Australia s current trade position in agriculture

Transcription

1 Queensland University of Technology Faculty of Business Essay EFB314 International Trade and Economic Competitiveness Semester 2/2007 Australia s current trade position in agriculture Competitiveness Determinants and Influences Instructor: Student: Dr. Mark McGovern Martin Gaechter Student-Nr Brisbane, 02/10/2007

2 2 EFB314 International Trade and Economic Competitiveness 1 Introduction Agriculture in Australia has traditionally been one of the most competitive sectors of the economy. Due to favourable factor endowments such as land and other resources, Australia has a comparative advantage in producing agricultural goods compared to other economies in the world. The aim of this paper is to examine the determinants of this comparative advantage, as well as various influences on the competitiveness of Australia s agricultural sector. A review of the literature highlights some important issues. Firstly, due to the comparative advantage in producing agricultural products, this sector remains very important for Australia, especially for its exports. Secondly, Australia still runs a huge balance-of-payments deficit despite the recent gains in its terms of trade. Thirdly, domestic as well as international policies have strongly affected Australia s competitiveness in the agricultural sector. As agriculture is still the most highly protected and distorted sector in the world economy, a further liberalization would bring substantial gains for the Australian economy. 2 The agricultural sector in Australia Economic growth of developed economies is usually accompanied by a decline in the primary and manufacturing sectors and relatively rapid growth in the services sectors (Anderson 2000, p. 5). That pattern can also be observed in Australia. However, as Table 1 shows, the reduction in manufacturing protection enabled the GDP shares of the more competitive primary sectors to increase slightly in the 1990s. Although the shares of GDP (3.3%) and employment (5%) of the agricultural sector indicate decreasing importance compared to other sectors, agriculture remains highly important for Australia s exports. Table 1: Composition of Australia's GDP and Employment in percentages (Source: Anderson 2000, p. 18)

3 3 EFB314 International Trade and Economic Competitiveness Economic policy reforms and the slow growth in world agricultural trade have contributed to a remarkable transformation of the structure of Australia s exports. As Table 2 shows, the share of rural products has fallen steadily from more than 80 per cent in the early 1950s to 20 per cent today. Much of that decline was due to the growth of minerals and energy exports as well as manufacturing and services exports (Anderson 2000, p. 5). Table 2: Composition of Austrlia's exports in per cent (Source: Anderson 2000, p. 18) Despite the relative decline in agriculture, it remains an important part of Australia s merchandise exports. Australia exports around 65 per cent of its agricultural production (Penm/Glyde 2007, p. 22), representing 27 per cent of its merchandise exports. As shown in Figure 1, exports of agricultural products in 2006 (8346 million AUD) were nine times the imports in this sector (912 million AUD). Considering the increasing current account deficit in recent years the relative importance of agricultural as well as mining products is beyond question. Figure 1: Australian Exports and Imports of Agricultural Products ( ) in million dollars (Data: ABS 2007)

4 4 EFB314 International Trade and Economic Competitiveness 3 Comparative advantage According to the Heckscher-Ohlin-Model (Van den Berg 2004, p. 88) and the Ricardian model (Krugman/Obstfeld 2006, p. 24), there are fundamental economic drivers that tend to result in countries specialising in the production and export of products for which they have a comparative advantage, which means lower opportunity costs to produce them. Comparative advantage between countries and regions typically results from differences in the relative supply of inputs, such as labour or natural endowments. In Australia s case, the relatively scarce resource tends to be labour. On the other hand, relatively abundant resources include natural endowments and capital. Australia can therefore be expected to have a comparative advantage in products that are relatively more land and capital intensive than those of their trading partners (Short et al. 2006, p. 36). A popular concept for measuring the comparative advantage of a certain product or sector of an economy is the Balassa Index or the Revealed Comparative Advantage (Balassa 1965). Here, a comparison is made between the extent to which an exporting country captures world market share for a particular product and the degree to which it captures export market share for all traded goods. An RCA greater than 100 signifies a revealed comparative advantage for the particular industry. Merchandise exports, Australia 105,800 Merchandise exports, World 10431,000 Market share for all traded goods for Australia Value of agricultural products exported, Australia 21,209 Value of agricultural products exported, World 851,847 Market share for all agricultural exports for Australia! Revealed Comparative Advantage for Australia in agriculture "# $ % &'() * +,-. / Table 3: Revealed comparative advantage for Australian agricultural products (following the concept of Balassa 1965, as applied in Short et al. 2006, p. 37), numbers in billion dollars (Data: WTO 2005) The RCA for the Australian agricultural sector indicates a clear comparative advantage compared to its trading partners (Table 3). However, the RCA index is an imperfect measure because it embodies not only the fundamental economic factors (such as relative factor endowments) affecting relative efficiency but also government policies and institutions that may distort markets (Short et al. 2006, p. 37). As current international trade policies and trade arrangements result in lower exports of agricultural products from Australia, for example through tariff barriers, the RCA Index for Australia may even be understated.

