the economic transformations in china and...

CHAPTER2the economic transformations in china and Australia

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Key messAges

TheAustralia–Chinaeconomicrelationshipisenteringanewphase,shapedbythebigchangesnowunderwayinbotheconomies,whichareseeingtheservicessectorandinnovationemergeaslargerdriversofgrowth.

TheChineseeconomyisinthemidstofamajortransformationafterdecadesofrapidheavyindustrialgrowth.Itisnowshiftingtowardstheservicessectorandadvancedmanufacturing,industriesthatwillbecrucialinsustainingChina’sprogressiontoahigh-incomeeconomy.Atthesametime,China’slargeandincreasinglywealthymiddleclasswilldrivemassivegrowthinconsumerspendinginthecomingyears.

• Tosupportthistransformation,Chinamustprioritisesupply-sidereformsthatallowinefficientindustriestoshrinkandmoredynamicandinnovativesectorstogrow.Thiswillrequirefinancialmarketreformstoimprovetheefficiencyofinvestment,moreprivatesectorinvolvementinanumberofstate-dominatedsectorsandsupportingthemanufacturingsectortomoveuptheglobalvaluechain.

• China’stransformationwillhaveprofoundimplicationsforAustraliaandtherestoftheworldasrisingdemandfromChina’shugemiddleclasscreatesvastnewexportmarketsinareasfromfinancialservicestofood.Likewise,China’stransitiontowardsamoreopencapitalaccountwillcontinuetoreshapetheglobalinvestmentlandscape,asChinesesaverslookforinvestmentopportunitiesabroadandforeigninvestmentexpandsintonewsectorsofChina’seconomy.

InAustralia,theendofthemininginvestmentboomandsteepcommoditypricefallshavealsonecessitatedstructuralchangetowardsbroaderdriversofgrowth,especiallygivencompetitivepressuresintheregion.ThishassharpenedthepolicyfocusonliftingAustralia’sproductivity,especiallyinthelargeservicessector,whichexperiencedarelativedeclineagainstinternationalbenchmarksoverthepastdecade.

• AbetterproductivityperformancewillbecrucialforAustraliatocaptureashareofemergingexportmarketsandsupporthigherlivingstandards.Amongotherthings,thiswillrequireremovingprotectionforlessproductivefirms,greatercompetitioninshelteredservicesindustriesandfacilitatingcost-effectiveinvestmentinnewinfrastructure,includingbyattractingfurtherChineseinvestment.

WhiletheAustralia–Chinarelationshipwillcontinuetobeunderpinnedbythetraditionalareasofcomplementarityincludingcommoditytrade,newareasfortrade,investmentandbroadercooperationareemerging.Besidesthegrowingprominenceoftheservicessectorinbotheconomies,thisalsoreflectsthebroadershifttowardsinnovation-drivengrowth,whichwillrequirehighly-skilledworkforcescapableofdevelopingandabsorbingnewtechnologies.

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PartnershiP for Change

TheAustralia–Chinaeconomicrelationshipisenteringanewphase,shapedbytheverybigchangesthatarenowtakingplaceinbotheconomies.Whilethedynamicofthesechangesisdifficulttopredictexactly,somethingsareclear.

InChina,thestructureoftheeconomyisshiftingtowardstheservicessectorandhigher-valuemanufacturing,andthesenewdriversofgrowthwillbecrucialinsustainingChina’sprogressbeyondmiddleincome.Householdconsumptionisbecomingamoreimportantsourceofdemand,underpinnedbyrisingwagesandincomes.

China’seconomictransformationwillhavefar-reachingimplicationsfortheworld,givenChinanowaccountsforaboutone-sixthofglobaloutputandglobalincome,andhasafast-growingmiddleclassthatisprojectedtoreach630millionpeopleby2022(WorldBank2016;Barton2013).AsChineseconsumersdemandanincreasinglybroadrangeofgoodsandservices,vastnewexportmarketswillopenupinareassuchasprofessionalservices,healthandagedcare,andagriculturalproducts.

ForChina,thedevelopmentofmoreadvancedmanufacturingindustrieswillallowitsexportsectortomoveuptheglobalvaluechain,whilestrongertransportandinfrastructureconnectivitywiththeregioncansupportdemandforChina’straditionalmanufacturingexports.

Meanwhile,China’songoingfinancialsectorreformsandcapitalaccountliberalisationwillcontinuetorecasttheglobalinvestmentlandscapeoverthenextdecade.AccordingtoWorldBankprojections,China’sshareofglobalinvestmentflowscouldincreasedramaticallyoverthenexttwodecades,asChina’sdomesticratesofinvestmentmoderateanditshugepoolofdomesticsavingslooksoffshoreforbroaderinvestmentopportunities(WorldBank2013).

China’seconomictrajectoryoverthecomingdecademaynotbesmooth.AchangeofthekindtowhichChinesepolicymakershavecommittedisunprecedented,andmanagingtheeconomy’stransformationpresentsarangeofdifficultchallengesforpolicymakers.Amongotherthings,Chinamustpushaheadwithsupply-sidestructuralreformsthatfacilitateindustrialrestructuring,allowingoutdatedfirmsandindustriestoexitandencouragingnewandinnovativefirmstoflourish.Furtherfinancialmarketreformwillbecrucialtothisshift,byallowingmoreproductivebusinessesinemergingsectorstosecurefinanceforinvestment.Facilitatingmoreprivatesectorinvolvementwithinindustriescurrentlydominatedbystate-ownedenterprises(SOEs)—suchasenergy,utilities,transportandbanking—willbesimilarlyimportant.

Afterdecadesofeconomicgrowthdrivenbyincreasingthenumberofworkersandtheamountofcapital,thesesupply-sidestructuralreformswillbenecessarytopromotegreaterefficiencyandachievesustainedincreasesinmultifactorproductivity,andthereforeincomes,overthenextdecade.

Muchasinthepastdecade,theChineseeconomywillcontinuetohavealargeinfluenceonAustralia’seconomicprospectsinthecomingdecade.

AustraliacapitalisedontheChina-ledincreaseinglobalcommoditydemandinthelastdecade,thankstoanabundanceofeconomicallyprovenmineralreserves,agloballycompetitiveminingindustryandpolicysettingsthatfacilitatedalarge-scaleexpansionoftheresourcesindustry.

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CHAPtER 2: the economic transformations in China and Australia

However,Australia’sincomegrowthhasnowslowed,partlyasaresultofChina’seconomictransformationtowardslessresource-intensivegrowth.Inthenextdecade,Australiawillneedtobroadenitsexportbasebeyondminingbytappingintothefast-growingmarketforconsumerandcommercialservicesthatiscurrentlyemerginginChinaandacrosstheregion,whilecementingitspositionasareliable,low-costsupplierofabroadrangeofenergyandindustrialcommodities.

Succeedinginthesenewmarketsforservicesintheregionwillnotbeeasy.Australiawillfacefiercecompetitionfromservicesuppliersglobally,withoutthenaturalandgeographicadvantagesitpossessesinmineralsproduction.Australiawillneedtoreinvigorateitseconomicreformagendatohelpdriveinnovationandproductivity,particularlyinAustralia’slargeservicessectorwhereproductivitylagsbehindtheglobalfrontierinmanycases.Improvingproductmarketefficiencythroughouttheservicessector,includingbystrengtheningandextendingcompetitionpolicy,willbeessentialifAustraliaistoexpanditsserviceexportsandmaintainprosperityinthenextdecade.

ForbothChinaandAustralia,drivinginternaleconomicreformwillalsorequireengagingfurtherwiththerestoftheworld.InChina’scase,thismeansallowingtheChineseeconomytobecomemorecloselyintegratedwithglobalfinancialmarketsasawayofimprovingtheallocationofcapitalinternally,andopeningupitsexpandingservicessectortogreaterforeigntrade,investmentandtechnologies.

