Phil Goff: Contemporary China Research Centre

Reposted from Labour’s website.

Speech by Hon Phil Goff MP, Labour Trade Spokesperson, Victoria University, 2 July 2014

The Central Committee of China’s Communist Party’s decisions at a Plenary meeting would, two decades ago, have been of limited interest to New Zealand.

The situation today is very different.

China’s importance in the global economy and the size of its trade with New Zealand means that reforms to its economy are now very relevant to us.

China two years ago became our largest trading partner and the largest export market for our goods.

Just last week, two-way trade between our countries passed the $20 billion per annum benchmark.  By 2020, it could easily exceed $30 billion on present growth projections.

Growth in demand for high quality, safe and protein rich food by China’s growing middle class has been phenomenal.

Last year, the sale of NZ dairy products soared from $2 billion to $4 billion in one year.

Trade in New Zealand logs peaked at $1.7 billion though that is reducing sharply as the infrastructure boom in China is wound back.

Sheep meat exports moved from 1 per cent of NZ’s lamb exports in 2009 to 35 per cent last year valued at $670 million.  Beef exports jumped 271 per cent to $190 million.  An astounding $240 million worth of live crayfish, almost all of our exports, went to China last year.

Growth of trade in services has been similarly spectacular.  China has remained our largest source of international students at 24,000.   Tourism leapt to 250,000 a year making China our second biggest source of tourists.

That growth has been incredibly valuable to us.  When Europe and the US markets during the GFC were shrinking, growth in demand from China stopped New Zealand from facing the same depth in economic crisis as other western economies.

The increasing level of dependence by New Zealand on a narrow range of primary sector commodities and one market has at the same time caused some concern.  Having too many eggs in one basket creates risks.

China takes nearly 23 per cent of our total exports, up from 6 per cent in 2010.  That is still a long way from the level of dependence we had on the United Kingdom in the 1950s and 1960s.

However, within 10 years our exports to China could be around 30 per cent of our exports, a similar level to what we had with the UK at the time it entered the EEC in 1974.

Indirectly we are even more dependent on China because of its high level of trade with other important trading partners like Australia.  China is the largest trading partner for some 124 other countries.  If the Chinese economy were to collapse, the direct and indirect effects on New Zealand’s trade and economy would be dire.

The catalyst for the growth in trade was the high quality, comprehensive Free Trade Agreement I signed in the Great Hall of the People with Chen Deming in 2008.

The timing was perfect.

It coincided with the cumulative impact of decades of consistently high growth in the Chinese economy.  That produced an urban middle income group of over 300 million who had disposable income and a hunger for high protein and high quality food.

That demand is likely to be sustained into the future.  While demand for hard commodities like iron ore and coal is diminishing as the boom in infrastructure promoted by the Chinese Government to counter the effects of the GFC is wound back, demand for soft commodities like dairy is continuing to increase.

China is not able to meet this demand internally, with the current state of its agriculture and constraints on water and agricultural land.

When prices are high, however, other competitors are drawn into the market.  It is unlikely that dairy prices will be sustained at their current level.  As recent events have shown, nor can we be complacent about our reputation for high quality safe food.

Real damage was done to our reputation by the DCD and botulism scares.  It could have been even worse.  The New Zealand Government through its restructuring, cost-cutting and understaffing of MFAT and MPI must bear some responsibility for that.  Likewise Fonterra whose communication strategy and quality safeguards fell well short of the mark.

Aside from these issues, what are the risks of an economic crisis or downturn in the Chinese economy that might damage New Zealand given our growing dependence on it?  And will the reforms foreshadowed at the Third Plenum mitigate these risks?

Pessimists point to the slowing rate of growth in the Chinese economy.  They point out that China is no longer increasing its share of the US and European import markets.

They highlight growing debt levels, an appreciating currency where the RMB is 35 per cent up against the US dollar compared to 2005, and that China’s low cost advantage has been blunted by rising wages which have tripled in the past decade.  Internal inefficiencies, bureaucracy and corruption undermine China’s performance.