5 5 EFB314 International Trade and Economic Competitiveness 4 Effects on balance-of-payments, terms of trade and sustainability Considering Australia s comparative advantage in producing agricultural and other primary products, it is not surprising it has always been a net exporter of primary products and a net importer of manufactures. Through exporting primary products which can be produced relatively cheaply in Australia, the country can improve its terms of trade and therefore, can afford more imports. However, despite the recent enormous gains in its terms of trade, 30% in the past three years (see Figure 2), due to Australia s commodity and mining boom, it still runs a huge balance-of-payments deficit (5.4% in 2007, The Economist 2007 C). Figure 2: Australia's Terms of Trade (The Economist, March 2007 B) This means the comparative advantage in primary products is not able to balance the less competitive sectors, such as the manufacturing sector. A possible reason for the current account deficits may be that agriculture is more protected in major world markets than other traded goods, leading to lower world prices and decreasing exports from Australia. Furthermore, the long-run trend in the relative price of primary commodities seems to be heading downwards (Anderson 2000, p. 8). This does not mean that Australia should abandon exporting primary products, rather fully exploiting the comparative advantages may not yield as much for the type of economy as it would for one whose comparative advantages are in products whose markets are growing faster. Therefore, the long-term sustainability of this comparative advantage is highly controversial. The agricultural sector in Australia will face some serious issues in the near future. Firstly, the severe drought will lead to reductions in access to irrigation water (Penm/Glyde 2007, p. 25). The cost of water and water delivery services are likely to increase. Secondly, unlike commodities, export prices for farm products have declined more significantly than other exports over the past three decades (Penm/Glyde 2007, p. 22). In the face of

6 6 EFB314 International Trade and Economic Competitiveness these changing conditions Australian farmers rely on productivity increases to maintain their competitiveness. However, the developments in water and natural resource management can undermine the continued productivity improvements. Finally, agriculture is still strongly protected in major world economies and increasing competition from developing countries could decrease Australia s competitiveness further. These domestic and international influences will be examined in more detail in the following section. 5 Impacts of trade policies on Australia To understand the impacts of domestic trade policies it is necessary to take a short look into the history. By the 1950s, Australia was a dual economy with an export oriented rural and mining sector and a strongly protected manufacturing sector. Tariffs and import controls were used increasingly until the early 1970s leading to a larger manufacturing sector than what would have emerged under free trade. However, it stifled the growth of other sectors, particularly those natural resource-based ones in which the country enjoyed its strongest comparative advantage (Anderson 2000, p. 2). This follows the Lerner symmetry theorem which claims that an import tariff, by raising opportunity costs to exporters, is a tax on exports as well as imports (Van den Berg 2004, p. 194). Since the 1970s tariffs and other trade restrictions have been reduced continuously in the manufacturing sector as well as in agriculture. Considering the import side of the economy, the quarantine issue is of special interest for Australia. The Agreement on the Application of Sanitary and Phytosanitary Measures provides a basis for quarantine arrangements under the framework of the WTO (Trebilcock/Howse 2005, p. 207). Quarantine restrictions protect against the entry and spread of pests, diseases and health risks. However, strict measures are sometimes erected to act as non-tariff barriers, motivated by political and economic reasons rather than genuine sanitary concerns (Islam 2002, p. 789). Without question, Australia s geographical position justifies high quarantine restrictions to avoid the contamination of diseases such as foot-and-mouth disease. Nevertheless, to prevent its trading partners using unjustified quarantine, Australia must maintain a transparent and scientifically justified quarantine regime in order to show that its measures are not arbitrary and trade restrictive. From an international perspective, agriculture remains the most highly protected, subsidized and distorted sector under the WTO (Islam 2002, p. 783). If the international markets become more liberalized, the prices of commodities and agricultural products are expected to rise along with the export income of Australia. Therefore, the liberalization of agricultural trade is one of the major economic issues for Australia as an exporting country in agricultural products.