ForAustralia,increasingcontestabilityincurrentlyshelteredserviceandinfrastructuremarketswillhelpattractawiderrangeofChineseandotherforeigninvestment.Asarelativelysmall,openeconomy,thiswillbecriticalinfinancingnewinfrastructureandAustralia’sbroaderinvestmentneeds.

InbothAustraliaandChina,theservicessectorisbecomingalargerdriverofgrowth,especiallyinprofessionalserviceareasandintheinformationeconomy,wherenewtechnologiesarefundamentallychangingthewaybusinessisbeingdoneacrosstheworld(Box2.1).

BOx 2.1: THe gLOBAL Rise OF THe innOvATiOn eCOnOmy

ChinaandAustralia,liketherestoftheworld,arelookingtowardsinnovationandtheinformationeconomyaskeydriversofinvestmentandgrowthinthecomingdecade.

Rapidlyemergingdisruptivetechnologiesarereshapingthewayconsumersandbusinessesinteract,includingthroughtheadventofthesharingeconomy,thegrowingcapacitytocollectandanalyse‘bigdata’andthroughtheshifttowardsknowledge-basedcapital(KBC).

KBCincludesinvestmentindigitalinformation(softwareanddata),innovativeproperty(patents,copyrights,trademarksanddesigns)andorganisation-specificcompetencies(brandequity,trainingandorganisationalcapital).TheOECDestimatesthatinvestmentinKBCnowrepresentsalmosthalfofallinvestmentintheUnitedStatesandotheradvancedeconomies(OECD2013b).

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Bothcountriesarerightlyfocusedonfosteringaninnovativebusinessclimatethatsupportsnewanddynamicfirmstoexpandandcreateemployment.Theirleadershipsopenedanewdialogueabouttheircountries’innovationstrategiesinAprilthisyear.Aspartofthis,policymakersmustensurethatlocalworkforceshavetheskillsandcapabilitiestotapintothelatesttechnologiesandbusinesspracticesdevelopedabroad.Buttherearedeepertrendsdrivingtheglobalenvironmentinwhichinformationandbigdatabusinessesarereshapingtheworldeconomyandinternationalbusiness,andthesetrendswillneedtobeontheiragendaforcooperationoverthecomingdecade.

Althoughmerchandisetrade—includingincommodities—willremainafoundation,theChina–Australiaeconomicrelationshipwillincreasinglybedefinedbyeachcountry’stransitiontowardsmoreservices-andinnovation-basedeconomies,andthebilateralcollaborationsthatcanhelpbringthisabout.

Thiswillmeangreatertradeinservices,butalsoabroadeningofpeople-to-peopleengagementtosharetechnologies,businesspracticesandinstitutionalknow-howaseachcountrynavigatesitsreformchallenges.Theseareasforgreaterbusinessandgovernmentcollaborationarediscussedinfollowingchapters.

ThischaptersetstheeconomiccontextfortherestoftheReport.ItbeginswithasummaryofChina’sriseandimpactontheglobaleconomyoverthepastfewdecades,withthenextsectionfocusingonChina’sinfluenceoncommoditymarketsandAustralia.ItfirstexaminestheeconomictransitionthatisnowoccurringinChinaandtheimplicationsforAustraliaandtherestoftheworld.Thisincludesadiscussionofthekeyeconomicreformsthatwillberequiredinbothcountriestohelpsustaineconomicgrowthandprosperityoverthenextdecade.

KBCwillbeakeyfactorinspurringnewsourcesofgrowth,byallowingfirmsandorganisationstoprosperinacompetitiveglobaleconomyandcreatehigh-wageemployment.ThisisparticularlyrelevantforAustraliaandChinaastheylooktoreplacethetraditionalsourcesofexportgrowthoverthepastdecade.AstheOECDnotes:‘KBCallowscountriesandfirmstoupgradetheircomparativeadvantagebypositioningthemselvesinhighvalue-addedindustries,activitiesandmarketsegments’.New,innovativefirmsarealsobecomingthemaindriversofemploymentcreation,with‘high-growth’firmsaccountingforuptohalfofalljobsgrowtheventhoughtheyonlyaccountforaround5percentofallbusinesses(OECD2012).

Thatsaid,theriseofKBCiscreatingnewchallengesforpolicymakersandbusinesses,notleastthedifficultiesinvolvedinmeasuringeconomicactivityassociatedwithKBC.Forexample,theriseofKBChasmadeacountry’sintellectualpropertyregimeevenmoreimportant,apointhighlightedinAustralia’srecentReviewofCompetitionPolicy.

KBCbusinessesarealreadydrivingmassiveinnovationintheAustralia–Chinarelationshipthroughinnovativedeliveryofgoodsandfinancialservicesviae-commercethatisleapfroggingoldbarrierstoeconomicintegration.Whatweseesofarisjustthetipoftheiceberg(seeChapter3).

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China’s rise and its impact on the world economy

China’seconomictransformationsince1978hasbeenremarkable.Atthecommencementofthereformperiod,China’sGDPpercapitawaslessthan5percentoftheUnitedStates’(TheConferenceBoard2015).AccordingtoWorldBankDevelopmentIndicators,since1978,China’seconomyhasgrowninsizebyanannualaveragerateofaround10percentandisnowalmost30timeslargerthanitwasin1978(WorldBank2016).Thisreflectsasubstantialincreaseinlabourproductivity,whichhasrisenfrom3percentoftheUSlevelin1978tomorethan20percentnow(TheConferenceBoard2015).

ThisperformancehasresultedinChinarapidlycatchinguptohigher-incomeeconomies,which,combinedwithahugepopulation,hasseenChina’sshareofglobaloutputandincomerisefromlessthan5percentin1990to17percenttoday(Figure2.1).

Whileuniqueinscale,China’seconomicconvergencebroadlymatchesthepreviousexperienceofotherAsianeconomiessuchasJapanandSouthKorea.Indeed,theprinciplefactorsbehindChina’ssuccessaresimilartothosethathavedriveneconomicconvergenceelsewhereinAsia.Theseincludeveryhighratesofphysicalcapitalaccumulationandmassmobilisationoflabourtowardsanexport-orientedmanufacturingsector,supportedbyongoingimprovementsinhumancapitalandtechnologicalcatch-up.

ThescaleandspeedofChina’seconomicriseoverthepastfourdecadesalsoreflectsthesizeanddemographicprofileofChina’spopulation,whichsawtheworking-agepopulationgrowsignificantlyfasterthantheoverallpopulation.Thiscoincidedwiththemassmovementofruralsurpluslabourfromthelowproductivityagriculturalsectortohigherproductivityindustrialandservicesectors.

China’sexport-orientedgrowthmodelhasunderpinnedalargeandrapidexpansioninitsinternationaltradeandintegrationwithglobalmarketssince1978.

Figure 2.1: China’s share of the global economic aggregates

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Inthepast15yearsalone,China’sexportshaveexpandedmorethan10-fold,facilitatedbyaccessiontotheWTOin2001.HavingsurpassedboththeUnitedStatesandGermany,Chinaisnowtheworld’slargestexporterbyvalue,accountingfor12percentofglobalmerchandisetrade(Figure2.1).

GreaterinternationalopennessallowedChinatoabsorbforeigntechnologiesandknow-how,drivingimprovedproductivityacrossthebroadereconomy.Amoreopeneconomyalsoincreasedcompetitiveforcesdomestically,promotingefficiencyandinnovationintrade-exposedsectors.

Figure 2.2: investment as a share of gDP

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Sincethemid-1990s,China’srapideconomicconvergencehasreflectedverylargeinvestmentsinphysicalcapital.Chinacommencedthereformperiodwithrelativelylowcapitalperworker,allowingforinitiallylargelabourproductivitygainsandhighreturnsoninvestment.Growthinthecapitalstockisestimatedtohaveaveraged10percentannuallyfromthe1980s,accountingforsignificantlymorethanhalfofGDPgrowthoverthistime(Wu2014).

