Report by Joint Working Parties

1 February 1980

CONFIDENTIAL

Australia- New Zealand Economic Relations Report by Joint Working Parties 1 February 1980

In accordance with the terms of reference established by Permanent Heads in November 1979,1 Australian and New Zealand working parties have separately completed a series of studies aimed at identifying the implications of various options for a new trans-Tasman trading relationship.

A joint meeting of the two working parties was held in Wellington on 30 January - 1 February 1980 to consider the principal issues and conclusions to emerge from the respective national studies and has prepared the following summary report as a basis for the further discussions to take place between Permanent Heads in Canberra on 25/26 February.

ITEM 1

To assess as far as practicable the economic, industrial and institutional implications for Australia and New Zealand of eliminating over say five to seven years all tariff and non-tariff barriers and other protective devices between the two countries on all products.

1(a) With Each Country Maintaining its Freedom to Vary its Tariff and non-Tariff Barriers Against Third Countries

Because the areas of trade still subject to bilateral barriers presently also receive high protection against third country imports, the protection against those imports would remain high, at least initially.

From the New Zealand perspective, the maintenance of a protective regime against the rest of the world of a height close to the present while allowing free trade with Australia, would almost certainly lead to significant trade diversion. For Australia the problem of trade diversion would appear to be less significant. In consequence, there could be scope for the expansion of internationally inefficient industries in one country or the other, even though the combined size of such industries would be unlikely to alter much under such conditions.

In the absence of suitably designed rules of origin it would be possible for third countries to avoid the domestic tariff of the higher tariff partner by routing products through the lower tariff partner. This so-called trade deflection would, over time, force the more protected industry to retrench or to lower its costs, so as to be able to compete with only the protection available in the other country.

Particular problems would arise where one country has an industry which the other does not. New Zealand manufacturing is to a much greater extent than Australia, protected by high levels of protection on finished goods and very low protection on raw materials and intermediate goods that are not manufactured locally.

While Australia permits concessional entry of imports, the equivalent of which are not available from local manufacture, its wider industrial base means that many goods imported at world prices into New Zealand would attract duties in Australia. The margin between tariffs on finished goods and inputs is, however, in most instances, less in Australia than in New Zealand.

Because of this, it is of particular concern to Australia that in a full free trade area New Zealand final good manufacturers might expand their exports to Australia, not because they were necessarily more efficient, but because they have access to cheaper world-sourced inputs and lower wage related costs. This could occur even though such New Zealand industries might be less efficient than their Australian counterparts and require higher protection against third country imports. Even though a New Zealand industry receives the same nominal protection as the Australian industry, it could be more competitive because of its access to cheaper raw materials and its consequent higher level of effective protection.

Notwithstanding the problems of trade diversion and the expansion of inefficient industries, the increased exposure of each country’s industries to competition from the other’s, offers advantages of greater incentives for efficiency wherever both countries have an industry. These effects would, in some degree, spill over to affect the management climate in some segments of industry generally. The larger market would tend to promote intra-industry trade and more specialisation.

There is a tendency for some self-correction over time of the problem of the expansion of inefficient industries in a full free trade area of the type envisaged. This comes about because of market forces, national self-interest in protection policy and the general commitment to outward looking development policies. For instance if one country finds its local market for the product of an inefficient industry being taken by imports from a less inefficient producer in the other country, then it will increasingly question the desirability of forcing its own consumers to pay above world market prices to protect employment in the other country. In the extreme case where the domestic industry is forced to close there would be no domestic justification in maintaining the protection. These considerations would influence investment considerations.

In the agricultural sector, it should be noted that free trading conditions already exist for a number of products. However, there are some industries for which movement to free trade between the two countries would create problems. These include dairying for Australia, wheat and wine for New Zealand and for both countries a number of horticultural products. Freeing trade would in some cases involve major policy changes affecting production and marketing arrangements in both countries and these would be the same regardless of the option chosen for closer economic association.

The principal concern would be to ensure that in a free trade situation rural industries in both countries would be able to compete on an equitable basis. Because of the particular measures used to support agriculture, this raises the issue of current marketing/stabilisation schemes and assistance measures which can affect the relative competitive position of these industries.

l(b) With a Movement to a Common External Regime based on the Adoption, in respect of each Industry, of the Lower of the Two External Regimes currently in force

A common external regime deals effectively with several of the problems attendant upon a free trade area. For example, it dispenses with the need for special rules of origin since all third country imports enter the wider customs territory on the same basis and may therefore be interchanged between the two countries without additional impost other than for domestic fiscal purposes.