7 7 EFB314 International Trade and Economic Competitiveness Since the 1950s there has been substantial growth in agricultural protection in the advanced industrial economies (Anderson/Hoekman/Strutt 2001, p. 192). Through forming the Cairns Group of non-subsidizing agricultural exporting countries in 1986, agriculture was brought on the agenda of the Uruguay Round of trade negotiations. The Uruguay Round aimed at correcting and preventing distortions in world agricultural markets (McGovern/Pace 2004, p. 7), as shown in Table 3. Goals Achievements Issues and Exemptions Reduction of domestic support measured in terms of a common standard (Aggregate Measure of Support AMS). Reduction in export subsidies Improving market access for nations with comparative advantage in agriculture 20% reduction in domestic support in terms of the AMS over a six-year period ( ). Policies are subject to different levels of discipline according to their degree of distortion: - Green Box: no or minimally tradedistorting effects, and therefore exempted from reductions. - Blue Box: linked to production factors, but not to price and volume of output. - Amber Box: impact on trade and thus subject to a reduction. 21% reduction in the volume of export subsidies and a 36% reduction in the cash amount of export subsidies over a six-year period. Tariffs are to be reduced by at least 36% overall by each member over the six-year phase-in period, with a minimum 15% reduction on each product category. Existing non-tariff border measures are to be converted into tariffs. Existing non-tariff border measures must be reduced to the extent required to allow foreign producers a minimum of 3% market access in each product category, rising to 5% at the end of the six-year phase-in period. Direct payments to farmers, when made under production-limiting programmes are not subject to reduction commitments ( blue box"). The peace clause stipulates that domestic support measures that are exempt from reduction commitments are to be noncountervailable (expired in January 2004). Exemptions for developing countries (special and differential treatment). No elimination of export subsidies, which are particularly harmful to developing countries as they artificially lower worldmarket prices for their exports. The special safeguard provision permits imposition of an additional level of duty in the case where imports of a particular product exceed a trigger level in a given year or where the price of imports falls below a trigger price. Table 4: Goals and Achievements in the Uruguay Round, Agreement on Agriculture (Source: Trebilcock/Howse 2005, pp ; Islam 2002, p. 779; Landau 2001, p. 914) The Uruguay Round can be described as the start of a fundamental shift in thinking about the importance of liberalizing agricultural trade. However, the continued high levels of domestic support in developed countries are criticized as a major shortcoming of the Uruguay Round (Trebilcock/Howse 2005, p. 336). The export subsidy reduction scheme is unable to reduce the harmful effects of agricultural protectionism because countries can shift their export subsidy into exempt forms of direct domestic support programmes ( green box and blue box measures). Table 5 shows that agriculture remains a highly protected sector, especially in the EU, Japan and the US.

