Others such as wheat only have a small share going to China.

"The risks of a concentrated customer base or supply chain are not only being felt by commodity exporters.”

China has also become dependent on Australia for some commodities such as iron ore.

But Australia is not alone: Japan, South Korea, Indonesia - among many others - also count China as their largest goods customer. Even Germany now counts the nation as its largest export destination.

Diversification pressure

The risks of a concentrated customer base or supply chain are not only being felt by commodity exporters. Manufacturers with China-based supply chains are now cognisant of these risks.

French Finance Minister Bruno Le Maire stated France has to “decrease [its] dependence on a couple of large powers, in particular China, for the supply of certain products".

The impact is two ways: Chinese businesses understand the risks; Huawei is considering investing EUR200 million in a French production plant.

Australian exporters are now feeling pressure to diversify their markets. New trade agreements with Indonesia, regional agreements such as the Regional Comprehensive Economic Partnership (RCEP) and new bilateral arrangements with India will support diversification.

But reality checks are also needed. Consider Australia’s relationships with the US as the world’s largest economy, the European Union (EU) and India as prospective free trade agreement (FTA) partners, and Indonesia as the region’s largest economy.

United States

  • Share of Australian exports: 4 per cent
  • Largest exports: Beef, vaccines, aircraft parts
  • FTAs: AUSFTA

The US is probably Australia’s most diverse export market. Agricultural and resources/energy make up less than 40 per cent of exports to the US. Australia is a supplier of a number of manufactured components to the US, notably aircraft parts - a good example of how an open investment regime encourages growth in exports, in this case manufactured by Boeing.

Australian businesses have little difficulty exporting to the US. The market is mature, sophisticated, and the internal market is diverse. The more important element of the relationship is services and investment; the services trade between the countries is similar in size to the goods trade.

...

European Union

  • Share of Australian exports: less than 5 per cent
  • Largest exports: gold, coal, canola, wine
  • FTAs: Under negotiation

Around 5 per cent of Australian goods exports go to the EU but the largest export partner – the UK – has left, reducing this share to around 3.5 per cent.

Agricultural exports are low because trade barriers in the EU are high; manufactured exports are generally niche products.

Like the US, the EU relationship - and the push for a FTA - is more about high-value add goods (such as therapeutic goods), services and investment.

Some EU policymakers also see Australia as a possible gateway to Southeast Asia.

India

  • Share of Australian exports: 7.5 per cent
  • Largest exports: coal, LNG, aluminium
  • FTAs: None

The new strategic agreement with India is the latest chapter in Australia-India relations. FTA negotiations were effectively put on hold in 2015. India’s middle class sits at around 80 million and although middle class projections have been pulled back, this is still a considerable prize.

The size of the export opportunity is matched by the difficult operating environment, e.g. relatively closed agricultural markets and foreign investment. India – unlike China – isn’t oriented towards trade, imports or exports. This means even getting product samples to India can be difficult.

New approaches will need to be taken to build the trade relationship.

...

Indonesia

  • Share of Australian exports: 2.1 per cent
  • Largest exports: crude oil, coal, live cattle, wheat, raw sugar
  • FTAs: Indonesia-Australia, ASEAN-Australia-NZ FTA

Indonesia is the de facto leader of ASEAN and cannot be overlooked. Increased integration with Indonesia has been a ‘holy grail’ of Australian policymakers for decades. Australia has two FTAs with Indonesia (a bilateral, another with ASEAN) and is about to have a third (RCEP). The country’s middle class sits at 52 million, around 20 per cent of its population.

Indonesia is a relatively closed economy. Liberalisation is slow and tariffs are falling but regulatory requirements are difficult for exporters used to dealing with Singapore or Malaysia. Establishing business partners in Indonesia demands patience and cultural adaptation. Exporters need to work within these limits rather than trying to force change.

China’s reality check

Australia generally has an exceptional trading relationship with China. The China-Australia Free Trade Agreement (CHAFTA) was China’s first comprehensive trade agreement. It gave Australia preferential tariffs for many agricultural goods and liberalised Chinese inward investment. Trade has moved beyond bulk commodities and into consumer goods, particularly food. Exporters have highlighted clear reasons for this.

First, consumers are sophisticated. China’s middle class is around 350 million people, dwarfing India and Indonesia. They have high levels of exposure to international goods; they seek out specific qualities in goods, which Australia’s ‘clean green’ reputation plays into.

Second, there are multiple marketing routes. Chinese consumers are able to tap into various channels to obtain the products they want. The daigou channel for infant formula and other goods is a clear example.

Third, Chinese investment in Australia means orientation towards Chinese markets. Chinese companies such as New Hope and Mengniu have invested in beef and dairy production in Australia. The relationship is not just about trade; it’s now about broader economic integration.

One executive recently stated: “It’s very well to talk about diversification but there aren’t three more Chinas out there.” Every exporting country has a biggest customer. It will take some time for other markets to reach the size and sophistication of the Chinese market.

If trade was simple or easy, free trade agreements wouldn’t help or be needed. Exporters and politicians can’t expect zero problems in the trading relationship.

This is something that must always be navigated, regardless of the market.

Khalil Hegarty is Director at ITS Global

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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