Countries operating or contemplating a full free trade agreement are normally brought to appreciate that a common external regime has the attraction of ironing out at least some of the distortions and inequities that are necessarily attendant upon the free interchange of goods which are produced by countries having divergent external policies.

The formation of a customs union which based the common external tariff on a lower of the two union partners would minimise the potential for trade diversion. Conversely, trade diversion would rise to the extent that the common external tariff was set above the lower of the two previous tariffs.

Both working groups see problems in establishing a full customs union within the terms of reference. These difficulties relate to the existence of significant Australian input industries and the fact that the tariff and non-tariff barriers applied by Australia and New Zealand against third countries are diverse and substantially different. A common regime, particularly, if based on the adoption of the lower common denominator, would bring about a shift in economic and trade policy for both countries, but particularly for New Zealand.

An important implication would be the removal of duties assisting Australian producers of intermediate goods where similar goods are imported duty-free into New Zealand. This would involve severe adjustment pressures for the Australian producers of the inputs concerned. At the same time, there would be an increase in effective production for the Australian producers of associated finished goods unless the tariff on those goods moved downwards.

On the other hand New Zealand would not generally wish to raise its tariff and protective structures in these industries to the present Australian level. This would subject New Zealand’s finished goods industries to greater competition and place greater pressure on New Zealand industries to relocate in Australia to minimise the impact of higher costs, including freight rates. This would also cause New Zealand to divert trade away from third countries to Australian sources. Equally important from both a trade and foreign policy point of view would be the adverse impact on relations with New Zealand’s other trading partners of raising tariff and protective structures to the Australian level in these industries.

The long-term industry and trade effects of a customs union would be more fluid as factor utilisation and prices adjust to the combined market, technology advances, new products emerge and international economic changes occur. Predictions beyond the immediate future cannot be made with any confidence but present circumstances can give some guide to the likely future development. The common external tariff that would result from taking the lower common denominator in those cases where both countries had similar industries would be only slightly lower that the pre-union Australian tariff because that tariff is in most cases already lower that the New Zealand tariff. However, such a common tariff would be considerably lower than the pre-union New Zealand tariff and, given the more extensive use by New Zealand of quantitative restrictions, a greater liberalisation by New Zealand of quantitative restrictions would be involved. Other commercial factors and policies notwithstanding, it seems likely that in a customs union of the type proposed by Permanent Heads, Australia could become the preferred location for development of some types of manufacturing activities. There would be a tendency for New Zealand to specialise in areas where its blend of natural resources and where the relatively lower New Zealand labour related costs could be important. In the longer term a customs union might facilitate corporate planning involving both countries which would lead to rationalisation of production between existing manufacturing entities.

Such a customs union would require a reconsideration of the policies that have been devised (for instance, following reference to the Australian lAC and the New Zealand IDC) relating to particular sectors of the economy.

1(c) A Combination of the Two Approaches

The joint working parties recognise that it is possible to envisage a wide variety of combinations of the two options examined under 1(a) and 1(b).

However, given the principal problems and issues of a Free Trade Area and Customs Union as classically defined, a hybrid arrangement which appears to present a promising option for the progressive development of the closer long-term relationship compatible with the overall economic aims might be based upon commitment to move to free trade in as broad a band of industries as possible. It would be essential that there be automaticity in the phasing-in of the free trade arrangements with exceptions, rather than inclusions, being nominated.

Such a hybrid agreement should make provision for the following:

1. Recognition that for developmental and other reasons some industries may require special arrangements, including differential phasing within the overall objectives of the agreement. Recognition also of the possible need for phasing arrangements beyond the five to seven years’ time frame specified in the terms of reference where warranted by special industry circumstances.
2. Provide scope for study of agreed cases where industries in both countries would have extreme problems of adjustment to be undertaken before existing bilateral trade restrictions are eased and, where appropriate, adjustment assistance be provided.
3. Examination of the options open to deal with the problems caused by intermediate goods industries. These might include: 1. special area content rules 2. production subsidies 3. lowering of tariffs to the lower level of the two countries 4. margins of preference
4. Proposals for change in external tariffs for the products of industries common to both countries be based on recommendations by separate advisory bodies in each country working in consultation, and leading wherever possible to a common external tariff.
5. Safeguard mechanisms based on present NAFTA arrangements. Resort should only be had to these measures in circumstances of significant concern.