ThesetrendshaveresultedinChina’sinvestmentasashareofGDPreachingveryhighlevels,bothhistoricallyandevencomparedwithotheremergingeconomies(Figure2.2).

China’selevatedratesofinvestmenthavebeensupportedbygovernmentpoliciesthathaveincentivisedpropertydevelopmentandinfrastructureinvestment,andexpansionsinmanufacturingcapacity.Thisincludesthestructureofthefinancialsystem,whichhaschannelledsubsidisedcapitalfromsaverstolargeprivateandstate-ownedenterprises,andanexchangerateregimeinpreviousdecadesthatencouragedexportsoverdomesticspending.China’sveryhighratesofinvestmenthavebeensupportedbyveryhighratesofnationalsaving(Box2.2).

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The impact of China’s rise on global commodity markets and Australia

ItisnotjusttherapidgrowthandtransformationoftheChineseeconomythathasaffectedopportunitiesglobally;itisalsothesheerscaleofChina’simpactthathasmatteredtotheworldeconomy.

TheunprecedentedscaleofChina’sindustrialisationhasresultedinChina’sconsumptionofmetals,otherrawmaterialsandenergyexpandingmassivelyoverrecentdecades.Chinaisnowtheworld’slargestuserofarangeofindustrialandenergycommoditiesincludingsteel,copperandcoal(Figure2.4).

BOx 2.2: CHinA’s HigH RATes OF nATiOnAL sAving

China’svaststockofsavings,togetherwithitscapitalaccountcontrols,hasplayedanimportantroleinhighratesofinvestment.SavingasashareofGDProsefromlessthan40percentinthe1980stoapeakof50percentinthelate2000s.Whilethenationalsavingratehaseasedinthepastfewyearstoaround48percent,itremainsveryhighbyhistoricalandinternationalstandards(Figure2.3).

Thehouseholdsectorhasmadeasignificantcontributiontohigherratesofnationalsaving,reflectingagrowingworking-agepopulationwithanincreasingcapacitytosave.Incompletedomesticfinancialmarketsandrestrictedaccesstoforeignfinancialassetshavealsoencouragedhighhouseholdsavingrates,ashasthelimitedstateprovisionofsocialsecurityandhealthinsurance.

CorporatesavinghasalsomadealargecontributiontoChina’shighratesofnationalsaving.AflexibledividendpolicyhasallowedSOEstoretainandthenreinvestmostoftheirprofits,ratherthandistributingdividendstothestate.Financialunderdevelopmenthasalsomadeitdifficultfortheprivatesector,especiallysmallbusinesses,toaccessintermediatedfinancing,inducinghighersavingratesinthatsector.

Plannedreformstofinancialmarkets(includinginterestrates)andtotheregulationofSOEs,aswellasthebroaderprovisionofsocialinfrastructure,shouldsupporthigherhouseholdconsumptionandcorrespondingdeclinesinhouseholdandcorporatesavingrates.Likewise,China’sageingpopulationislikelytoplayapartinreducingsavingrates,asanincreasingshareofChina’sadultpopulationmovesintoretirementageandbeginstodrawdownsavings.

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Figure 2.3: national saving by sector

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China’sgrowthinsteelconsumptionhasbeenparticularlydramaticoverthepasttwodecades,drivenbyrisinginvestmentinsteel-intensivebuildingsandinfrastructure,aswellaslargeexpansionsinthemanufacturingsector.Chinaisnowthelargeststeelconsumer,accountingfor45percentofglobalsteelusagein2015(WorldSteelAssociation2015).China’sincreasingsteelrequirementsnecessitatedamassiveexpansioninitssteelindustry,whichisestimatedtohaveproducedover800milliontonnesofcrudesteelin2015—morethansixtimesasmuchasitdidin2000(Figure2.5).

Figure 2.4: China’s share of global commodity consumption

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China’sincreasingproductionofsteelhashadflow-oneffectstoitsdemandfortherawingredientsusedinsteelmaking,namelyironoreandmetallurgicalcoal.Mostnotably,China’sshareofworldironoreconsumptionrosefrom14percentin2000toanestimated65percentin2015.

Whilehavinglargequantitiesofitsownresources,Chinahasbecomeincreasinglyreliantonimportedinputsasstrongcommoditydemandhasdrawninlower-cost,higher-qualitycommoditiesfromabroad.Tradedependencycontinuestoriseascommoditypricesfall,andtheshareofimportedindustrialinputsindomesticconsumptionisatanall-timehigh.

Figure 2.5: China’s steel production

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RespondingtothesharpriseinglobalcommoditypricesandgrowthinChina’sdemandforrawmaterials,Australia’sminingindustryinvestedheavilyinnewexportcapacityoverthepastdecade(Figure2.6).Thisinvestmentwasinitiallyconcentratedintheironoreandcoalsectors,butwasfollowedbyanevenlargerinvestmentinliquefiednaturalgas(LNG)capacity,whichwillmakeAustraliathelargestexporterofLNGwithinafewyears.Atitsheightin2013,theminingindustry’sshareofprivateinvestmentinAustraliareachedone-third,morethantriplethetypicalhistoricalshare.

Therewasalagintheresponseofinvestmentandcapacitytorisingpricesbecauseofitsgestationperiod.Butasthisnewcapacitycameonline,Australia’sexportvolumesoftheseproductsalmostdoubledcomparedtothepreviousdecade.Intheironoremarket,Australianowaccountsforalmostone-thirdofglobalproductionandone-halfofseabornetrade,significantlyhigherthanadecadeago.

AlmostallofAustralia’sadditionalironoresupplyhasbeenabsorbedbyChina,withAustraliaincreasingitsshareofChineseimportstoover60percentaslessefficientglobalsupplyhasbeendisplaced,includingwithinChinaitself.Australia’sshareofChina’scoalimportshasalsoincreased,fromaround10percentin2009toaroundone-thirdnow(Figure2.7).

By2018,theminingindustry’scapitalstockwillbealmostfourtimeslargerthanitwasin2004,amassiveinvestmentinnewcapacitythatwillunderpinAustralia’sminingexportsfordecadestocome.

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Extensivereservesofironore,coalandothercommoditiesmeantthatAustraliawaswellpositionedfromtheoutsettobenefitfromChina’srisingcommoditydemand.ButthemereexistenceofthesenaturalresourcesdidnotguaranteeAustralia’ssuccess.Instead,Australiaowesitssuccesstothecompetitivenessofitsminingindustryaswellastheflexibilityofthewidereconomythatallowedresourcestobeefficientlyreallocatedtoexpandthemineralssector.

Figure 2.6: mining investment in AustraliaPanel A: By commodity type Panel B: share of total private investment

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Australia’swell-establishedmacroeconomicpolicyframeworks,includingafloatingexchangerate,playedanimportantroleinaccommodatingtheexpansioninAustralia’sminingcapacitywithlimiteddisruptionstothebroadereconomy.Alongwithasufficientlyflexiblelabourmarket,thesesettingshelpedinflationexpectationstoremainanchoredwhenthetermsoftraderosesharply,avoidingmanyofthemacroeconomicdifficultiesthataroseinprevioustermsoftradeboomsinAustralia(Gruen2011).

Figure 2.7: Australia’s share of Chinese commodity imports

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China’s economic transformation to new drivers of growth

Afteralmostfourdecadesofrapidgrowth,theChineseeconomyisundergoingamajortransformation,broughtaboutbyacombinationofinternalandexternaleconomicforces.

Ontheexternalfront,substantiallyslowergrowthininternationaltradehasseenacorrespondingmoderationindemandforChina’straditional,labour-intensivemanufacturedexportsinrecentyears(Figure2.8).ThisslowdownpartlyreflectsChina’salreadysignificantmarketshareinsomeglobalmanufacturingsegments,aswellasamorefundamentalshiftinglobaltradetowardsinformationandservices,consistentwiththeriseofe-commerceglobally.

