Ministry of Foreign Affairs Draft Discussion Paper for Officials' Working Group

Wellington, 12 February 1980

CONFIDENTIAL NEW ZEALAND EYES ONLY

Australia/New Zealand Economic Relations: The Status Quo1

Purpose of Paper

Some broad judgement needs to be drawn on the viability of what has come to be known as the ‘status quo option’-i.e. a decision by New Zealand to reject a broader economic relationship with Australia and try to maintain, throughout the coming decade, the existing NAFTA framework in broad terms.
It is acknowledged that of the many difficult issues involved in considering the best course of action for New Zealand to take in the context of this exercise, there is probably none that is so predictive in nature and dependent on intuitive judgements. The only possible d fence of the approach taken below-which does not shy from making such explicit sweeping judgements-is that a failure to arrive at an agreed view of New Zealand’s future economic relationship with Australia under the status quo option is itself an implicit broad judgement that the status quo is tenable and a reasonable basis against which the costs of moving towards a broader-based relationship can be measured. As the latest NZIER study (Butcher & Copeland) observed, the question that must be addressed is not a comparison of before integration with after integration but with integration and without integration.
The importance of this issue is clear enough: New Zealand manufacturers are basically happy with the status quo. If you can have your cake and eat it too, why bother changing the recipe? Putting aside the extremist viewpoints expressed to officials in the DTI Industry Survey (January 1980), a dominant theme running through manufacturers’ verbal comments to members of the survey team was:’Look, we’ve got what we want now. You blokes and your Ministers have done a great job negotiating with the Australians-just carry on’.
The history of New Zealand’s trade with the U.K., however, underlines the importance of taking a longer-term view of the longevity of even the happiest and apparently most mutually satisfactory of trading relationships. To state at the outset this Ministry’s overall assessment of the realities of this exercise: just as it was obvious from the early 1960s that the cornerstone of New Zealand’s trading links-the provision of ‘cheap food’ to the British housewife-could not be taken for granted any longer, so too today the existing framework of trans Tasman economic relations does not fit with the long-term political and economic aspirations of the dominant (Australian) trading partner. The broad policy inference to be drawn from this historical analogy is rather similar too, we think: New Zealand must begin the task of negotiating a long-term relationship that is consistent both with our own needs and our trading partner’s aspirations before the existing framework is further whittled away.

The ‘Status Quo’ Further Defined

To avoid the accusation that one is setting up a ‘straw man’ argument, it is necessary to define approximately what one means by the status quo.
It would be quite inaccurate to portray the current NAFTA framework as a static thing. Since the NAFTA was signed in 1965, it has been in a process of constant evolution: the implementation of article 3:7 deals from 1967, progressive changes in the rules of origin, the transition from British Preferences to the present-day Preferences Agreement, and so on. But at the level of generality on which this assessment is based, it is easy to identify a set of broad assumptions underlying the evolution of the NAFTA. First, it is not a free trade area approach but essentially a preferential area approach to trade relations. Second, competition has been consciously avoided (cf. panel arrangements, positive list approaches, highly disaggregated additions to the schedules). As Les Castle2 once put it: ‘the avoidance of competition has run through the NAFrA like a theme in a Greek play, but whether it is tragedy or comedy, I have not yet decided’. Third, it has been marked by an exceptionally high degree of administrative intervention. Fourth-and less and less true in recent years-it has been imbalanced in New Zealand’s favour (this has nothing to do with the balance of trade-we are referring to the form of institutional arrangements). Finally, there is no provision for harmonisation of policies that can lead to accusations of unfair competition; in practice, New Zealand has been the main beneficiary of this feature.
All of these central assumptions are, it is suggested, at variance to a greater or lesser extent with the trend in Australian policy thinking.

