US-Aust pact a setback only

By BRIAN FALLOW economics editor

A free trade agreement between the United States and Australia, but excluding New Zealand, would be a setback rather than a major economic shock, officials say.

The Government yesterday released two studies, by the New Zealand Institute of Economic Research and by Robert Scollay from Auckland University, on the impact of an Australian-US free trade agreement (AUSFTA) on investment and trade flows, respectively. On both fronts the impact would be negative.

Scollay's economic modelling found that the impact on exports to Australia, arising from the loss of the advantage New Zealand exporters now have over US firms under CER, would be more than four times greater than the loss of competitiveness to New Zealand exports to the US if Australia gained unfettered access to US markets.

"The fall in exports to the US is concentrated in the dairy products, meat and other food products sectors, while the fall in exports to Australia occurs mainly in manufacturing sectors," Scollay said.

A surprising result of Scollay's work was that it would make little difference if agriculture was excluded from an AUSFTA.

Partly, this is because of an offsetting "backfill" effect: if Australian produce were diverted from other markets, in Asia say, to more lucrative US ones New Zealand might be able to fill the gap.

(Respondents to the NZIER survey, however, doubted Australia would divert too much attention from Asian markets, especially for meat, given their long-term potential.)

Overall, Scollay found, the trade impact would be very modestly negative, equivalent to 0.03 per cent of GDP or $40 million.

But that should be regarded as "very much the lower bound" of possible effects, he said.

By contrast the gains from a New Zealand-US free trade agreement would be about nine times larger - 0.27 per cent of GDP.

The NZIER study of effects on investment is unquantified, and based on interviewing 60 firms and industry bodies in key sectors.

Many found it difficult to separate a specific impact from an AUSFTA from other factors eroding New Zealand's relative attractiveness as an investment destination or place to do business, such as Australia's larger economy, faster economic growth and lower corporate tax rates.

"This wasn't a universal view but it was prominent," NZIER said. "New Zealand was seen by some to be losing ground to Australia in terms of relative investment opportunities, and larger threats to business expansion in New Zealand.

"For example the long-term price of energy was seen as a constraint to the expansion of manufacturing processing activity in energy-intensive sectors."

A major theme of responses, NZIER said, was that there could be a significant "announcement effect" on investor perceptions, with Australia attracting favourable attention while New Zealand looked marginalised.

But that would be a short-term phenomenon and the real medium and longer-term effects would be only moderately negative.

Understandably the investment impact is greatest on sectors facing significant trade barriers, such as the dairy industry.

Respondents from sectors such as creative and high-technology, where exporters are not competing on price or where trade barriers are low, doubted there would be much effect on investment flows.

In the dairy industry, New Zealand would suffer a competitive disadvantage if gaining access to key, and heavily protected, US markets was easier from Australia.

Fonterra would be able to partly hedge against the negative effects through its shareholdings in Australian dairy processors.

But "it was suggested that major economic benefits would flow to Australian milk producers, effectively at the expense of New Zealand farmers".

For the forestry industry access to the US market is not a major issue. Import protection for forest products is equivalent to an average tariff of about 3 per cent.

Also the forestry industry would benefit from any strengthening of the Australian economy - a major market for building products exports - as a result of AUSFTA.

The prognosis from the tourist industry was fairly negative, NZIER said. It was thought Australia would receive free publicity from the negotiations themselves, and a boost in business travel.

Much of the foreign direct investment into the tourist sector on both sides of the Tasman comes from Asia. "All things being equal it would be logical to expect some investment diversion into Australia from New Zealand as a result of AUSFTA."

In the meat industry, most recent foreign investment in the industry has come from Asia.

"These investments - and those made in Australia from Asia - are likely to have been driven by the potential for future access to Asia, and Japan in particular, rather than by the possibility of gaining further access to the North American market."

Some manufacturing firms suggested that while the US duties they face are quite low (around 5 or 6 per cent) in a very competitive business this can make a difference - perhaps enough of a difference to attract investment Australia's way.

NZIER reported that some respondents cited the difficulties that an AUSFTA would face.

Australia's exports to the US include arguably the three most difficult agricultural sectors: sugar, dairy and wheat.

And US free trade agreements tend to have highly bureaucratic disputes resolution procedures (unlike CER), creating the risk that non-tariff barriers can offset tariff liberalisation.