I J Macfarlane: Asia's role in Australia's economic future
Tenth Annual Sir Edward "Weary" Dunlop Asialink Lecture by Mr I J Macfarlane, Governor of the
Reserve Bank of Australia, Sydney, 16 October 2003.
* * *
I would like to start by thanking the University of Melbourne's Asialink Centre for inviting me to deliver
this lecture commemorating such a distinguished Australian as Sir Edward "Weary" Dunlop. It is a
great honour, and I will devote the major part of my lecture tonight to Australia's economic relations
with Asia - a theme of which I am sure he would have approved. But before moving on to the main
topic, I would like to follow normal practice by saying a few words about the person whose memory we
are honouring. In doing so, however, I intend to follow up on a couple of unusual connections that
occurred to me as I was preparing the lecture. I do not intend to dwell on Weary Dunlop's
achievements or his place in Australia's history or folklore. I assume that everyone here tonight is
familiar with these.1
Instead, I ask your indulgence to start by drawing what you may find is a tenuous connection between
Weary Dunlop and two important economists, one he may or may not have met, the other he certainly
did meet.
The first economist was Professor L.F. Giblin, who was Australia's foremost economist in the inter-war
period. Since he held a chair in economics at Melbourne University in the 1930s, the two men may
have met, but there is no record of them having done so. But if they had, it would have been an
interesting meeting because from what we know from their biographies, they had some remarkable
similarities. Both were big strong men and natural leaders. Both had excellent minds and rose to the
top of their professions. Both were decorated for their courage in war - Giblin in the first world war,
Dunlop in the second. Both were outstanding sportsmen in the same sport - rugby. If Dunlop, the
Victorian, playing rugby for Australia is a sporting oddity, what of Giblin, the Tasmanian, playing rugby
for England during his Cambridge days?
The connection with the other economist of note was only recently revealed, and I am indebted to
Professor Leeson of Murdoch University for his excellent detective work. When Weary Dunlop and Sir
Laurens van der Post, amongst others, were in the Japanese prisoner-of-war camps in Indonesia and
Thailand, they tell of the miniaturised home-made wireless that they used clandestinely to keep up
with the course of the war. This device had been cobbled together by a fellow prisoner of war - a New
Zealand officer in the RAF. That officer we now know was Flight Lieutenant A.W.H. (Bill) Phillips,2
known to economists the world over as the inventor of the "Phillips Curve". Phillips had been trained in
New Zealand and Australia as an electrical engineer, had spent time in Asia before the war, spoke
fluent Cantonese, and only embarked on a career in economics after his discharge from the RAF
when the war ended.
Output growth
Enough of these biographical curiosities. I will now turn to the main subject of my lecture tonight which
is the role of Asia in Australia's economic future. I think for most of the past two decades, there was
general agreement on the importance - if not the primacy - of Asia in Australia's economic future. But
this agreement suffered a couple of setbacks in the 1990s. First, Japan, the biggest Asian economy
and the one which had been the main driving force, fell back into a period of very slow growth at the
beginning of the 1990s. Second, the Asian crisis which started in mid-1997 and lasted for about
18 months, severely dented many people's confidence in Asia's future.
This event - the Asian crisis - had a profound influence on opinion for three or four years. Many people
saw it as evidence that the "Asian miracle" had feet of clay after all. There was a widespread view
among western observers that the crisis was the inevitable result of severe governance deficiencies in
Asian countries, and that these deficiencies would hold back further economic development. During
the "tech boom" and the period of infatuation with the "new economy" in the late 1990s, perceptions of
Asia suffered again as its economy was compared unfavourably with more technologically advanced
western economies, especially the United States.
We now know that governance deficiencies were not confined to Asia, and that some countries that
were pointing the finger had governance deficiencies closer to home to worry about. The infatuation
with the "new economy" also resulted in a bubble, the bursting of which has been exerting a
dampening influence on world economic growth for the past three years. We also know that during the
period when many Asian countries were suffering from the crisis, one important Asian country - China
- was powering ahead. Now the dust of the Asian crisis has largely settled, it is worth sitting back and
taking a fresh look at Asia's place in the world economy, and particularly its place in Australia's
economic future.
I propose to start this task by looking at the world economy and asking the question - which regions
are increasing their share of output, and which regions are finding that their share is falling? I will use a
long-running International Monetary Fund (IMF) data base for the comparisons, the results of which
are shown in Tables 1 and 2.