Australia’s Approach to Economic Relations with New Zealand

The old cliché about Australia’s approach to NNZ Economic Relations-Australia takes New Zealand for granted; it is up to New Zealand, as the smaller partner, to define the nature of the relationship–once an accurate statement of reality, is now most misleading. It remains true, we think, of the Australian population generally, the Australian press and the Australian State and Federal Parliaments, but it is no longer true of that group of Departments and their Ministers responsible for formulating Australian Government policy towards New Zealand.
For about the last three years the Australian Governmental system has, at first fitfully but now in a concentrated fashion, been redefining the relationship from an Australian perspective. This process of redefinition represents the confluence of many factors-many of them contradictory-but some of the main elements can be identified readily enough. The most important initial impulse was plain old-fashioned protectionism. Once New Zealand manufacturers began to make real gains in the Australian market in the 1970s, at a time of growing unemployment and heightened concern over import competition, the Australian bureaucracy was put under intense pressure to re-examine the basis of that market penetration. About the same time Australia became embroiled in a domestic and international debate over the desirability of protectionism. This was engendered by complex political and economic forces (differential relative rates of inflation, tensions created by the explosion of mineral wealth in Australia which worked its way through the system principally via the exchange rate mechanism). In the circular debate over protectionism that followed, everyone had their own barrow to push. Some (Treasury/IAC) were concerned principally with the economic costs of retaining these rigidities. Others (DFA) were concerned with the impact of protectionist measures on Australia’s trade relations with a highly selective group of countries which they decided were ‘theirs’ in terms of their bureaucratic and their foreign policy preoccupation (i.e. ASEAN). Industry and Commerce represented the concerns of Australian manufacturers.
New Zealand-and the NAFTA-got squeezed in the middle. Because of the momentum built up behind the NAFTA, New Zealand received in 1976 two totally contradictory signals from the Australian Government on the future of the economic relationship: the quota decision and the extension of the NAFTA.
The 1976 quota shock resulted from the convergence of views between the free traders/foreign policy people on one side and the protectionists on the other. For entirely different reasons, both agreed it was not in Australia’s interest to continue to exempt New Zealand from the range of quantitative restrictions introduced in the 1974-76 period. This paradox is by no means unknown in other contexts. The main voice in favour of UK entry into the Community was an uneasy coalition of free-traders and protectionists: the free-traders were looking at the intra-community barriers while the protectionists had their eyes firmly fixed on the common external tariff. In the case of the 1976 quota decision, it is understood that the Department of Overseas Trade representatives (now Trade and Resources) walked out of the final senior officials meeting indicating that what was being recommended to Ministers was totally inconsistent with the whole spirit of the economic relationship between the two countries built up over the last ten years. They were delivering an instant but correct historical judgement.
The decision to renew the NAFTA for a further ten years was, we consider, simply too hard to contemplate not doing. To have taken such a cataclysmic step in terms of relations with a political partner as close as New Zealand would have presupposed a consensus of opinion at the political and bureaucratic level that was only then in the process of formation. It can only be a matter of speculation, but had the Agreement come up for renewal two years later we might well have been faced with a major renegotiation rather than a rubber-stamping operation.
This current exercise to explore the prospects for closer economic integration between the two countries has, we think, to be considered against this background. For very clear political reasons, this exercise must be presented as a New Zealand initiative. In many ways it is. It represents the realisation of the importance to New Zealand of the relationship with Australia-a process which culminated in Mr Talboys’ extended visit to Australia in 1978. But future historians will probably be puzzled if they attempt to trace the links of the present exercise back to the Nareen Statement. The Nareen Statement contained words to the effect that it was agreed that because of the difficult economic circumstances, it was not an appropriate time to consider a major expansion of the economic relationship between Australia and New Zealand. Eighteen months later, it would seem the reverse applies.
Fortunately, the process of redefining the A/NZ relationship in Canberra took a positive, rather than a negative tum. Whether we consider it accurate or not, it has a lot to do with very pessimistic assumptions about New Zealand’s economic future held at the highest level (cf. Mr Anthony’s comments to Mr Wright) and a lot to do with a genuine feeling that Australia’s and New Zealand’s futures are indivisible. The latter in itself owes a good deal to the strong New Zealand orientation of a few Permanent Heads and Ministers, largely through their association with New Zealand or the NAFTA over the last two decades (Scully, McKinnon, Parkinson, Currie and of course Mr Anthony). Stone has, more recently, lent his not inconsiderable weight behind the exercise-for the moment.
While relationships between two countries can be observed to be ‘at a particularly critical phase’, year after year, the statement is almost certainly true of Australia/New Zealand relations today. The historical explanation of the trend in Australian attitudes in paras 8-14 above is intended to show that: 1. the Australians have done a lot of thinking about A/NZ relationship over the last three years, 2. this took initially a negative tum but is now very positive.
Officially, the line taken by senior Australian officials is that if New Zealand decides now is not a propitious time to countenance a major change in the relationship, that is understood. At the same time, official cognizance is given to the ‘greater difficulties’ of attempting the exercise again in ten years time when the two countries’ policies may have diverged further. This formal Australian position is merely a political recognition that if the initiative is seen to be imposed by ‘big brother’ it would be rejected by New Zealand. It should not, we think, be interpreted as a sign that the Australian Government is quite relaxed about the matter.
It would, we consider, be naive to think that life with the Australians would be that simple. The forces that they have led to the redefinition of the relationship will continue, if not quicken, because of the essential relative dynamism of the Australian economy. The political consequences of New Zealand rejecting a closer economic relationship are likely to be quite severe over time. Such a decision by New Zealand would be widely perceived by the Australians as inward-looking. The common reaction would be to ‘leave New Zealand to its own devices’. This would, over the longer term, come to have a damaging impact on the foreign policy relationship. In the short term, its impact would be very largely concentrated on the bilateral economic relationship. Where conflicts were seen to exist between economic arrangements with New Zealand and other objectives of policy, New Zealand would be the loser.
It cannot be over-emphasised that we are suggesting a trend in policy, not a single decision. It is in fact no more than an extension of what has been happening for some time. This is very different from suggesting that the Australians, in a fit of pique, would immediately commence dismantling the framework of the current economic relationship.
It is extremely difficult to move beyond this general prediction to specify precisely what form these consequences would take. But among the possibilities would be: * –the Preferences Agreement,3 up for renewal in year’s time, would be allowed to lapse, * – the NAFTA, when it came up for renewal in 1986, would be emasculated and allowed to continue in name only unless New Zealand exempted all goods on Schedule A from import-licensing or, alternatively, agreed to remove all goods with import licensing on Schedule A and (say) place them on Schedule B, * –Article 3:7 arrangements would eventually lapse, * –Special quota arrangements negotiated under the NAFTA umbrella would be, on expiry, renegotiated on an equal basis along the lines of the current apparel negotiations (or the emerging issue of hand-held rotary cultivators). 20 It might well be asked why Australia would consider such actions which would impair its own economic future in the New Zealand market-since all these arrangements are partly reciprocal. The answer is simple: in some cases that would indeed be an offsetting consideration (eg. CKD packs) but generally the Australians have, rightly or wrongly, come to the conclusion that their exports to New Zealand do not depend on existing preferential arrangements-i.e. that New Zealand would continue to source 20% of its imports from Australia regardless of the NAFTA.
These possibilities represent the most pessimistic limits. New Zealand would of course take corrective action. In doing so, the possibility of New Zealand adopting a de facto ‘hybrid’ (i.e. being forced to adopt harmonised policies particularly on non-tariff barriers-as the price for maintaining free trade) cannot be discounted. If that were the result, it is likely that it would be a hybrid which would take far less account of New Zealand’s interests than one entered into voluntarily from a position of negotiating strength based on the existence of current contractual arrangements. It is worth recalling that some of the most intractable NAFTA issues-whiteware, leather wallets-could have been resolved through addition to Schedule A but for the opposition of manufacturers at the time.