TERMS OF REFERENCE-ITEM 2

POSSIBLE TECHNIQUES FOR THE ELIMINATION OF TARIFF AND NON-TARIFF BARRIERS BETWEEN AUSTRALIA AND NEW ZEALAND

1. The Terms of Reference arising from the Permanent Head’s Statement of Understanding asked officials ‘to determine the most desirable and practicable technique that might be applied in achieving the elimination of tariff and non-tariff barriers between Australia and New Zealand’ over an agreed period.
2. Decisions in this area would be interdependent with those relating to the form and timing which the elimination of tariff and non-tariff barriers to trade might take. Moreover, any consideration of the best techniques for elimination of trade barriers cannot be divorced from institutional issues-including the possible involvement of industry advisory bodies-and such safeguard provisions as might ultimately be implemented.
3. The following are amongst the options that are available and which show the greatest practicability and advantage. 1. An across-the-board phased removal of tariffs, possibly following a basis similar to the phasing arrangements provided for addition to Schedule A in the existing NAFTA (i.e. an 8 year phasing arrangement with reductions of 20 per cent of the base rate bi-annually). 2. Possible adaptation of the phasing arrangement which could include, for example, variations to the degree and period of tariff cut and/or special provisions relating to those goods where the existing tariff rates are already low or relatively high. However, regard should be had to the fact that levels of tariff are not always necessarily indicative of the sensitivity of the goods in question. 3. General or selective references to industry advisory bodies which might be asked-with some degree of co-ordination between the two countries-to determine arrangements appropriate to particular industries for the removal of existing trade barriers. 4. Concurrent with tariff action, the phased elimination or liberalisation of such non-tariff barriers as may be agreed. Progress in this respect would require to be carefully monitored to ensure that distortions were minimised and the administration of any such restrictions as might continue to be applied against third countries was not complicated. 5. For sensitive items, New Zealand import licensing might best be liberalised on a licence-on-demand basis for successive increments of the domestic market over the duration of an agreed phase-out period. For less sensitive items, an unrestricted move to licence-on-demand within a shorter period, thereafter a full removal of licensing requirements might be possible. Conditions for each industry would need to be determined ultimately on a case-by-case basis. 6. A progressive removal of protection should be accompanied by an appropriate range of adjustment assistance measures and safeguards to prevent unnecessary industry dislocation.

ITEM 3: ADMINISTRATIVE ADJUSTMENTS INVOLVED IN HARMONISATION INDUSTRIES ASSISTANCE

Harmonisation of the work of advisory bodies would involve considerable legislative and administrative change. Perhaps an option with some advantages, but involving the greatest change, would be new joint bodies with modified guidelines, etc. An option involving less change would be to retain the two sets of institutions, with perhaps minor changes, and provide for greater co-operation between them before separate reports are submitted to the respective Governments.

CUSTOMS

Although there are differences in the institutional arrangements involved in setting tariff levels, a considerable degree of commonality already exists in the policies and procedures followed by the two countries in administering their Customs Tariffs.

Significant differences do, however, apply in relation to the following elements.

1. By-law and Concession Policies

Although both countries provide mechanisms whereby rates of duty appearing in the Customs Tariffs might be reduced by the exercise of discretionary authority, there are considerable differences in the operation of such discretion. This reflects, inter alia, differences that exist in the substantive tariffs and in industrial development between the two countries.

1. Valuation

Presently New Zealand’s Customs valuation system is based on Current Domestic Value in the country of export whereas Australia applies the Brussels definition of Value at free-on-board level. The differences are substantial. A possible means of achieving compatibility would be for both countries to adopt the GATT Valuation Code developed within the Multilateral Trade Negotiations.

1. Rules of Origin

Significant differences are noted in the Rules of Origin adopted by each country in relation to trading with third preference receiving countries.

1. Anti-Dumping and Countervailing

Australia’s anti-dumping legislation is aligned to the principles contained in the GATT Anti-Dumping Code and also includes countervailing provisions. New Zealand has not acceded to this Code. A number of differences are apparent in the policies applied by the two countries. Both countries could achieve compatibility on the basis of the Codes on Anti-Dumping, and Subsidies and Countervailing, developed in the Multilateral Trade Negotiations though this would involve a consideration of wider trade policy issues.