However, these things should be seen in context.  After 30 years of double digit growth, it is entirely predictable that the rate of growth will slow.  It is also worth pointing out that while growth in 2009 was 9.2 per cent, it produced increased value of 2.7 trillion RMB.  In 2013 growth was lower at 7.7 per cent but because it came from a much higher base, added value was in fact five trillion RMB.

China’s debt has gone up but as a percentage of GDP it is still lower than Germany’s, the least indebted of the G7 countries.

The NZ Treasury last year concluded that there are cyclical risks to China’s economic performance in the medium term but the risks were manageable.

The Reserve Bank in May of this year warned of the build-up of fragilities in the financial sector.  The so-called shadow banking sector runs higher risks than the more regulated and supervised banking sector.

Local government financing vehicles face significant funding and liquidity risks.  There is a risk of a sharp decline in property prices which could reduce household wealth and trigger more widespread asset losses in the financial sector.

The Reserve Bank warned that a contraction in Chinese demand could have a major impact on New Zealand’s exports.

However it reported that reforms in the Third Plenum aimed at liberalising interest rates, reforming local government finances and improving transparency and regulation in the shadow banking sector addressed these risks.

The central government in China holds extensive assets and foreign reserves.  External debts are minimal and central government debt low.  The Chinese Government, it said, therefore has the capacity to intervene to stabilise financial markets and manage the risks.

The Third Plenum and the leadership of Xi Jinping mark a clear commitment by the new Administration in China to address the need for economic, social and environmental reform in China.

Comparing it with the land mark reforms of Deng Xiaoping at the Third Plenum of 1978 may be an exaggeration.

The 1978 reforms marked the abandonment of Mao’s disastrous economic policies and political management and a platform to launch China’s opening up and reform.

The 2013 reforms build on preceding changes and mark an intensification of efforts to address outstanding problems.

The most significant change will be to allow the market to play a more decisive role in the allocation of resources, and to price those resources accordingly.  The power of SOEs will be curbed and new areas opened up for private sector investment and competition.  Unnecessary red tape and regulation will be cut.  Financial markets will be liberalised and improved and the tax system further reformed.

Social reforms are also significant.  Most families will be allowed to have a second child if they choose.  The hukou or household registration system will be reformed to give rural migrants equal access to public services.  Re-education via labour systems will be abolished.

The crackdown on corruption has already seen over 31,000 officials convicted in 2013 and has reached up to the highest levels of the Party.  Importantly the crackdown has been sustained and appears likely to continue to apply pressure to change an entrenched culture.

There is a renewed commitment to addressing the air, water and soil pollution caused by decades of subordinating the environment to rapid economic development.

The reforms, however, don’t embrace political liberalisation.  Media censorship has tightened and the pervasive and dominant role of the Party entrenched.

It remains to be seen whether the intent of reforms can be realised without the accountability that the rule of law, an independent judiciary and free media and upholding of human rights provides in a democratic society.

To conclude, it is too early to judge conclusively what impact the Third Plenum reforms will have on China’s economy and society and on us and the region.  The need for reform is undoubted, the commitment to reform and leadership of it apparently strong and the general direction of the reform positive.

The ability to implement it and whether the extent of necessary reform goes far enough are both less certain.

New Zealand will benefit economically from the successful implementation of reform because of the high level of interaction between our economy and China’s.  So too will the region.

New Zealand should seize the opportunities China offers us as a trading partner and make changes to ensure we are best able to realise the full potential it offers.

At the same time we would be wise to make strenuous efforts to diversify our export markets and the narrow export base our country relies on.

That is a common sense safeguard against the risks that dependency on any one market or narrow range of products involves.

With reform and continuing economic success, China’s influence over us, the region and the world will grow commensurately.  Political and military power grows with economic power.

Our engagement with China and the balancing of our relationships with China and the other super power in our region, the United States, will more and more become front and centre of New Zealand’s foreign and trade policy.