The Status Quo (II): Marketing Aspects

We have attempted to draw a very approximate picture of the long-term policy consequences of New Zealand deciding to reject the concept of a closer economic relationship. There is however, a further aspect to the status quo option to be considered-the ability of New Zealand manufacturers to continue to enjoy export growth rates in the Australian market implied by the Planning Council’s projections and the Manufacturing Federation’s own target of exporting, by 1984, 20% of output.
This Ministry has no particular competence to assess this issue but in the absence of any other analysis offers the following observations.
It is clear from the Manufacturers’ Survey (DTI, January 1980) that marginal pricing techniques, buttressed by export incentives, are the basic marketing technique employed by a majority of exporters to the Australian market. Indeed, there is explicit recognition of that fact in the common observation that New Zealand manufacturers need the domestic market to export. This Ministry considers that as a long-term policy to secure compounded rates of growth of New Zealand manufactured exports this is an untenable strategy because of (i) the fiscal constraints implied by permanent export incentives matched to growth in exports, (ii) demographic and economic growth trends in New Zealand-i.e. the domestic market (on which export prices are averaged downwards) is likely to be static. There is also the question of countervailing, particularly if we do not accede to the subsidies/CVD code (and thus gain benefit of the injury clause) but this is unlikely to be a problem in the Australian market so long as Australia itself maintains export incentives.
Marginal pricing (and the associated policy instrument of export incentives) will always play a role in marketing strategy, getting companies committed to exporting but this seems to provide no basis for long-term sustained growth.
New Zealand manufacturers will also face gradually increasing competition from third country sources in the Australian market. Since 1968/69 there has been a slow rise in market penetration in imports of manufactured goods in Australia. Quite contrary to Australian perceptions, this is not due to ASEAN imports but to developed imports and imports from East Asia.
Australia is again on the verge of profound currency strength based on continued rapid growth in mineral exports and its growing importance as an exporter of energy and energy-based products (e.g. coking coal and aluminium). In the long-term this can feed its way through the Australian economic system in one, or a combination of two ways: revaluations or tariff cuts. Revaluations will improve the competitiveness of third countries’ performance in the Australian market (New Zealand too of course). But tariff cuts would not help New Zealand much (the average tariff applicable to imports from New Zealand is only about 6%) while it would greatly enhance the relative competitiveness of third countries. There is a strong and growing body of opinion in Australia that will lobby for the tariff cut option rather than general revaluations (since they affect the competitiveness of all industries, efficient or inefficient, in the traded sector).
It is assumed that if we seek to retain the status quo for the foreseeable future, it will be because Ministers decide New Zealand cannot afford the adjustment costs required to obtain the economic benefits from bilateral trade liberalisation. It is difficult to imagine, therefore, that resource-switching will take place at a pace much higher than has been achieved in the last five years. It is suggested that this will have a significant impact on the possibility of future growth of our manufactured exports to Australia over the period leading up to the expiry of the NAFTA in 1986. In brief, there is a serious prospect of failing to make progress in the Australian market comparable to that achieved in the 1970s because of a growing failure of competitiveness relative to domestic Australian manufacturers and third country suppliers. This could be so even if one assumed the most optimistic scenario in a policy sense-i.e. that the Australians were prepared to maintain the current institutional framework in the NAFTA context. It could affect some of the important assumptions underlying the Planning Council’s estimates of realisable economic growth.
It is acknowledged that this is an especially difficult area for judgement. But the current performance of New Zealand textile and apparel exporters in the Australian market may be a portent of our growing marketing difficulties.

