How much does the Australian economy rely on China?

Chief Economist's View

Download the PDF version including our economic update by region here: How much does the Australian economy rely on China?

Amid the good news of the ongoing recovery in the Australian economy (consumer confidence at a 10-year high, business confidence at a 2½ year high), the deterioration in relations with China casts a pall over an otherwise improving outlook. In this week’s Brief, we revisit the dispute with China and its fallout on trade. Australia is a relatively small trading nation, with around a quarter of our GDP accounted for by our international exports of goods and services. China is our main trading partner and in the pre-COVID year of 2019, we sold around $169 billion of goods and services to China, around 34% of all exports from our shores and about 8½% of GDP.

Of our exports to China, the overwhelming majority are resources, which account for $121 billion or 6.1% of GDP. Of these iron ore, coal and LNG account for $109 billion for 65% of total exports to China and about 5½% of Australian GDP in 2019. The remainder of Australian exports to China consist of services exports of education and tourism (around $18 billion, 1% of GDP), agriculture ($17 billion, 0.9% of GDP), manufactures ($6 billion, 0.3% of GDP), and other miscellaneous goods and services ($7 billion, 0.4% of GDP). To date, China has largely targeted our agricultural exports such as beef, barley, rock lobster, wine and timber.

As we can see from the numbers, even if Australia were to lose the entirety of sales of agriculture products to China, the impact on the Australian economy would be sizeable, but not devasting at a loss of just under 1% of GDP. Of course, at this stage, China has mainly resorted to tariffs on our agriculture exports rather than quotas or outright embargoes. Of course, the more serious threat to the Australian economy would be if China were to target our resource exports; in particular, iron ore and coal. But here Australia is fortunate – at least for the time being. China needs our iron ore and metallurgical coal to produce steel. At the moment, and for some time to come, there is no technological alternative to the use of these two inputs in steel production. In addition, Australia dominates seaborne trade in iron ore accounting for over 50% of global iron ore exports. The next largest exporter is Brazil, with just over 20% of global trade, followed by a smattering of small producers, none of which account individually for more than 5%.

Apart from size, Australia has a number of advantages over its competitors. It is the lowest cost producer and its proximity to China means it also has lower freight costs. Australia’s ore is of the highest quality and our supply is secure and free from mismanagement, union and worker disruption and corruption. Realistically, we think China will have little alternative but to source its iron ore and metallurgical coal needs from Australia for at least the next five years and possibly as long as to the end of the decade.

However, this does not mean we will be selling our iron ore to China at prices anywhere close to current levels of around US$140/tonne. Apart from additional supply eventually coming from Brazil (and possibly Africa), China steel production is most likely peaking and as we exit COVID, and secular trends of falling population growth and slowing rates of urbanisation reassert themselves, China steel production and, hence, the price of iron ore will inevitably decline. As revenue and growth in our resource exports fades, we need to be positioning our non-resource exports for growth. This means ensuring that they remain competitive in international markets and that we have a diverse market base, as unlike our resource exports, we will not have monopoly power for these exports.

Unfortunately, our international tourism and educational services exports have been hard hit by COVID. However, the backdrop for these services is extremely positive. Australia has strong international comparative advantage in these two service exports, favoured by natural and exotic tourist attractions and high-quality education facilities offering English-language degrees. We sit in a region that accounts for around 35% of the global population, even when China is excluded.

And the region’s middle class is growing exponentially, both in numbers and income. Asia’s (ex China) middle class spent US$8.1 trillion in 2015, which is estimated to have risen to US$11.4 trillion in 2020 and is projected to grow to US$22 trillion by the end of the decade. This will lift Asia’s (ex China) share of world middle class expenditure from its current level of 27% to 35% by 2030. The market is huge, and the aspirational expenditure of this growing middle class is on travel, education and health services.

Our resource exports buy us time to ensure that these nascent export industries have time to grow and develop into world class offerings. But that time is limited and we must ensure that conditions are optimal to allow these industries to compete successfully in international markets. This means having a skilled workforce and an industrial relations environment that promotes productivity. It means embedding these industries in best-of-class infrastructure. And it means ensuring that potential export markets in our region are aware of our offerings and that we are perceived as a safe and welcoming destination to visit.

Table 1: Financial market movements: 3 - 10 December 2020

Source: Bloomberg