Figure 2.8: growth in global trade

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Domestically,aswagesandincomesrise,householdconsumptionisemergingasamoreimportantdriverofeconomicactivity.Atthesametime,China’sgrowthdriversinrecentdecades—investmentinphysicalcapitalandlabour-intensivemanufacturedexports—areslowing.Thelowergrowthininvestmentinthesesectorsreflectsoversupplyinthepropertymarketandtheexcesscapacitythathasemergedacrosssegmentsofthemanufacturingsector,andthelowerprofitabilityinthesesectors.

DemographicforcesandlabourmarketdynamicsarealsoplayingtheirpartinChina’sshiftawayfromfactor-drivengrowthtowardsmorebalancedgrowth.Aftergrowingstronglyfornearlyfourdecades,China’sworking-agepopulationisnowshrinking,whichisdirectlyreducingChina’sgrowthpotentialvialowergrowthinthelabourforce.

China’sageingpopulationhasimplicationsthatgobeyondtheimpactonaggregateeconomicgrowth.Forexample,therewillbeanextra110millionpeopleagedover65by2030,whichwillincreasethedemandforaged-careservicesandputpressureonChina’sstilldevelopingsocialsafetynet.

Inthelabourmarket,theslowergrowthinthelabourforceandshrinkingpoolofsurplusrurallabouriscontributingtohigherwages.Higherwagescombinedwithasignificantappreciationoftherealexchangerateoverthepreviousdecadeishelpingtoshiftthecompositionof

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demandfromexportsandinvestmenttowardsconsumption.Thisisbeingsupportedbyashiftineconomicresourcestowardsconsumers,illustratedbytheuptickinthewageandhouseholdsectorsharesofGDPinrecentyears(Figure2.9).

Similarly,consumptionexpenditurehasnowovertakeninvestmentspendingasthemaincontributortoeconomicgrowth.Whilethispartlyreflectsslowergrowthininvestmentinrecentyears,thecontributionfromhouseholdconsumptionalsorosein2015(Figure2.10).

Withinconsumption,theshifttowardsservices,aswellasdiscretionarygoods,isoccurringasChinesehouseholdsbecomewealthier.Thischangingpatternofdemandisgivingrisetofasteremploymentgrowthintheservicessector.Overthepasttwoyears,employmentinChina’sservicessectorhasgrownstronglyandnowaccountsforalittlemorethan40percentofemploymentacrosstheeconomy,upfrom30percentadecadeago(WTO2016).

TheappreciationofChina’srealexchangerateisalsoencouragingemploymentcreationinChina’snon-tradedservicessectors,whichultimatelywillbeattheexpenseofemploymentinChina’sexport-orientedsectors.ThisdynamicisconsistentwiththeexperienceofotheremergingeconomiessuchasJapaninthe1970sand1980swhereincreasesintherealexchangeratereinforcedashifttowardsdomesticallyorientedindustriessuchaseducation,healthandfinancialservices(Dorruccietal2013).

WhileinvestmentasashareofGDPhasfalleninrecentyears,andmayfallfurther,China’stransformationtowardsservices,higher-endmanufacturingandthedigitaleconomywillstillinvolvesubstantialnewinvestmentinthesegrowingindustries.Forexample,China’sentryintonew,higher-technologymanufacturedsegmentswillrequirelarge-scaleinvestmentinplant,equipmentandhumancapital,asillustratedbytherecentplantoestablishasemi-conductorindustryinChina.

Figure 2.9: Wages and household disposable income

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ThetypesofassetsattractinginvestmentarealsolikelytoevolveasChina’sindustrybecomesmoreadvanced.ThisreflectsthegreaterneedforinvestmentininnovationandinformationtechnologyasChineseindustrydevelops,inlinewiththeglobaltrendtowardsknowledge-basedcapital(OECD2013b).ForChina,thismeansagreaterproportionofinvestmentislikelytobedirectedtowardsintangibleassets,suchasdigitalinformation,computersoftwareandresearchanddevelopmenttosupportChina’sprogressionintohigher-technologymanufacturing(Box2.3).

Figure 2.10: Contributions to China’s gDP growth

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ThatisnottosaythatinvestmentintraditionalformsofphysicalcapitalwillnotremainessentialinsupportingChina’scontinuedurbanisationandraisingthequalityoflifeinurbancentres.Thisincludesfurtherinvestmentinpublictransportnetworksandurbanamenities,whichinmanycitiesremainunderdeveloped.Notwithstandingthecurrentareasofoversupply,continuedurbanisationwillalsorequiresubstantialnewinvestmentinresidentialandcommercialbuildingoverthecomingdecade.

Reforms to assist China’s economic transformation

Tosustaineconomicgrowthinthenextdecade,China’spolicyenvironmentwillneedtosupporttheshiftinactivitytowardstheservicessector,higher-techmanufacturingandenergytransformationtoaddressenvironmentalchallenges.Itwillalsoneedtoalloweconomicresourcestoshifttowardsthesemoreinnovativeandfast-growingsectorsoftheeconomy.

Thisfocusonliftingmultifactorproductivityrecognisesthatthelongperiodoffactor-drivengrowthChinahasexperiencedoverthepast40yearscannolongerbesustained.Thisreflectsfallingratesofreturnandthebuild-upofexcesscapacityinsignificantpartsoftheindustrialsector,ashrinkingworking-agepopulationaswellasbroaderqualityoflifeconsiderations,includingreducingthepollution-intensityofgrowth.Inthiscontext,China’seconomicperformanceoverthecomingdecadewilldependinlargepartonwhetherChinacanimproveuponthelimitedgrowthinmultifactorproductivityachievedsince2007(Figure2.13).

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BOx 2.3: CHinA’s PROgRessiOn TOWARDs HigHeR-enD AnD vALue-ADDeD mAnuFACTuRing

ThepaceandscaleofChina’sriseasamanufacturingexporterhasbeentrulyremarkable.SinceaccessiontotheWTOin2001,China’sshareofglobalmanufacturingexportshasgrownfrom5percentto18percent,makingastrongcontributiontoeconomicgrowthbothdirectlyandthroughtechnologyspilloverstothewidereconomy.

However,growthinChina’sexportsoftraditional,labour-intensivemanufacturingproductshasslowedinrecentyears,reflectingarangeoffactors—includingthatglobalmarketsmayhavereachedsaturationpointfortheseproducts.Forexample,China’sshareofinternationalclothingexportshasremainedatalmost40percentinrecentyears,havingrisencontinuouslyoverthepreviousfewdecades(WTO2016).

Inthenextdecade,Chinawillthereforeneedtobuilduponitstraditionalexportcategoriesbycontinuingtoprogressintohigher-technologymanufacturing,followinginthefootstepsofcountriessuchasJapan.Thisprocesshasbeenunderwayforsometime,withtheshareofmedium-andhigh-techmanufacturinginChina’smerchandiseexportsnowsubstantiallyhigherthanwhatitwas20yearsago(Figure2.11).

Figure 2.11: China’s export mix 1995–2015

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%

2000 2005 2010 2012 2015

High-tech Medium-tech Low-tech Resource-based Commodities

Source:OECDandUnitedNation’sComtradedatabase.

Atthesametime,China’smanufacturingsectorwillneedtocapturealargershareofthegrossvalueofitsmanufacturingexports,bymovingupthevaluechaininlinewiththeMadeinChina2025initiative,anofficialinitiativeaimedatpromotingadvancedmanufacturing.ThiswillbeessentialifChina’sexportsectoristocontinuetomakeastrongcontributiontoeconomicgrowthoverthenextdecade.Again,therearesignsthatChinaisalreadymakingprogressinthisrespect,havingcapturedalargershareintheglobalvaluechainacrossmanymanufacturingsub-categoriesoverthepasttwodecades(Figure2.12).Thisincludesparticularlylargeincreasesinthedomesticeconomy’sshareofthevalue-addedofcomputers,electricalmachineryandapplianceexports.