Table 1
Asian output (excluding Japan)
Per cent
Share of world output1 Change in share
1982 1997 2002 1982-2002 1997-2002
China 3.76 10.27 12.67 237 23
India 3.00 4.28 4.77 59 11
Korea 0.81 1.67 1.77 119 6
Indonesia 1.17 1.87 1.58 35 -16
Taiwan 0.53 0.99 1.01 89 1
Thailand 0.58 1.08 0.95 64 -12
Philippines 0.82 0.69 0.68 -17 -1
Malaysia 0.26 0.47 0.45 72 -5
Hong Kong 0.29 0.42 0.40 39 -5
Vietnam 0.20 0.34 0.37 80 8
Singapore 0.13 0.24 0.24 92 2
Total 11.56 22.32 24.88 115.3 11.5
Total (ex China) 7.79 12.05 12.22 56.7 1.4
1
PPP basis.
Source: IMF, World Economic Outlook database.
No-one should be surprised to find that over the past 20 years Asia's share of world output has risen
noticeably, or that the share of the developed OECD countries has fallen. Note that I include Japan in
the latter group because it is a developed high-income country and as such has been a member of the
OECD since the 1960s. While much of the rise in the share of Asia is due to China, even when it is
excluded, the rest of Asia's share still rises from 7.8 per cent to 12.2 per cent over the two decades.
In the above comparison, I chose a 20-year period because it gives a good idea of how longer-term
trends have developed. If we instead chose the past five years for the comparison, we would be
choosing Asia's worst period, that is the one that contains the Asian crisis. As a result, we might
expect to find a different conclusion. But even here, the same picture emerges - Asia's share of world
output has risen from 22.3 per cent to 24.9 per cent. It is true that most of this growth is due to China,
but even without China, Asia's share rises slightly. Thus, the conclusion is that, whatever time period
we choose, Asia's share of world output is rising.3
Before we leave the tables, it is worth having a look at the performance of OECD countries in more
detail. Over the 20-year period from 1982 to 2002, there are only two significant OECD countries that
have increased their share of world output - Australia and the United States.4 I have used this fact
before to try and cheer up my fellow citizens who for a long time were inclined to assume that we were
slipping behind. When we shift the comparison to the past five years, Australia still comes out looking
good. We have increased our position more than any other significant OECD country, and the only
other ones to show an increase over this shorter period were Canada, Greece, Finland and Spain.
The general conclusion from these comparisons is that Asia has been, and still remains, the world's
fastest growing region and that Australia has done well compared to other high-income developed
OECD countries. The two facts are, of course, not independent.
Table 2
OECD output
Per cent
Share of world output1 Change in share
1982 1997 2002 1982-2002 1997-2002
United States 20.78 21.32 21.10 1.6 -1.0
Japan 8.32 8.20 7.11 -14.5 -13.3
Germany 5.45 4.78 4.43 -18.7 -7.3
France 3.95 3.25 3.20 -19.1 -1.7
United Kingdom 3.52 3.23 3.12 -11.3 -3.5
Italy 3.92 3.26 3.04 -22.4 -6.6
Canada 2.08 1.95 2.02 -3.1 3.2
Spain 1.86 1.73 1.76 -5.3 1.7
Australia 1.08 1.11 1.15 7.3 4.0
Netherlands 0.98 0.91 0.89 -9.8 -2.3
Belgium 0.75 0.62 0.59 -20.9 -4.5
Sweden 0.62 0.49 0.49 -21.8 -1.1
Austria 0.56 0.48 0.46 -17.5 -4.2
Switzerland 0.63 0.48 0.45 -28.7 -7.4
Greece 0.47 0.38 0.40 -15.2 3.1
Portugal 0.41 0.38 0.37 -10.2 -2.2
Denmark 0.40 0.35 0.33 -16.4 -5.1
Norway 0.31 0.31 0.30 -3.1 -5.1
Finland 0.33 0.28 0.29 -13.1 1.1
New Zealand 0.21 0.17 0.17 -19.2 -2.5
Total 56.6 53.7 51.7 -8.7 -3.8
1
PPP basis.
World Economic Outlook
Source: IMF, database.
Trade and investment
But that still leaves open a number of questions. Have our exports become over-reliant on Asia?
Alternatively, have we kept up our share of Asian imports? Has the closeness of our trade linkage
been mirrored in the capital markets? And are we well placed to adapt to future changes in patterns of
growth, as we appear to have done in the past two decades? These are the questions I will address in
the remainder of my talk tonight.
More than half of Australia's exports go to Asia, and the proportion has not greatly altered over the
past two decades (Table 3). It rose in the 1980s to peak at 59 per cent in 1996/97, then fell back
slightly as the Asian crisis had its effects to a figure of 55 per cent in 2001/02. Within this relatively
stable total, there has been a clear fall in the share going to Japan, and a commensurate rise in the
share going to non-Japan Asia (NJA). The other thing that stands out is that the share going to China,
while clearly increasing, is still quite low. Moreover, when we look at these exports to Asia and
compare them to the total imports that these economies are taking in, we see that Australia's share is
quite small - less than 5 per cent in most cases, and only 2 per cent for China (Table 4). Clearly, there
is a huge amount of room for expansion here.