Both Australia and New Zealand are active members of the Customs Co-operation Council, a factor which has reinforced the considerable degree of harmonisation which exists in Customs procedures. The extent to which harmonisation is desirable in the particular areas identified above as having significant differences would depend upon the nature of the arrangement reached between the two countries. Complete harmonisation would be seen as necessary in the event of a decision to adopt a Common External Regime.

ITEM 4: EXAMINATION OF OTHER FORMS OF ASSISTANCE CURRENTLY PROVIDED TO INDUSTRIES IN AUSTRALIA AND NEW ZEALAND WITH A VIEW TO ASSESSING THE LIKELY EFFECTS OF:

1. their elimination in respect of trade between the two countries, or
2. their harmonisation in such a way as to provide equal treatment of the industries in each country.

Having examined a wide range of measures falling within the category of other forms of assistance, the working parties consider that special and particular attention needs to be given to at least three cases to determine their significance for trans-Tasman trade and the effects of their elimination or harmonisation. The three cases identified are: export incentives, agriculture support arrangements and production subsidies and government purchasing.

While these measures require further detailed study the following points can be noted:

1. Export Incentives

The various export incentive and development schemes operating in both countries have a common approach in that they are intended to assist exporters by defraying the costs of export promotion and to reward and encourage export performance. However, while the current Australian schemes are viewed by them as providing a short-term incentive to the export sector, in the New Zealand context they are regarded as a major plank of New Zealand industry policy. The range and level of incentives available to New Zealand exporters is wider and more generous than those .available to Australian exporters. In this regard, the disparity between the schemes operated by the two countries is such that Australian industry is likely to complain that New Zealand exporters are able to compete unfairly in the Australian market. On the other hand New Zealand industry may also feel justified in complaining that some Australian exporters will be able to use the current Australian scheme to unfairly assist rapid growth in the New Zealand market.

Harmonisation of the schemes would provide a means . to overcoming such potential difficulties in that it implies fair treatment by both countries. As the New Zealand scheme has been specifically tailored to meet industrial development and export objectives, it could be expected that there would be strong resistance to change or major modification, particularly if it involved a significant scaling down of the level of incentives. On the other hand it is not clear that, notwithstanding the positive effects on export performance which could be expected, Australia would be prepared to adopt the New Zealand scheme.

While elimination of the schemes in relation to trade between the two countries is a possibility, such a move would in effect act as a disincentive to bilateral trade, the growth of which is one of the objectives of the exercise. One possibility, to reduce the disincentive to bilateral trade, could be set a common level of assistance lower than that applying to third countries.

1. Agricultural Support Arrangements

The operation of agricultural marketing/stabilisation schemes and assistance measures in both countries influence[s] the performance and competitiveness of agricultural industries. However, because of the complexities of these mechanisms, appropriate solutions may lie in approaches other than elimination and harmonisation. In any approach the objective would be to ensure that the net effect of support measures on producers in either country were approximately equal.

In the case of wool, meat, tobacco and eggs the existing marketing/stabilisation schemes would not be significantly affected by closer economic co-operation. In other cases such as the dairy, wheat, citrus and some fresh and canned fruit industries, closer economic association could have significant implications for the. operation of existing marketing/stabilisation arrangements and assistance measures.

Appropriate solutions would need to be developed through detailed discussions in respect of particular agricultural industries. In this respect, it is recognised that both countries may wish to maintain the freedom to assist their agricultural sectors in ways which they feel are most in line with their overall policy objectives.

1. Government Purchasing

The preferences which the Governments of both countries extend to domestically-made goods in their procurement policies and practices constitute an additional layer of protection for Australian and New Zealand suppliers, within their respective markets, over and above that accorded where applicable by duties and non-tariff barriers.

The implications of removing discrimination in government purchasing as it applies to bilateral trade would be to increase competition between potential suppliers on both sides of the Tasman. For New Zealand industry it would provide the opportunity to bid for a larger procurement market. While the total procurement market which would be opened to Australian manufacturers would not be significant, it needs to be borne in mind that the manufacturing base in New Zealand is much narrower than in Australia. Accordingly, Australia would enjoy a preferred position over third country suppliers for a range of goods which are not available in New Zealand.

As the purchasing policies and practices of the two countries are broadly similar, the implications of any move to harmonise them around a common denominator close to existing arrangements, are unlikely to be major, however, the progressive liberalisation of tariffs in trans-Tasman trade would enhance the competitiveness of both countries in relation to third country suppliers given the continued application of notional duties for some purchases from such sources.