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Figure 2.12: Domestic value-added share of China’s gross exports

20

30

40

50

60

70

80

%

Tota

l

manufactu

res

Food products

,

bevera

ges and to

bacco

Texti

les, te

xtile pro

ducts,

leath

er and fo

otwear

Wood, paper,

paper pro

ducts,

printin

g and publishing

Chemica

ls and non-m

etalli

c

minera

l pro

ducts

Basic m

etals

and

fabricate

d meta

l pro

ducts

Machinery

and

equipment, n

ec

Compute

r, electr

onic

and optical e

quipment

Electrica

l mach

inery

and apparatu

s, nec

Transp

ort equipm

ent

Manufacturin

g nec;

recy

cling

2011 1995 2005

Source:WTOandOECD2016.

WhileChina’sprogressiontoamoreadvancedandhigher-incomeeconomywillnotbestraightforward,the13thFiveYearPlanrecognisestheseeconomicimperatives,buildinguponthereformstrategiesassetoutintheThirdPlenumofthe18thPartyCongressinlate2013.Thisincludestheneedtosupportgreaterhouseholdspending,improvetheefficiencyofinvestment,encourageamoreinnovativescience-ledeconomyandexpandintohigher-technologymanufacturing(Box2.4).

Figure 2.13: Contribution to China’s gDP growth

0

2

4

6

8

10

%

12

1977-84 1984-91 1991-01 2001-07 2007-12

Capital Total factor productivity Labour GDP Source:ConferenceBoard2015;Wu2014.

Mostimportantly,thePlan’sfocusonsupply-sidestructuralreformsrecognisestheneedtoencourageanexpansioninChina’smoredynamicprivatesectorwhilelimitingfurtherinvestmentinthosepartsoftheeconomythatarenowexperiencingover-capacity.Thiswillencompassabroadrangeofreformsincludingopeningupmonopolyindustriestoprivatesectorparticipation,reducinggovernmentinvolvementinanumberofsectorsstilldominatedbySOEsandimprovingmarketexitmechanisms.

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Financialmarketreformswillalsoplayaroleinallowingmoredynamicandefficientfirmstoexpandbyprovidingbetteraccesstofinanceatlowerrates.Thiswillrequirepushingaheadwithbankingsectorreforms,includingliberalisinginterestrates,aswellasencouragingagreaterrolefornon-traditionalbanking(includingthroughemergingonlinecreditproviders)anddirectequityfinancing.

BOx 2.4: CHinA’s eCOnOmiC TRAnsFORmATiOn AnD THe 13TH Five yeAR PLAn

The13thFiveYearPlan(‘thePlan’)presentsaroadmapforChina’seconomictransformationtowardsahigherincomeeconomy.ThePlanprioritisesarangeofareasincluding:improvingdevelopmentqualityandefficiency;supply-sidestructuralreforms;bettermatchingsupplyanddemand;encouragingamoreinnovativeeconomy;fosteringmorecoordinated,greenandinclusiveeconomicdevelopment;andacceleratinginstitutionalreformstosupportChina’scontinuedeconomicdevelopment.ThePlanfocusesonthethreeeconomicgoalsofliftinghouseholdconsumption,transformingindustrytowardsservicesandhighervalue-addedmanufacturing,andpromotingthedevelopmentofaninnovation-andtalent-basedeconomy.

Strengtheningconsumption-ledgrowth.Chinawillpromoteconsumptiontobecomeamoreimportantcontributortoeconomicgrowth.ThisencompassespoliciesthatpromoteanindustrystructurethatbetterreflectsdemandfromChineseconsumersforhigher-qualityproductsandencouragesanexpansioninChina’sconsumer-orientedservicesindustries,includinghealthandagedcare.Consistentwithagreaterdomesticcapacitytoproducehigher-endconsumerproducts,Chineseconsumerswillbeencouragedtoconsiderswitchingtheirspendingfromoverseastodomesticmarkets.

Encouragingtheservicessectorandhigher-endindustry.Chinawilllifttheshareoftheservicessectorintheeconomyandencouragehigher-endmanufacturing.Whileaggregatedemandwillbeadjustedappropriately,theemphasiswillbeonsupply-sidestructuralreformsthatenabletheChineseeconomytomeettheChinesepeople’sgrowingmaterial,cultural,ecologicalandenvironmentalneeds.Consistentwiththe‘MadeinChina2025’initiative,thetransitionintohigherendmanufacturingwillallowChineseindustrytocapturealargeshareofvaluechains.Tohelpacceleratethedevelopmentofamodernservicesector,thesepartsoftheeconomywillbeexposedtogreaterforeigncompetition.The‘InternetPlus’actionplanwillhelptopromotebetterandbroaderuseoftheinternet,withgreateraccesstoinformationandbetterinformationnetworksfacilitatingtheadoptionofmoreefficientproductionmethodsandorganisationalstructureswithinindustry.

Fosteringscientificandtechnologicalinnovation.Chinawillaimtoimprovemultifactorproductivity,underpinnedbyscientificandtechnologicalinnovation,investmentinhumancapitalandgreaterentrepreneurship.Marketreformswillbeundertakentoensurethatresearchandinnovationisgearedtowardsthemostvaluableareas,supportedbyclosercollaborationbetweenresearchersandindustry.Whileabsorbingandintegratingforeigninnovationwillremainimportant,thePlanprioritiseswaysofencouraginglocallygeneratedtechnologiesandnewideas,tohelpgenerateself-sustainingeconomicdevelopment.

Atthesametime,thePlanhighlightstheneedtoaddressdistortionsinpolicyandinstitutionalarrangementsandtheneedtopromotefurthercompetitionamongfirmsinsomeindustriesaspartofagenerallyopenandcontestablemarketsystem.

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Capitalaccountliberalisationcanalsoassist,byprovidinganotherchannelthroughwhichChinesefirmscanaccessfinanceatmarketrates,whilealsosubjectingdomesticprovidersoffinancetoexternalcompetition.

BesideshavingthepotentialtoimproveChina’sefficiencyofinvestment,capitalaccountliberalisationcanalsosupporttheshifttohouseholdconsumption.Astheconstraintsonoutboundinvestmentareloosenedfurther,Chinesehouseholdswillbeabletoinvestinawiderrangeofassetswithhigherrisk-adjustedreturns.Thiswillbereinforcedbyestablishingmarket-determinedinterestratesandamoremarket-determinedexchangerate,helpingtoreallocateincometowardsthehouseholdsector.

AlthoughitisinChina’slonger-terminterests,thetransitiontonewdriversofgrowthwilltaketime,andthepaceofeconomicgrowthmaymoderatemorethananticipatedinthetransitionalperiod.Alternativegrowthscenariosareexaminedinlaterchapters(seeChapters3and6)toconsidertheeffectofdifferentChinesegrowthtrajectoriesandstructuresontheAustralia–Chinaeconomicrelationship.Forexample,China’sprogressionintohigher-techmanufacturing,whichisadifficulttransitioninitsownright,maynotoccurquicklyenoughtooffsettheimpactofslowergrowthintraditionalmanufacturingsegments.Likewise,China’sconcernabouttheenvironmentalimpactofheavyindustryandtheminingsectormayweighfurtheronindustrialproductionasnewpoliciesintheseareasbegintotakeeffect.

Duringthistransition,Chinamuststriketherightbalancebetweenpoliciesthatsupportnear-termgrowthandpoliciesthatpromotetheeconomy’slonger-termgrowthpotential.