Table 3
Australia's merchandise exports by region
Share of total
1981/82 1991/92 1996/97 2001/02
Asia 48.8 58.0 58.9 54.9
Japan 27.8 26.5 19.5 18.8
NJA 21.0 31.5 39.4 36.1
NJA ex China 18.2 28.8 34.9 29.7
China 2.9 2.6 4.5 6.4
EU 12.7 13.0 10.3 11.9
US 11.0 9.5 7.0 9.9
Other 27.5 19.6 23.8 23.2
Total 100.0 100.0 100.0 100.0
Source: ABS.
Table 4
Australia's share of merchandise imports
Per cent of total; year to May 2003
China 1.9
Hong Kong 0.9
India 2.2
Indonesia 5.2
Korea 3.7
Malaysia 1.6
Philippines 1.5
Singapore 2.0
Thailand 2.3
Source: IMF, Direction of Trade Statistics.
BIS Review 45/2003
One of the major characteristics of the development of Asia over the past decade has been the
increase in cross-border interdependence of production, as China became the centre for
labourintensive phases of manufacturing using intermediate inputs manufactured elsewhere, which were
then re-exported as finished manufactures. As a result, there has been a large increase in intra-Asian
trade, particularly between China and its neighbours. This intra-Asian trade, which is predominantly in
manufactures, has grown more quickly than trade between Asia and the rest of the world. It mirrors a
general shift in the trade patterns of developing economies which are now predominantly exporters of
manufactured goods. As recently as 1980, only 25 per cent of the exports of developing countries
were manufactures; now the figure is well over 80 per cent - for Asian countries, the figure is likely to
be over 90 per cent.
The question for Australia then is whether our exports to Asia are growing as fast as those of other
countries into Asia. It is difficult to answer this with precision, in large part because of gaps and
inconsistencies in data, but the approximate calculations we have made suggest that our exports are
keeping up (Graphs 1, 2 and 3). These graphs look at imports into non-Japan Asia and its two biggest
economies - China and Korea. As already established, the relevant question for us is whether imports
from Australia are growing as fast as imports from other countries outside the region. The data we
have suggest that this is the case; imports from Australia have grown faster than imports from the
G10 countries. This is less true for China, where our performance is more or less in line with the
G10 countries, but for Korea, imports from Australia have grown a lot faster than their imports from
G10 countries.
Graph 1
Graph 2
Graph 3
As we would probably expect, when we look at the breakdown of Asian imports by category, it is in
categories such as food, fuels and crude materials that Australia's performance has been particularly
strong. Imports of these goods to China and Korea from Australia have grown much more quickly than
their total imports. Australia has been increasing its exports of manufactures into Asia as well,
particularly to China, but this is from a very small base. Exports of manufactures to China grew at an
annual rate of 22 per cent over the past five years, but even then they represent only 4 per cent of our
total manufactured exports.
In summary, I think these comparisons show that we have been doing reasonably well. Our pattern of
international trade is strongly integrated into Asia, and apart from a small downward adjustment due to
the probably temporary effects of the Asian crisis, the trend is stable. There appears to be a lot of
upside potential in the trading relationship with China, given our low market share in that country.
When we come to financial integration, however, the story is very different because we do not have a
high propensity to buy Asian financial assets (Table 5). I have always been struck by the contrast
between the closeness of our trading relationship with Asia and the lack of closeness in our financial
integration into Asia. Australian direct investment in Asia, that is owning or having a controlling share
in Asian companies, has always been relatively small. We have always been more comfortable
running businesses in the United States, Europe (especially the United Kingdom) and New Zealand.
What is perhaps more surprising is that the share of direct investment going to Asia has fallen over the
past decade, particularly over the most recent five years. During this most recent period, the share of
our direct investment going to the United States has risen sharply, which is not unique to Australia -
the strong performance of the US economy during the stock market boom years around the turn of the
century attracted significant direct investment from all developed economies, and portfolio investment
from everyone.
While Asia is a very big player in the world of international trade and is also a major recipient of direct
foreign investment, it receives very little portfolio investment. Financial markets generally in the region
are not well developed, and portfolio investment is costly and involves investors taking risks that are
hard to evaluate. The lack of development is reflected in the low weights for the region in the global
market indexes which drive so much of the allocation of portfolio investment in the present world: Asia
accounts for less than 4 per cent of the Morgan Stanley MSCI global equity index - the most widely
used - and an even smaller share of global bond market indexes. In both cases, the shares are very
much lower than the region's 25 per cent share in world GDP. Needless to say, the share of
Australia's outward portfolio investment going to Asia is also quite small, accounting for only 10.9 per
cent of our portfolio investment in 2002.
