News

Australia-China trade deal – prospects and pitfalls

14.06.2011

Daniel Moulis, Principal

Charles Zhan, Chinese and Australian law graduate

In recent announcements, the Australian and Chinese Governments have suggested that they will re-energise their free trade agreement (“FTA”) negotiations. New enthusiasm for this initiative will be welcomed by traders and investors. However there is nothing to suggest that the negotiations will be any easier than before. The 15 rounds of the negotiations so far, first launched in May 2005, have underlined the difficulties of the exercise. But viewed in a positive light, the talks up to now have exposed the differences in trade policy that exist between the two countries, differences which can now be of greater focus and new bargaining. Other developments in world trade and in the bilateral relationship suggest that there is more at stake than before, adding greater impetus to the negotiations.

In this China Messenger, we take a look at what the current issues are, and what they tell us about the prospects for a successful consummation of this ambitious undertaking.

Doha Round delays create new FTA urgency

The Doha Development Round of trade negotiations in the World Trade Organisation (“WTO”) have now dragged on for 10 years. Comparatively speaking, this is the same length of time that it took to get a result in the previous Uruguay Round. But in contrast to that Round, there is no present anticipation that the Doha Round is nearing a conclusion, whether successful or otherwise. A less ambitious “Doha-lite” proposal is now on the table, which falls well short of the trade opening goals of the original Doha Round mandate.

The WTO’s burgeoning success in terms of increased membership and dispute settlement has proved to be an impediment to its growth. Because unanimous outcomes are required to install any changes to the various agreements which define their multilateral relationships, the Members of the WTO have always had a strong voice in any new deal. However there are now 153 of them. Members who were previously less active now have a much better understanding of their obligations and their rights, and are demonstrably shy about adding to the former without a commensurate improvement in the latter.

Eulogies for the rules-based trade regulation system embodied in the WTO agreements are premature. That system will persist. But there is a growing realisation amongst Members that bilateral or regional trade agreements with key trading partners will deliver faster and more predictable benefits. Australia and China are key trade partners, and the continuing failure of the Doha Round is one of the factors which have brought both sides back to the negotiating table.

Mutual trade dependency

Energy and resources, including iron ore, coal and natural gas, are at the heart of the Australia-China trade relationship. China is Australia’s largest export market for Australia. Iron ore alone accounted for nearly half of Australian exports to China in 2009-2010. According to Australian Department of Foreign Affairs and Trade statistics, bilateral trade volume grew by 24.6% between 2009 and 2010.

And, as one might expect from such a strong dependency on key industrial feed stocks, a cashed-up China is an increasingly large investor in Australian assets. The bilateral relationship is also hungry for the support of the services sector, where trade levels are also significant and growing.

The FTA “dance” – first in, best dressed

Both Australia and China are working on other FTA agreements with their respective major trade partners, in an effort to achieve better deals faster outside the multilateral negotiations. Outwardly, Australia still professes strong support for the Doha Round and its objectives. However in its Trade Policy Statement issued in April of this year, the Australian government has announced that the negotiation of bilateral trade deals with China, Japan, Republic of Korea, Malaysia, Indonesia and Gulf Cooperation Council are a policy priority.

At the same time, China, Japan, and Korea seem to be involved in a FTA “competition” amongst themselves. A breakthrough in the Australia-Korea or Australia-Japan FTA negotiations would be bad news for China in terms of its trade parity with its north Asian competitors.

Adding to this competitive pressure has been the commencement, in May of this year, of Australia’s FTA negotiations with India. Like China, India is a rising economic power with a huge population and increasing resource demand. This will add further pressure on China to secure Australia as a preferred partner before other suitors do the same

What are the two countries saying, publicly?

In a speech during her first visit to China in April 2011, Australian Prime Minister Julia Gillard told a China-Australia Economic and Trade Forum meeting that there were three priorities in the Australia-China economic relationship: investment, trade and clean energy. Gillard reiterated the need for a bilateral FTA for the long-term benefit of Australia-China relationship, and said that the negotiation progress had been too slow. She reassured her hosts that Chinese investment is welcome in Australia, and that it would be subject to the same review process as other foreign investment.

In response Chinese Vice Premier Li Keqiang expressed the hope that “the two countries should seek a long-term stable and strategic cooperation in energy and resources, rather than maintain a simple buyer-seller relationship”. Li urged the two countries to liberalise and facilitate trade and investment in a bid to create a sound environment for business. Li said that China and Australia should “innovate their ways of cooperation” and “seek mutual benefit” with respect to energy and resources.

The mood is positive: however these public pronouncements do not tell us much about the key areas of disagreement that have so far prevented progress.

Agriculture, investment policy and domestic change are key barriers

As is the case in the Doha Round, agriculture is an area of major difficulty. Agriculture has always been a “sensitive” area for China, with Chinese interest groups seeing commercial dangers in a trade deal with the highly competitive Australians, and a lack of certainty as to their ability to navigate their way past Australian quarantine barriers. By the same token, as food prices and inflation become more pressing issues in China, it is quite possible that China will be more inclined to alleviate the situation by encouraging more imports. If that transpires then agriculture may not be the most difficult part of the FTA negotiations after all.

Australia’s emphasis on a comprehensive and high-quality trade agreement means that all “sensitive issues” must be dealt with if there is going to be a deal. These days, “comprehensiveness” in an FTA extends the reach of such agreements into many areas of domestic regulation, such as competition policy, movement of natural persons, government procurement and administrative transparency. China is already struggling to cope with its WTO obligations in many areas of domestic reform. An overlay of FTA obligations on a “WTO-plus” basis will not be easy for the Chinese side to manage.

China has also been slow to liberalise its services sector, another area of business in which Australian companies are seen as being seriously advanced and highly competitive.

