Back in 2014, then foreign minister Julie Bishop raised eyebrows when she described the US, not China, as our most important economic relationship. The argument was that one ought to consider foreign direct investment and not just trade in making an assessment.
US ambassador Arthur Culvahouse made a similar argument which was reported in these pages this month. Going against the common wisdom that China is well entrenched as Australia’s most important economic partner, Culvahouse pointed to the $1.6 trillion two-way investment between the US and Australia. This is on top of the US remaining our third-largest two-way trading partner.
Many will view with scepticism the comments by the ambassador given the increase in two-way trade and foreign direct investment with China that has occurred since Bishop made her comments. But we need to get the economics right if we are to better debate how best to position Australia vis-a-vis the two largest economies in the world. Bishop was correct back then and Culvahouse is correct now.
As at the end of 2018 and at over $214 billion, our two-way trade with China is almost three times more than that with the US. When it comes to two-way FDI with Australia, the figure for the US is about 12 times more than for China. How best to understand these statistics?
Back in August 2017, the United States Centre released a report titled “Indispensable Economic Partners: The US-Australia Investment Relationship”, pointing out the positive spill-over effects between investment partners in terms of knowledge and technology transfer, infrastructure development and deepening of capital markets between investment partner nations.
What about the undoubted importance of trade? Consider this scenario. You go to the same supermarket every day to buy your groceries to stock the cafe you own. As your cafe is booming, you are buying more and more products from the supermarket, making its owner very happy. In the midst of the booming trade relationship with the supermarket, you have a dispute with the local mayor who bans you from entering the town where the supermarket is located.
From your point of view, this is highly inconvenient as you need to establish relationships with another reliable supermarket to stock your cafe. This is time consuming, potentially costly and might disrupt the normal running of your cafe in the short term. The supermarket owner has lost an important customer which will affect their bottom line. This is what trade might look like.
Now consider the situation if you are an investor in the supermarket. A deterioration in your relationship with the mayor — and a subsequent ban against you coming anywhere near the supermarket — is much more serious. You can no longer run your business properly, and if things take a turn for the worse, it will be difficult to sell your stake in the supermarket. If the mayor decides to seize the equity in your business, you lose a major asset. It is in your overriding interest to do whatever it takes to have a good relationship with the mayor. This is what an investment relationship could look like.
Trade is a series of important but short-term mutually beneficial transactions that hopefully recur to maximise efficiency and convenience. But in the longer term, exporters do not inherently care who they sell to and importers are not inherently interested in who they buy from as long as the exchange is fair and reliable.
An investment relationship has far more at stake for both firms and governments. For the firm, FDI is an investment of significant capital, manpower and the firm’s brand and reputation in a foreign political-economic system for a substantial period. Withdrawing capital prematurely entails significant sunk costs and substantial loss of reputation for that firm and its management. To invest substantial amounts in another country, that firm must have considerable confidence in the present and future stability, transparency and fairness of that foreign country and its government.
In short, if one wants an economic indicator of intimacy between countries, look for long-term bets made in each other’s political-economy and FDI is a superior indicator of just that.
Even if one refuses to accept this argument with respect to the greater importance of FDI, then Australians might ask of themselves another question: where would they park their hard-earned assets outside the country?
Would it be the US with its deep and efficient capital markets and financial system and institutions that obey transparent rules and laws? Or in China where private property, capital and assets can be arbitrarily seized, where the party and state intrude systematically in economic life, and where the rich are finding ever more ingenious ways to bypass capital controls and transfer their assets to havens such as the US?
It is useful to occasionally be reminded of the importance of the economic relationship with the US. Getting to a good policy position depends on it.