Conclusion

A decision by New Zealand to opt for the ‘status quo’ would, in effect, be likely to be negated in due course. The ‘status quo’ contains features which do not sit well with Australian attitudes as they have evolved over the last three to four years. The ‘status quo’ is disliked both by those seeking faster economic restructuring than is currently taking place in Australia and also by those with traditional concerns of protecting Australian industry from ‘unfair’ competition from New Zealand. This prognosis of NAFTA’s future (and agreements under its umbrella) is thus not critically dependant upon a continuation of outward looking trade policies.
The economic basis to the network of Australia’s trading relationships has undergone some marked changes in the last fifteen years-away from Europe and towards Asia. The political responses have, until recently, lagged a little behind. The MTN was, essentially, Australia’s last hurrah with Europe. The Australian economic interest in Asia will broaden progressively, largely in response to economic development in the region and the impetus this will give to Australian resource-based development. The ‘ASEAN and Japan’ focus of the mid 1970s has already been changed to encompass Korea, Taiwan, Hong Kong, and the PRC.
It is evident that the Australian Government would like, in effect, to get the NNZ economic relationship on the right footing-i.e. a basis compatible with Australia’s changing external economic circumstances. From New Zealand’s point of view, we would be likely to negotiate an arrangement that reflects our concern to a greater extent if we do so on the basis of current contractual arrangements. For the reasons advanced in this paper, a negative decision by New Zealand would be likely to undermine those arrangements. This would coincide with the decline in the relative importance of New Zealand both as a market overseas and as a market for Australian manufactured goods.
New Zealand’s export performance in the Australian market will thus be adversely affected by likely policy changes and growing commercial difficulties arising principally from greater third country competition. Successful development of new substantial export lines can only expect to be met by precisely the same negative policy reaction that has occurred on all of New Zealand’s ‘winners’-whiteware, leather wallets, carpets, cheese, peas and beans, apparel.
The ‘status quo’ option thus seems to offer the prospect of a loosening of economic ties and increasing frictions in the trading relationship. This could be offset by consequential policy adjustments by New Zealand (e.g. substantial import-licensing concessions) by this would be equivalent to New Zealand adopting a de facto hybrid from a position of relative weakness.
In this paper we have concentrated our attention on the economic consequences of a decision not to pursue at the present time the options for a closer economic relationship with Australia. In the view of this Ministry, the foreign policy implications of such a decision are also likely to be serious. These implications will be spelt out elsewhere.

[ABHS 950/Boxes1221-1226, 40/4/1 Part 11–42 Archives New Zea1andffe Whare Tohu Tuhituhinga 0 Aotearoa, Head Office, Wellington]

1 At this time at least two departments (Customs and Foreign Affairs) drafted papers setting out the likely consequences of dropping the CER exercise or allowing it to fail. This Foreign Affairs draft is the more exhaustive, but both reached similar conclusions. There is no reason to suppose that key Ministers such as Muldoon or Talboys ever considered dropping CER, but the drafts may have been intended to convince other more recalcitrant Ministers and their departments (possibly elements in the often protectionist Department of Industries and Commerce). There is no indication that the draft published here was further developed or put to any official use.
2 A former Treasury official, later Professor of Economics at Victoria University of Wellington.
3 Agreement on Tariff and Tariff Preferences, operative from 1 December 1977.