8 8 EFB314 International Trade and Economic Competitiveness Simple Average of ad valorem duties Non ad valorem duties Australia 3.4% 1.6% European Union 15.4% 32.0% Japan 28.4% 15.3% New Zealand 5.7% 0.2% United States 5.2% 39.9% Table 5: World Tariff Profiles 2006 for Agricultural Products (Data: WTO 2007) In essence, the Doha Round aims to reduce market distortions in the same areas as the Uruguay Round (see Table 6). The concept of multifunctionality plays an important role in the negotiations, especially in the EU position (Landau 2001, p. 915). The arguments are based on special characteristics of agriculture, which includes exceptional price and income instability, the importance to national security of agricultural selfsufficiency and the cultural and social value of preserving rural lifestyles (Trebilcock/Howse 2005, p. 321). As the negotiations are not completed yet, the results still remain uncertain. Goals (WTO 2001) Expected Outcome (WTO 2005) Issue Substantial improvements of market access (tariff reductions) Further tariff cuts. Disagreement about the extent of reduction. Reductions of, with a view to phasing out, all forms of export subsidies End date of 2013 was agreed for export subsidies and their equivalents. Export subsidies are a relatively minor part of the farm support that leads to dumping, constituting only 3.6% of EU farm support. Substantial reductions in trade-distorting domestic support Cut in trade-distorting domestic support. Disagreement about the extent of reduction. Providing special and differential (S&D) treatment for developing countries The Special Safeguard Mechanism (SSM) recognises the need for developing countries to decide for themselves which products need to be protected to safeguard food security, rural development, and the livelihoods of poor farmers. Table 6: Goals of the Doha Round (Source: WTO 2001 and WTO 2005) Disagreement between developed and developing countries on the pace and form of further agricultural liberalization. Islam (2002, p. 777) argues that, in agricultural trade, there are many similarities between Australia and developing nations. While developing nations enjoy an exceptional rule of the most-favored-nation (MFN) clause through the special and differential (S&D) treatment to developing nations, Australia is not entitled to receive any S&D treatment. Due to Australia s dependence on agricultural exports it cannot compete in the export markets of industrial products and therefore, its benefits of MFN have been limited. However, because of the special characteristics of the agricultural sector (as mentioned above) the establishment of a fair trade system in agriculture is very difficult and controversial. Additionally, Australia s competitiveness is affected by free trade agreements. Such arrangements change relative prices in favour of imports from partner countries in the agreement, thereby influencing production and trade patterns, both within the group and with other countries. Australia negotiated a number of free trade agreements in recent years (see Table 7).

9 9 EFB314 International Trade and Economic Competitiveness Free Trade Agreement Since Australia-United States Free Trade Agreement (AUSFTA) 2005 Thailand-Australia Free Trade Agreement (TAFTA) 2005 Singapore-Australia Free Trade Agreement (SAFTA) 2003 Australia-New Zealand Closer Economic Relations Trade Agreement (ANZCERTA) 1983 Australia/NZ-ASEAN Malaysia China Chile Gulf Cooperation Council Japan Table 7: Australia's Free Trade Agreements (Source: Commonwealth Australia 2007) However, the gains of such agreements are highly controversial (see, for instance, Economist 2007 A) and they cannot substitute a global multilateral solution under the framework of the WTO. A detailed analysis of the FTA, however, would go beyond the scope of this paper. According to Penm/Glyde (2007), global merchandise trade liberalization would boost Australia s agricultural exports by an estimated nine billion dollars in 2020, while world agricultural trade is estimated to expand by more than 286 billion USD. Fabiosa et al. (2003) and Diao et al. (2003) conclude with similar results and expect world prices in agricultural products would rise significantly. Production expansions would occur in countries that are natural exporters, such as Australia, leading to substantial terms-of-trade effects. Additionally, movements in the exchange rate have been a major factor affecting the competitiveness of Australian agricultural exports for two decades. A rising Australian dollar makes exports less price competitive on international markets and reduces returns to producers in Australian dollars. However, currency appreciation can also reduce some costs of production by lowering the costs of imported inputs such as fuel and machinery. Nevertheless the net effect of a rise in the exchange rate on profit margins is likely to be negative as a result of lower export incomes in Australian dollars (Apted et al. 2006, p. 37). 6 Conclusions The determinants of and the influences on Australia s competitiveness in the agricultural sector are complex and varied. With a comparative advantage in producing agricultural goods, the farm sector remains a very important issue for Australia, especially for its exports. Remarkably, Australia still runs a huge balance-of-payments deficit despite the enormous gains in its terms of trade in recent years. Possible explanations include the inability to exploit its comparative advantage based on fundamental economic factors due to the high level of protection in international agricultural