It is possible that agreement might be reached on the harmonisation of policies including, for example, an agreed maximum margin of preference to apply to domestic suppliers, or to significantly reduce the area touched by discriminatory policies. Consideration could also be given to a combined area content to apply when assessing bids, irrespective of whether the last place of manufacture was in the domestic or partner country.

This subject also directs attention to the preferences which the Australian State Governments accord to their own ‘domestic’ suppliers. Harmonisation might be achieved by agreement between the Commonwealth, State and New Zealand Governments on a uniform maximum level of preference. The States might be able to agree that goods which are the produce of New Zealand are treated no less favourably when traded in an Australian State than goods from any other Australian State.

ITEM 5: TO REPORT BROAD CONCLUSIONS INCLUDING IDENTIFICATION OF MAJOR ISSUES TAKING ACCOUNT OF BOTH DYNAMIC AND STATIC IMPLICATIONS AS FAR AS IS PRACTICABLE

Dynamic Effects

The Working Groups noted the difficulties of assessing the dynamic effects, but recognised their significance in reaching an overall judgement of any future form relationship. The Working Group considered the following points worth noting:

The increase in competition, and the greater market size, should result in a higher level of efficiency in both countries in the use of resources and improved allocation of those resources. The larger market size and inter-industry rationalisation within the agreement should enable more of the advantages of economies of scale to be realised. Consumers in both countries should benefit. In the long term improved employment and stronger economic growth could be expected for a closer economic relationship but there would be severe short term adjustment problems from any rapid change in the relationship, particularly for New Zealand. The major benefit that will accrue to New Zealand will come about through the dynamic gains that a greater level of competition will bring. New Zealand’s small market size and the low level of international competition locally suggest that there is considerable room for improvement in productivity simply through better use of resources. Work that has been carried by international agencies in highly protected economies suggest that the major gains from free trade operate through this type of mechanism.

The overall benefit for Australia is likely to be less significant in relative terms and would depend importantly on equal market opportunity, including the treatment of the intermediate goods industry.

The Working Group considered it important that the potential benefits from closer economic ties between the two countries are not diminished by the impact of trans-Tasman freight rates or inadequacies in transport services.

There are dangers in closer ties, the most important of which is trade diversion, with its impact on both higher balance of payments costs for the country whose trade is diverted and also through the expansion of inefficient industries to take advantage of the possibility of trade diversion or trade creation which is not based on internationally efficient industries. Both impose costs on the countries involved and both should be avoided if possible. A good deal will depend on the rate of change in the protective structure between the two countries, and between each country and the rest of the world.

The reduction in bilateral trade barriers and the longer term impact of that on competitiveness could result in the present exchange rate being inappropriate. In Australia’s case and adjustment in unlikely to be large, given the relatively small potential impact of New Zealand on the Australian balance of payments. However, a reduction by New Zealand of direct controls on imports and other forms of assistance to industry could require an adjustment of the New Zealand exchange rate over time, to ensure that the balance of payments remains within reasonable bounds.

However, closer association will only be one factor bearing on the overall balance of payments outcome. Exchange rate policy will continue to be framed in the light of other factors including internal economic conditions, policy objectives and the setting of other policy instruments.

Conclusion

The studies confirm Permanent Heads’ views that any new arrangements need to reflect an outward looking approach based on an efficient allocation of resources and should be designed to enhance relationships with third countries.

The Working Groups consider that Australia would favour a Customs Union based upon the lower of the two external tariffs in those cases where both countries have the same industries, but would find difficulty in completely removing protection for industries which New Zealand did not share. New Zealand has substantial problems however, with any Customs Union which would require its industries to accept increased input costs and, in many cases, reductions in protection for its finished goods industries. For this reason, it considers a Free Trade option, suitably qualified, as being more acceptable. As a consequence the third option of a ‘hybrid’ arrangement appeared to offer the best prospects for providing the basis for any possible future agreements. Such a ‘hybrid’ would attempt to deal with the major problems identified by each country, but it should not compromise long term possibilities of a Customs Union approach.

The Working Groups believe that the problems of achieving a mutually beneficial closer economic relationship are likely to become more difficult if the two countries proceed along different lines of development in the coming years. The overriding concern should be to achieve a relationship that promotes the long term growth of economic activity, employment and living standards.

[NAA: A1838, 370/1/19/18, xv]

• 1 See Document 52, paragraph 8.