Inparticular,excessivelyloosemonetarystimulustosupportshort-termgrowthwouldhavethepotentialtoencouragehigherborrowingandleverageinthecorporatesector,whichcouldcreatefragilitiesinthefinancialsystemandundercutlonger-termreformstoimprovetheefficiencyofinvestment.Chinashouldbeextremelycarefulinmanagingfinancialrisksassociatedwithhighlevelsoftotaldebt,whichreached237percentofChina’sGDPinthefirstquarterof2016,from148percentattheendof2007.Deleveragingisoneoffivetopprioritiesfortheworkofthegovernmentfor2016.DeleveragingwillhelpChinaachievemoresustainablegrowthinthelongertermbutcanputdownwardpressureintheshortterm.

implications of China’s transition

implications for the global economy

Firstandforemost,thesheersizeoftheChineseeconomymeansopportunitiestodobusinesswithChinawillcontinuetoexpandevenifaggregatesratesofeconomicgrowtharelower.TheIMFprojectsChina’sgrowthratetoremainmorethantwicetheglobalaverageinthenextfewyears,whileitscontributiontoglobalgrowthwillbemuchlargerthanitwas10yearsagogivenitisnowasignificantlylargershareoftheworldeconomy.

ButthetransformationunderwayintheChineseeconomymeansthatChina’simpactontheworldeconomywillbeverydifferentfromwhatitwasinthelastdecade.Theincreaseinpercapitaconsumption,urbanisationandtheemergenceoftheserviceseconomy,aswellasthefurtherliberalisationoffinancialmarketsinChina’seconomy,willfundamentallychangehowChinainteractswiththerestoftheworld.

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Thelargerroleforconsumerspendingandtheshifttoamoreservices-basedeconomywillprovideChina’stradingpartnerswithvastexportopportunitiesinnewareasoftheChineseeconomy.China’smiddleclassisprojectedtoreach630millionpeopleby2022,providingahugeandexpandingmarketforinternationalprovidersofconsumergoodsandservices,inareasspanninghealthcare,educationandfood(Barton2013).

China’sdemandforhigh-valuefoodstuffsisexpectedtorisedramaticallyoverthecomingdecades,withtheconsumptionofbeefandothermeatsdoublingoreventriplingaccordingtosomeprojections(Hamshereetal2014).WhilethemajorityofthisincreasedfooddemandwillbemetbyexpandingChina’sdomesticproduction,therewillbesignificantunmetdemandthatinternationalfoodexporterswillbeabletoexploit.

Likewise,theopeningupofChina’sdomesticservicessectorwillpresentnewopportunitiesforforeigninvestors,inareassuchasfinance,insuranceandtheutilitiessector.

TheshareofChina’slabour-intensivemanufacturingsegmentislikelytodeclinegoingforward.However,buildinggreaterconnectivityandinfrastructureprojectswithAsianandEuropeanexportsmarketsviatheinfrastructureinvestmentprojectsassociatedwiththeOneBelt,OneRoad(OBOR)initiativecansupportdemandforChina’straditionalexportcategories.

TheOBORinitiativecanalsoassistinabsorbingChina’sconstructioncapacity(includingforinfrastructure),whilesimultaneouslysupportingeconomicandtradenetworksacrossparticipatingeconomies.

BOx 2.5: THe OuTLOOK FOR CHinA’s sTeeL DemAnD

Havinggrownstronglyoverthepreviousdecade,China’sapparentsteelconsumptionfellby3percentin2014andisestimatedtohavefallenbyanother5percentin2015.ThisraisesthequestionofwhetherChina’ssteelconsumptionhaspeakedorwhetherthisweaknessreflectsmainlycyclicalfactorsthatwillgivewaytofurtherincreasesinChina’ssteelconsumptionoverthecomingdecade.ThisquestionwillhaveimportantimplicationsforChina’slargesteelindustryaswellasironoreproducersinChinaandoverseas.

Inthepast,largerisesinChina’ssteeldemandweredrivenbyconstructioninvestmentanddemandfromthemanufacturingsector,whicharethemainusersofsteel(Table2.1).

Table 2.1: China’s steel usage by purpose (percentage of total)

2000 2010 2014

Construction 56 56 55

Machinery 15 18 19

Automobile 6 7 7

HomeAppliance 3 1 1

Rail 2 1 1

Energy 7 4 5

Shipping(a) 3 5 2

Other 8 8 11

Source:ReproducedfromHamshereetal2016.(a)Shippingisdefinedasthesumofthe‘container’and‘shipbuilding’categories.

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ThelargecontributionfromtheconstructionindustryreflectsthesubstantialsteelrequirementsassociatedwithChina’surbanisation,includingforhigh-densityresidentialandcommercialbuildingsandforurbaninfrastructuresuchasrailways,highwaysandbridges.

China’sincreasedsteelconsumptionoverrecentdecadeshasbeensuppliedbyexpansionsinitsdomesticsteelindustry.Overthedecadeto2013,China’sdomesticsteelproductionincreasedalmostfour-foldtoaround820milliontonnes.Thishashadflow-oneffectstoironoreandmetallurgicalcoal—therawingredientsusedbyChina’ssteelmakers—withdemandfortheseinputsalsogrowingstrongly.Inthecaseofironore,China’sdomesticsupplies,whilesubstantial,areofrelativelypoorgradeandlocatedinlessaccessiblepartsofthecountry.ThishasmeantthatChinahasincreasinglyturnedtotheseabornemarket,includingAustraliansupply,toaccommodateitsgrowingironoreneeds(Figure2.14).

Inrecentyears,thedownswinginthehousingmarket,combinedwithweakerconditionsinChina’smanufacturingsector,havebothcontributedtolowerdemandforsteel.ThishasresultedinChina’ssteelconsumptionfallingoverthepasttwoyears.Steelproductionwasflatin2014andfellby2.3percentin2015despiteastrongincreaseinsteelexports.

Inthenearerterm,theoutlookforChina’ssteeldemandwilldependinlargepartonthestateofChina’shousingmarket,wherethereissignificantoversupplyacrossanumberofregions.Growthinrealestateinvestment,whichisanimportantdriverofoverallsteeldemand,isthereforelikelytoremainweakuntilthesepocketsofunsoldhousingareabsorbedbythemarket.

Similarly,excesscapacityinthemanufacturingsectorisweighingonproducerpricesandprofitability,andthiswillcontinuetolimitmanufacturing-relatedinvestment,andthereforesteelusageinthissector,untilthisexcesscapacityisabsorbed.

Notwithstandingcontinuedstrengthininfrastructure-relatedsteelusage,thesefactorsmeanthatChina’ssteelindustryislikelytofacecontinuedchallengingdemandconditionsincomingyears.Asaresult,China’sdemandforironoreisalsolikelytogrowatasignificantlyslowerratethaninthepreviousdecade,althoughtheremaybescopeforlow-costglobalsupplierssuchasAustraliaandBraziltoexpandtheirmarketshare.

Figure 2.14: China’s steel production and iron ore imports

2006

2008

2010

2012

2014

0 0

200

400

600

Mt

Mt

800

1000

200

400

600

800

1000

1200

2006

20

08

2010

20

12

2014

Iron ore imports Iron ore imports–Australia Steel production Steel exports

Source:Robertsetal2016.

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China’seconomictransitionisalsolikelytoresultinlessresource-intensivegrowththaninthelastdecade.Already,slowergrowthinindustrialproductionandrealestateinvestmenthascoincidedwithsignificantlyslowergrowthinChina’sdemandforsteelandothercommoditiesinrecentyears.Whilesomeofthisweaknessmayprovetobecyclicalratherthanstructural,theoutlookforChina’ssteeldemandremainsacentralsourceofuncertaintyforglobalsteelandironoremarkets(Box2.5).

