Hillary Clinton's trade warning: Can China coerce Australia?

Lowy Interpreter

Hillary Clinton believes Australia is too economically dependent on China, warning that dependence could 'undermine your freedom of movement and your sovereignty — economic and political'. Citing the example of European dependence on Russian gas, Clinton urges Australia to diversify its economic relationships. Is she right?

Economic dependence can be a problem in two ways. The first is 'sensitivity dependence', where one economy's health is tied to another's due to the depth of economic links between them. That is, 'China sneezes, Australia catches a cold'. A slowdown in China's economy causes a contraction in the construction and manufacturing industries, in turn reducing their imports of raw materials, depressing global prices and hurting our mining industry, especially higher-cost producers.

This is not a risk to be ignored, but even if Australia is sensitivity dependent on China, we're certainly not unique. Many countries — including the US — would suffer if China's economy fell off a cliff.

But Clinton is referring to 'vulnerability dependence'. This is a question of exit costs: how costly would it be for the two parties in an economic transaction to exit the relationship and find alternatives? The side that can do so cheaply has bargaining power, and in a political dispute could threaten the economic relationship as a way of achieving leverage. To use Clinton's Europe-Russia example, if it is easier and cheaper for Russia to find alternative customers for its gas than it is for Europe to find alternative suppliers, Russia has the upper hand.

How does this scenario play out for Australia and China?

It's true that over a third of Australia's exports go to China, but that statistic on its own tells us nothing about vulnerability. The important question is whether China could replace needed Australian imports at low cost. At present, this is a conversation about one commodity — iron ore — that overwhelmingly dominates Australian exports to China. According to the UN Comtrade database, iron ore comprised over 60% of Australia's merchandise exports to China in 2011, and China purchased almost 70% of all the iron ore Australia sold to the world.

But let's look this from China's perspective. Australian iron ore constituted almost 45% of China's iron ore imports in 2011. If we consider domestic iron ore consumption (ie. local supplies plus imports), Australia was responsible for roughly 20-25% of the total.

China is obviously a larger percentage of Australia's iron ore market than the reverse, but does this mean Beijing could stop buying Australian iron ore to punish Australia? This is not a crazy hypothetical. The Chinese steel industry attempted to boycott the iron ore spot market in 2009 to demonstrate its buying power during contentious negotiations over pricing with the 'Big-3' miners (BHP Billiton, Rio Tinto and Brazil's Vale). However, as Jeffrey Wilson details in his excellent book, Governing Global Production, the Chinese negotiating position was undermined when smaller steel manufacturers ignored the directive, choosing to take advantage of the much cheaper spot market prices. Individual profit motives thwarted larger strategic objectives, and China's steel industry was too fragile for the government to forcibly maintain a costly boycott.

Australian supplies are vast and cheap, and iron ore is a critical input into China's urbanisation and industrialisation, critical bases of the legitimacy of the Chinese Communist Party. It is not inconceivable that Beijing could decide to intervene in the iron ore market to place political pressure on Canberra — it would depend on how much China's leaders wanted to make a point. But doing so would come at a very high cost, one that Chinese firms might not be willing to pay for long.

This argument should not be mistaken for promoting overconfidence or arrogance in Australian foreign policy. China remains Australia's largest and most important trading partner, and managing the tensions between Australia's security alliance with the US and our economic interdependence with China is Canberra's greatest strategic challenge.

Nevertheless, Hillary Clinton's is wrong to imply that Australia's sovereignty is at risk. Evidence suggesting that our trading relationship with China renders us vulnerable to economic coercion is lacking. However, her suggestion that Australia should diversify its trade is still a good one, because it reduces the economy's sensitivity dependence on economic conditions in China.

Originally published by The Lowy Institute publication The Interpreter. Republished with permission.