Table 5
Destination of Australia's foreign direct investment
Per cent of total stock as at 30 June
1982 1992 1997 2002
United States 13.1 26.3 28.0 47.8
European Union 17.2 34.9 37.4 22.2
Japan na 0.5 0.3 0.2
Non-Japan Asia 34.6 16.4 12.6 7.4
Other 35.1 21.8 21.7 22.4
Total 100.0 100.0 100.0 100.0
Memo: Total
Australian FDI
$b 5.8 44.8 89.0 156.3
Per cent of GDP 3.5 11.0 16.8 22.0
Source: ABS.
In its foreign economic relations, Australia has given a very prominent place to Asia over recent
decades. As a result, Australia is a member of a range of Asian regional institutions aimed at
encouraging growth and trade. We at the Reserve Bank are also involved closely in a number of
similar groups that bring the central banks of the region together. The main aim of these meetings is to
find ways of encouraging the growth of Asian financial markets in order to emulate the success of Asia
in the international goods markets.
One concrete outcome of such co-operation has been the establishment of the Asian Bond Fund,
through which central banks in the region (including the RBA) have invested some of our foreign
reserves in bonds issued by Asian governments. So far, the only bonds included have been those
denominated in US dollars. In time, however, the central banks of the region hope to add bonds
issued in local currency into the Asian Bond Fund. We believe that this will help regional bond markets
develop greater liquidity and become attractive to a broader range of investors. In time, there should
be an increase in investment flows both within Asia and between Asia and other economies. This is
likely to see an increase in financial integration, but the process will be a slow one.
The future
Of course, the global economy does not stand still and we do not know how the recent trends within
Asia will develop. The story of the rise of China seems likely to have some way yet to run. But I doubt
that the rise in importance of China, and its impact on Australia, will turn out to be the end of the story
for Asia because the next chapter will probably contain a greater role for India. In terms of population,
India is growing at twice the rate of China and fast approaching it in size. It is noteworthy too that India
is now looking to the Asian region in its trade policy, recently concluding an agreement with
Association of South Eastern Nations (ASEAN) to eliminate most tariffs within eight years, at the same
time as ASEAN is eliminating internal tariff barriers and concluding free trade agreements with China
and Japan.
If India emerges as a second Asian engine of growth, Australia will face new opportunities and
challenges. But we are well placed to respond to its increasing demands for imports of food, materials
and intermediate goods. As with Korea, Australia has had a rising share over the past five years of
India's imports of materials.
We must make sure that we have the flexibility to respond to this additional source of growth if it
happens, just as we have responded to the shift from Japan to the rest of east Asia and then to China
over the past two decades.
Concluding comments
My main message - the importance of Asia to Australia's economic future - is not a new one, but it is
one that people lost sight of for a while. But it will be different in the future in that China will assume an
increasingly important role, just as Japan did in the 1960s and 1970s. In this sense, China is currently
the big story, just as India will probably be the next. At the moment, there is great apprehension in the
rest of Asia about China's rising dominance. Countries that compete with China as exporters of
manufactures, and recipients of direct foreign investment, feel that they will be overwhelmed.
I think most people in Australia have welcomed the growing importance of China. This is in part
because we do not see China as a competitor because we do not compete with them in low-tech
highvolume manufacturing. We tend to see them as a complementary economy. I do not think we would be
able to take the same comfort if we had maintained the old heavily-protected manufacturing sector we
had in the first half of the post-war period.
This complementarity does not mean that Australia has to see itself as only a provider of
resourcebased products from our mines and farms. Manufactured exports to China, while they are small, are
growing strongly. There is still plenty of scope for the further expansion of our high-value-added
manufacturing and service exports. It is remarkable how much of the growth in international trade is
intra-industry trade - that is two countries both exporting to each other within the same type of product.
This is particularly true of manufacturing.
I will conclude my talk tonight with two small but concrete examples of how intra-industry trade
between Australia and China is developing. These examples are drawn from the Reserve Bank's
Small Business Panel, a meeting we have with small businesses originally designed to hear their
views about finance, but now covering a wider range of topics. The two examples I will conclude with
tonight are as follows:
• One member of the Panel, who runs a company producing petrol and diesel driven electricity
generators, said he was experiencing a lot of competition for small generators from Chinese
imports. However, he was doing better in the export market and had just won a tender for an
important export order. When questioned, he revealed that it was for the Chinese army! As
an aside, the engines on his generators are imported from Japan and Italy. This is
symptomatic of the extent of intra-industry international trade that occurs these days.
• Another Panel member runs a company that installs wooden floors in Victoria using a special
locking device between the floorboards. His Australian supplier stopped supplying the
specially finished floorboards, and so he was forced to look elsewhere. Eventually, he came
up with a system whereby he ships the bulk wood to Malaysia, they glue and machine it to
his requirements, and he receives it ready for installation in Australia at 20 per cent below
the price of his former supplier. He is now exploring the alternative of moving his source of
supply to China at a probable saving of 50 per cent.