Beyondthenearterm,China’ssteelandbroadermetalusagewillbeunderpinnedbyanumberoflonger-termdrivers,notwithstandingtherebalancingcurrentlyunderwayintheeconomy.Theseincludefurtherurbanisation,withChina’surbanisationrateofjust55percentsuggestingthattheneedforinvestmentinnewconstructionisstillsubstantial.Likewise,China’spublicinfrastructureremainsunderdevelopedinanumberofareas,includingurbanamenitiesandnationaltransportnetworks.Withrisingincomes,Chinesehouseholdswillalsodemandagrowingnumberofdurablegoods,includingmotorvehicles(withChina’spercapitalvehicleusagestilllowbyinternationalstandards)andhomeappliances.

TherearealsodownsideforcesthatcouldaffectChina’ssteelindustryanditsdemandforironore.Thisincludesthepolicyobjectiveofconsolidatingthesteelindustrytohelpeliminateexcesscapacityandimproveenvironmentaloutcomes,whichisagrowingfocusforauthorities.ThepotentialforgreateruseofscrapsteelcouldalsosignificantlyaltertheoutlookforChina’sdemandforironore,notingthatscrapusageinChinaremainslowbyinternationalstandards.

WhiletheoutlookforChina’ssteelproductionandironoredemandishighlyuncertain,Australiahassomeofthelowest-costironoreproducersintheworldandwillthereforeremainamajorsourceofChina’sironoreimportsinthecomingdecade.

implications for the Australian economy

FortheAustralianeconomy,theslowergrowthinChina’scommoditydemandinrecentyearshascontributedtoamorechallengingglobalenvironmentjustastheinvestmentphaseoftheminingboomhasnearedcompletion.Combinedwithlargeincreasesinglobalsupplies,softerglobaldemandhasresultedinAustralia’scommodityexportpricesfallingsharplyinrecentyears.ThishasreducedAustralia’stermsoftradeandgrowthinnationalincome,withAustraliafacingtheprospectoflowergrowthinincomesoverthecomingdecadeunlessproductivitygrowthcanbeliftedabovehistoricalaverages(Figure2.15).

Whilegrowthhasbeenslowinrecentyears,establishedmacroeconomicpolicyframeworks,includingafreelyfloatingexchangerate,haveservedAustraliawellinmanagingthedownswinginglobalcommodityprices,reinforcingthepositiverolethesemechanismsplayedincushioningtheAustralianeconomyfromtheAsianfinancialcrisisinthelate1990sandtheglobalfinancialcrisisinlate2000s.Likewise,Australia’slabourmarket,whilestillover-regulatedinsomeareas,hasbeenflexibleenoughtoallowthenecessaryadjustmentsinrealwagestotakeplaceinrecentyears,helpingtosustainemploymentgrowth.

ButAustralia,likeChina,isnowsearchingfornewsourcesofgrowthastheoldonesfade,andthestructureoftheAustralianeconomyisrevertingbacktoamorenormalpatternofgrowthinwhichtheservicessectorwillagainbethemaindriverofgrowth.

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Australia’sservicessector,whichaccountsforaroundthree-quartersofoutput,comprisesadiverserangeofindustries.Thisspanstraditionalareassuchasutilitiesandgoodsdistribution,servicestohouseholdssuchashealthcareandrecreation,aswellasservicesmainlydirectedtowardsotherbusinessessuchasprofessionalservices(Figure2.16).

Figure 2.15: growth in Australia’s national income

-1

0

1

2

3

1960s

%

1970s 1980s 1990s 2000–2013 2013–2025

Labour utilisation Terms of trade Labour productivity National income per person

Note:GrowthinGNIpercapitaalsoreflectsagenerallysmallcontributionfromnetforeignincome,whichisnotshown.Source:GovernmentofAustralia2014.

Figure 2.16: Australia’s industrial composition

29%

19%

53%

Administrative and support services

Distributionof goods and utilities

Services to households and businesses

Commodities, manufacturingand construction

Arts and recreation services

Other

Accommodation and food

Information media and telecommunications

Financial and insurance

Rental, hiring and real estate

Professional, scientific and technical

Public administration and safety

Education and training

Health care and social assistance

Source:ABS2015a.

Whileitisimpossibletopredictexactlywhichindustrieswillprosperinthecomingdecade,China’stransitiontowardsamoreconsumer-driveneconomywillundoubtedlyseeChina’simportstilttowardsservicesandhigher-valuefood.TheongoingliberalisationofChina’sfinancialmarkets,aswellaslatentdemandofChinesehouseholdsandfirmsforabroaderrangeofinvestmentandcreditproducts,willpresentaraftofopportunitiesforAustralia’sfinancialservicessector.TheseopportunitiesarediscussedfurtherinChapter5.

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Exportopportunitiesarelikelytoextendwellbeyondfinancialservices.SupportedbyChAFTA,therewillalsobeopportunitiesforprovidersofotherservicestoaccessthegrowingChinesemarketinareassuchaseducation,tourism,healthcare,accountingandlegalservices.

However,unliketheexperienceofthelastdecade,Australiawillhavenoparticularnaturaladvantagesincapturingthesenewexportmarkets,andwillfaceformidablecompetitionfromotheradvanced,service-basedeconomies.

Infact,productivityinsomeofAustralia’sserviceindustrieslagswellbehindtheglobalfrontier,partlyreflectingarelativelypoorperformanceoverthepastdecade.ThispictureisconsistentwithmeasuresofAustralia’srelativeinternationalcompetitiveness,whichalsopointtoanunderlyingdeteriorationoverthepastdecade(Box2.6).

BOx 2.6: An AssessmenT OF AusTRALiA’s COmPeTiTiveness

TheWorldEconomicForumprovidesausefulcross-countryassessmentofcompetitivenessbasedonitsratingon12categories(or‘Pillars’)thathavebeenfoundtocorrelatewithacountry’slonger-termproductivityperformance(WorldEconomicForum2015).These12Pillarsincludeacountry’sinstitutions,infrastructureandmarketefficiency,withscoresineachofthe12categoriesaggregatedtoformanoverallglobalcompetitivenessindex(orGCI).

Australia’soverallGCIrankinghasfallenoverthepastdecade,from16thto21st.Whileslippingacrossmostcategories,Australia’sdropintheareasrelatedtomarketefficiency(inbothgoodsandlabourmarkets)hasbeenstarkest(Figure2.17).

Figure 2.17: Australia’s competitiveness ranking

19 16

9

27

36

7

21

22

27

23

1st pillar:Institutions

2nd pillar:Infrastructure

4th pillar:Health andprimary education

6th pillar:Goods marketefficiency

7th pillar:Labor marketefficiency

8th pillar:Financial marketdevelopment

9th pillar:Technologicalreadiness

10th pillar:Market size

11th pillar:Businesssophistication

12th pillar:Innovation

2015–16

2006–07

Note:Pointsfurtherfromtheorigindenoteahigher/betterranking.Source:WorldEconomicForum2015.

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Intheareaofgoodsmarketefficiency,thefallinAustralia’srankingreflectslowerscoresonindicatorsofdomesticcompetition,partlyoffsetbyincreasedscoresrelatingtoforeigncompetition.Thelowerrankingonlabourmarketefficiencyreflectsincreasingcostsassociatedwithredundanciesandhiring,andlittleprogressoverthepastdecadeinstrengtheningthelinkbetweenproductivityandpayoutcomesinemploymentagreements.

Australia’srankingoninfrastructurehasalsofallen,reflectinglowerscoresforroadandairtransportinfrastructure,partlyoffsetbyincreasesinthequalityofelectricityinfrastructureandamorecomprehensivemobilephonenetwork.

WhiletheGCIisonlyonemeasureofcompetitiveness,thesemovementsinAustralia’sGCIperformancehighlightsomeareaswherereformeffortsshouldbefocused,namelyinproductandlabourmarketefficiencyaswellascertaincategoriesofinfrastructure.InthecategoriesinwhichAustralia’sscorehasimprovedmost—healthandprimaryeducation—itisimportantthatincreasedpublicspendingintheseareasisallocatedefficiently,toensurethathigherspendingtranslatestobetteroutcomes.