10 10 EFB314 International Trade and Economic Competitiveness markets. This leads to decreasing earnings from exports and an increasing current account deficit. Furthermore, the sustainability of the comparative advantage is highly controversial, in particular due to the current drought and its consequences, decreasing prices for farm products in world markets and increasing competition from developing countries. Concerning domestic policies, the competitiveness was strongly influenced by the export oriented rural and mining sector and a strongly protected manufacturing sector until the 1970s. This not only led to a bigger manufacturing sector, but also to higher costs for other sectors, such as agriculture. From an international perspective, agriculture remains the most distorted sector of the world economy. Despite the efforts in the Uruguay Round, the level of support and protection has not changed substantially. The current Doha Round aims to decrease protectionist policies further. However, the special characteristics of the agricultural sector ( multifunctionality ) and its importance for national security and rural development make the negotiations difficult. As a further liberalization of the agricultural sector would raise world prices and increase Australia s exports, the Cairns Group must insist on ongoing reforms to achieve a fairer international trading system which does not discriminate against countries with a comparative advantage in agriculture, such as Australia. This issue is not only essential for the agricultural sector, but for Australia s trade position in general.

11 11 EFB314 International Trade and Economic Competitiveness References ABS - Australian Bureau for Statistics (2007): Table 35 and Table 32, Anderson, K. (2000): Australia in the International Economy, Centre for International Economic Studies and School of Economics University of Adelaide, CIES Discussion Paper Anderson, K. and Hoekman, B and Strutt, A. (2001): Agriculture and the WTO: Next Steps, Review of International Economics, 9 (2), pp Apted, S. and Berry, P. and Short, C. and Topp, V. and Mazur, K. and Mellor, T. (2006): International Competitiveness of the Australian Vegetable Production sector, Australian Bureau for Agriculture and Resource Economics (ABARE) ereport 06.5, April Balassa, B. (1965): Trade Liberalization and Revealed Comparative Advantage, Manchester School of Economic and Social Studies, 33, pp Berg, Van den H. (2004): International Economics, New York: McGrawHill Irwin. Commonwealth Australia (2007): Australia s Free Trade Agreements, [accessed 29/09/2007]. Diao, X. and Somwaru, A. and Roe, T. (2001): A Global Analysis of Agricultural Trade Reform in WTO Member Countries, Economic Development Center, University of Minnesota. Fabiosa, J. and Beghin, J. and Cara, S. and Fang, C. and Isik, M. and Matthey, H. (2003): Agricultural Markets Liberalization and the Doha Round, International Conference of Agricultural Economists, August 2003, Iowa State University, USA. Islam, R. (2002): Parochialism in Agricultural Trade Liberalization under the World Trade Organization. Dilemmas and Options for Australia as a Middle-Sized Nation, Journal of World Trade 36 (4), pp Krugman, P. and Obstfeld, M. (2006): International Economics. Theory and Policy, 6 th edition, Pearson Addison Wesley. Landau, A. (2001): The Agricultural Negotiations in the WTO: The Same Old Story?, Journal of Common Market Studies, December 2001, Vol. 39, No. 4, pp McGovern, M. and Pace, C. (2004): On International Agricultural Trade Reform, Academy of World Business, Marketing and Management Development Conference, July Penm, J. and Glyde, P. (2007): Australian Agriculture. Key issues for the future, in: Australian Commodities, Vol. 14, No. 1, March Quarter 2007, ABARE, pp Short, C. and Chester, C. and Berry, P. (2006): Australian Food Industry: Performance and Competitiveness, Australian Bureau of Agricultural and Resource Economics (ABARE) Research Report The Economist (2007 A): APEC a pretty empty chatter. Four adjectives in search of a conclusion, [accessed 19/09/2007]. The Economist (2007 B): Downwonder. The lucky country may not be so for too much longer, March 29th The Economist (2007 C): Weekly indicators: Trade, exchange rates, budget balance and interest rates, [accessed 22/09/2007]. Trebilcock, M. and Howse, R. (2005): The Regulation of International Trade, 3 rd edition, London/New York: Routledge. World Trade Organization (2001): Ministerial Conference, Fourth Session, Doha, Qatar, 9-14 November Ministerial Declaration, WT/MIN(01)/DEC/120. World Trade Organization (2007): World Tariff Profiles 2006, [accessed 22/09/2007]. Wright, A. (editor) ABARE (2007): Australian commodities, Australian Bureau for Agriculture and Resource Economics, March Quarter World Trade Organization (2005): Ministerial Conference, Sixth Session, Hong Kong, December Ministerial Declaration WT/MIN(05)/DEC.