Other areas of difficulties

If the Agreement truly is to become a “high quality” and comprehensive one, a number of other obstacles will need to be overcome. For instance, since the very beginning of the negotiations, Australia has been consistently pushing for a government procurement agreement to be included in the FTA. Neither Australia nor China is a party to the WTO’s plurilateral Agreement on Government Procurement (“the GPA”). However, Australia, like many of China’s other trade partners, wants to share in the huge Chinese government purchasing market.

Back in 2006, Australia stated that government procurement under any FTA deal must be at least as favourable as that under the WTO scheme. However China’s accession to the GPA itself is full of uncertainties. For this reason China has been reluctant to deal with Australia on government procurement issues before it can reach an agreement with other GPA members.

Australia has also tried to persuade China to include competition policy in the FTA’s coverage. But although China has made remarkable progress in terms of establishing its own new competition laws, a mature and effective competition policy scheme in China is still some way off. By contrast, Australia has established a sophisticated competition law system, built on decades of trade openness and international legal complementarities. The asymmetric experiences and standards of the two countries suggest that it would be very challenging for the parties to reach an agreement.

Mixed messages on investment policy

Freedom of investment in Australia is another area of concern for the Chinese. Despite the rhetoric on the Australian side about the non-discriminatory nature of foreign investment barriers, there can be no doubt that China feels targeted by Australia’s recently tougher policies. Although Australian investment policies are explained in general terms, the timing and topicality of changes to those policies gives China cause to question whether or not its investors are welcome.

At the time of the first wave of Chinese investment in resource assets, the Australian Treasurer introduced new guidelines for investment by entities known as sovereign funds, such as State-owned enterprises. Now, simultaneously with a new wave of Chinese investment in agricultural assets, a Foreign Acquisitions Amendment (Agricultural Land) Bill 2010 is now being debated in the Australian Parliament. This is a private Member’s Bill, meaning that it is not necessarily endorsed by the Government, but it does indicate the political concerns surrounding such investments.

As its name suggests, the Bill proposes several changes to the regulation of foreign acquisitions of Australian agricultural land. If passed, all foreign acquisition of interests in agricultural land greater than five hectares would require Government approval under a “national interest” test. Applications for approval would be published “on-line”.

DS 379 – a reassessment of “China Inc”?

In a recent WTO ruling, referenced as “DS 379”, the Appellate Body ruled that the US Department of Commerce had erred in its finding that all Chinese SOEs were “public bodies” for the purpose of assessing whether a government subsidy “benefit” had been conferred by them. The Appellate Body ruled that a definition of “public bodies” as “any entity controlled by a government”was insufficient. Instead, the Appellate Body defined “public bodies” as “an entity that possesses, exercises, or is vested with, governmental authority”.

Potentially, DS 379 has implications with extend beyond the countervailing duty context in which it arose, and it may feature as a topic of discussion at the FTA bargaining table. For example, Australian manufacturing industries have agitated for stronger trade protection, partly on the basis of alleged State collusion with Chinese manufacturing industries. With the “public body” justification now removed, Australian negotiators might need to temper their own protection requests

Also, “foreign government and its related entities” are excluded from the benefit of Australia’s dollar threshold for foreign investment notification and review, meaning that investment by such entities of any value must be notified and reviewed. DS 379 now assumes, for legal purposes, that trade distortion comes from the legal power or status of State-related entities, and not merely from their ownership. The Chinese side might see this as opening up new opportunities: the country has huge foreign reserves. There are major political constraints to Chinese investment in (say) the US and Europe.

The Australia-China FTA may be seen as a precedent-setting example of how developed countries might open up to China in the future.

Australia’s rejection of investor-State dispute clauses

The Australian Government Trade Policy Statement, to which we have already referred, abandoned the practice of agreeing to investor-State dispute (“ISD”) clauses in bilateral trade agreements. Typically, these clauses allow investors of the investment-giving country to take legal action against the government of the investment-receiving country for unequal treatment of them when compared to the treatment accorded to the investors of the investment-receiving country.

ISD clauses have traditionally been required by developed countries for the protection of the interests of their investors in countries that have less or insufficient legal protection for foreign investors, and where the political or judicial system may be considered to be unreliable or inconsistent.

It is unclear how the Chinese side will respond to this new development. Despite being perceived by the developed world as lacking in both legal transparency and judicial independence, China has enjoyed dramatic inflows of foreign direct investment (“FDI”) without offering ISD protections. However, to protect its outbound investors, China has negotiated ISD clauses in its FTAs with Pakistan, ASEAN, Peru and New Zealand. It has also been reported that China and Chile have achieved a common understanding on ISD for their proposed investment treaty. Also, Australia has attracted more investment from China than China has received from Australia, and the gap can be expected to widen.

China might therefore see it as being in its interest to have an ISD clause, especially considering the increasingly sensitive nature of the Chinese investment presence in Australia.

A most important FTA, in international terms

The process of negotiating an Australia-China FTA, and its outcomes, will be closely watched by the world’s major trade players. It will be China’s first FTA with a developed economy. It will signal China’s flexibility on agricultural trade. It will expose what China is willing to “give away” in exchange for greater investment access to resources and intellectual assets. It will define the degree to which China is prepared to move to a “WTO-plus” position on services trade.

The process will not be quick, and it definitely will not be easy. However it will be facilitated by some things that the Doha Round lacks: a genuine economic and political friendship between the negotiating parties, and a much better appreciation of what is in their mutual best interests.

For more information, please contact Daniel Moulis or Charles Zhan on +61 2 6163 1000 or email daniel.moulis@moulislegal.com or charles.zhan@moulislegal.com

This memo presents an overview and commentary of the subject matter. It is not provided in the context of a solicitor-client relationship and no duty of care is assumed or accepted. It does not constitute legal advice.