Tocompeteeffectivelyinemergingexportmarkets,Australiawillthereforeneedtoundertakefurtherreformstodriveproductivityperformance,particularlyintheservicessector.Thiswillrequireexposingthedomesticeconomytoincreasedinternationalcompetition,througheliminatingremainingtradebarriersandaddressingtherelativelyhighregulatoryburdenimposedonbusinessesengagingininternationaltrade,asnotedintheWorldBank’sEaseofDoingBusinessmeasureforAustralia.

Strengtheningandextendingnationalcompetitionpolicythroughoutthedomesticservicessectorwillalsobeneeded,especiallyinAustralia’slargehuman-servicessector,wherecompetitiveforcesandconsumerchoicearegenerallylacking(Box2.7).

BOx 2.7: ReFORm PRiORiTies ACROss AusTRALiA’s seRviCes seCTOR

Withthetermsoftradereturningtowardshistoricalaverages,thefocusofpolicymakersisnowonimprovingtheproductivityofAustralia’sservicessectorasawayofmaintainingeconomicgrowthandprosperity.

ThisfocusreflectsthelargeweightoftheservicessectorintheAustralianeconomy(morethan70percentofoutputand80percentofemployment)anditsunderperformanceinkeyareasrelativetoglobalproductivitybenchmarks.

Forexample,Australia’sProductivityCommissionfoundthatproductivityinAustralia’sretailindustryisalmost40percentbelowtheUnitedStates’,whileresearchersbasedattheRBAhavefoundbelow-parproductivitygrowthinthefinancialservices,educationandwholesaleindustriesoverthepastdecade.

Recognisingthisproductivitychallenge,theHarperReviewofCompetition(2015)highlightedtheneedtocultivatemorecompetitioninproductmarkets,particularlyacrosstheservicessector.TheReviewemphasisedtheneedforpolicysettingstobeflexibleinordertoallownewentrantspossessingdisruptivetechnologiesorlower-costproductsinto

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theAustralianmarket,includinginthe‘sharingeconomy’andthroughonlineprovision.Aspartofthis,theReviewidentifiedintellectualpropertylawasanareawherepolicyframeworksneededtobereassessedtoensurethattheexistingregimeisnotpreventingnewideasandtechnologiesfrombeingefficientlydispersedacrosstheeconomy.

TheReviewalsoemphasisedthepotentialforefficiencyimprovementsinhumanservices,includingthoseprovidedbygovernments,suchashealth,educationandcommunityservices.Whilealreadysignificant,theageingofAustralia’spopulationmeansthathumanservicesareexpectedtobecomeanevenlargerpartoftheeconomy,underliningthebenefitsthatcouldaccrueintheseareasfromincreasedcompetitionandcontestabilityaswellasgreaterconsumerchoice.

CompetitionreformwillnotonlyhelpAustralianbusinessestocompeteinfiercelycontestedserviceexportmarkets,butwillalsobeimportantinachievingproductivitygrowthacrossthenon-tradedsegmentsoftheservicessector.BetterproductivityperformanceinAustralia’snon-tradedsectorwill,inturn,freeupresourcestocopewiththedemandsofanageingpopulationandtofurtherimprovelivingstandardsoverthenextdecade.

AsnotedinBox2.6,thereisalsoroomforAustraliatosignificantlyimproveitsinfrastructure,withfurtherinvestmentneededinareasliketransportnetworkstosupportgrowingurbanpopulations.Additionalpublicspendingintheseareasneedstobeaccompaniedbyamorerigorousapproachforselectingprojects,toavoidwastingpublicresources(InfrastructureAustralia2016).

Asarelativelysmall,capital-importingeconomy,Australiawillalsoneedtoensurethatpolicysettingsremainsupportiveofforeigninvestmentininfrastructureandotherpartsoftheeconomy.China’smovetowardscapitalaccountliberalisationwillfundamentallychangetheavailabilityoffundswithintheinternationalcapitalmarket.China’svastpoolofsavingscouldhelpunderpinAustralia’sinvestmentneedsoverthenextdecade,butonlyiftheforeigninvestmentregimeandbroaderpolicyframeworkscontinuetomakeAustraliaanattractivedestinationforbothdirectandportfoliocapitalinflows.Improvinginfrastructuredeliveryforexistingassetswillbeapriority,includingthroughmoreefficientpricingintheareasoftransportandwaterinfrastructure(InfrastructureAustralia2016).Similarly,witharelativelysmallpopulation,Australianeedstoensurethatthelocalworkforcehasthecapabilitiesandnimblenesstocapitaliseonnewandemergingtechnologies.Inpart,thismeansbuildingupontheemergingcultureofstart-upbusinessesandentrepreneurship,andencouraginggreatercommercialisationofresearchideas,consistentwithAustralia’sNationalInnovationandScienceAgenda(AustralianGovernment2016).

Partners in economic transformation

ForbothChinaandAustralia,thepastdecadesaweconomicprosperityreachnewlevels,aseacheconomysuccessfullynavigatedtheglobalfinancialcrisistoextendalreadylongperiodsofunbrokeneconomicexpansion.

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Butglobaleconomiccircumstanceshavechanged,andthesourcesofgrowththatunderpinnedrisingincomesinthelastdecadewillneedtochangealso.Thechallengeinthenextdecadewillthereforebetounleashnewsourcesofgrowth,especiallyineacheconomy’sservicessectorandinotherareaswherenewtechnologiesarerapidlyemerging.

Toachievethis,bothcountrieswillneedtoextendanddeepenreforminthoseareasoftheeconomythathaveremainedprotectedfromdomesticandinternationalcompetition,whichwillbethemainrecipefordrivingproductivitygrowthandinnovation.

InChina,openingupdomesticcapitalmarketstotherestoftheworldwillbecrucialinsupportingdomesticfinancialmarketreformstoimprovetheallocationofcapitalandtounderpinfurtherincreasesinincomes.ReformstoreducetheroleofSOEs,includingthoseoperatinginthebankingsector,willalsobeneeded,aswillfurthertradeliberalisationofChina’sservicessector.Together,thesepoliciescanassistChinatorebalancetowardsmoreconsumer-orientedgrowth,andsupporttheeconomy’stransformationtowardstheservicesandhigher-technologymanufacturingsectors.

Intheeconomictransition,Chinaalsoneedstobalancetheshort-termgoalofsupportingaslowingeconomywithfiscalandmonetarypolicymeasures,whichmaycontributetotheriseoftotaldebt,andthelong-termobjectiveofachievingmorebalancedandsustainablegrowth,whichwillrequireapropermanagementoffinancialrisks.

AsChina’scapitalaccountbecomesmoreopen,itsinvestmentlinkswiththerestoftheworldarelikelytogrowdramatically,whichhasthepotentialtoprofoundlyaffectAustraliaandtherestoftheworld.

Asacountryreliantonforeigninvestment,AustralianeedstobereadytoembracetheexpansioninChineseoutboundinvestment,includingininfrastructurewhereAustraliawillneedtofinancenewprojectsinareasliketransportationtosupportgrowingurbanpopulationsandlivingstandards.

Morebroadly,Australiawillneedtoincreasecontestabilityacrossmarkets,includinginsignificantpartsoftheservicessectorthatarecurrentlyprotectedfromdomesticandinternationalcompetition.Foreignparticipationwillbeimportanttosuccessinthisendeavour.Amongotherthings,thiswillinvolveextendingreforminareassuchascompetitionpolicyandlabourmarketregulationandbreakingdownremainingbarrierstointernationaltrade.

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This text is taken from Partnership for Change: Australia–China Joint Economic Report, by East Asian Bureau of Economic Research and China

Center for International Economic Exchanges, published 2016 by ANU Press, The Australian National University, Canberra, Australia.

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