Asia-Pacific Trade and Economic Integration:

Strategic Opportunities for Russia and New Zealand

Address by Hon Tim Groser to the New Economic School

Moscow, 31 May

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On the 9th of May each year, a small group of now elderly men gather before a memorial plaque on the waterfront of Wellington, New Zealand’s capital. They are joined there by staff from Russia’s Embassy and senior representatives from New Zealand’s Defence Force.

Each year the numbers are necessarily fewer, yet each year the occasion is more significant. These men are the survivors of the New Zealanders who took part in the Arctic convoys between 1941 and 1945. Through their service and through their personal sacrifices, they helped to keep open the critical supply links between Russia and its wartime allies.

That commemoration is a reminder of the events that led to the establishment of formal diplomatic relations between Russia and New Zealand, 66 years ago. It was the reality of a wartime alliance that led the two countries to formalise their relationship. For New Zealand as a small country, it has always been important to be in touch with the thinking of one of the world’s major powers.

Today, building on earlier discussions between Foreign Minister Lavrov and the NZ Minister of Foreign Affairs, Mr McCully, Russia’s Minister of Economic Development, Elvira Nabiullina, and I reached agreement to begin laying the groundwork for formal commencement of Free Trade Agreement (FTA) negotiations with Russia, joined by its partners under the Customs Union, Kazakhstan and Belarus.

If our two Governments can bring this to a successful conclusion, I have no doubt that this will later be seen as the most important step forward in bilateral ties between NZ and Russia since the establishment of diplomatic relations all those decades ago.

A Russia/NZ FTA

This is not, I would argue, a predictable development – Russia and NZ forming a Free Trade Area? It is not part of the standard script.

Since the rationale for such a development is not immediately obvious, other than perhaps to a small and unfortunate group of experts who spend their waking hours strategising trade policy, I would like to explain, in some detail, the thinking behind this initiative.

We are a small country, with only a few assets in the sense of material power to bring to any negotiating table. However, you do not need to be a big country to have a big idea. NZ has, over a twenty year period or more, been quite influential in trade policy.

The influence NZ can assert is not at the end of any negotiation. I have been a professional negotiator for some 30 years and I can assure you that in every end-game negotiation, the realities of power inevitably assert themselves. Unless a New Zealander is chairing a negotiation – and it has been often remarked in trade circles that we do chair a rather unusual number of such negotiations or trade dispute panels – we will not be in the final room, where the final deal is done. But that is OK – we have usually left our finger-prints somewhere on the document they take into that final negotiating room.

However, the early stage of policy formulation is quite another matter. Here, NZ can influence and has influenced, sometimes decisively, trade agendas both in Geneva in the WTO or GATT multilateral negotiations and in the emerging architecture of the Asia Pacific. This initiative with Russia is very much part of that second agenda.

We first proposed the idea of a strategic FTA to the Russian Government some six months ago. Let me summarise here the strategic reasoning.

Key Trends in World Trade

World trade has grown some three times faster than world output since the War. It is unquestionably an engine of growth and economic development. In one landmark study, cited at the OECD Ministerial meeting I have just come from, per capita real income grew more than three times faster for developing countries that lowered trade barriers than other developing countries in the 1990s [5% per annum compared with 1.4% per annum. OECD CMIN(2010)12, p5.].

We ourselves are anxious to increase yet further the trade orientation of the NZ economy. The Government has set the goal of increasing the ratio of NZ exports to GDP by ten percentage points by 2025, so powerful do we believe is the link between trade and higher productivity. I am confident we will achieve this goal and probably well before 2025, the way things are shaping up.

Trade liberalisation is not a sufficient condition for more rapid growth – it certainly helps to have in place the institutions, legal frameworks, modern infrastructure, properly skilled workforce, sensible tax policies and the well-designed safety nets of a modern market oriented economy. But if your country does not engage with the global economy, it is clear you will pay the price of slower growth and diminished opportunities.

The growth of the global economy is of course also the product of technology, people and ideas. But certainly breaking down formal barriers to trade has been part of the equation.

Pathways to Trade Liberalisation

Broadly, over the last six decades, trade liberalisation has been advanced through three pathways. Unilateral liberalisation, multilateral liberalisation and what we used to call ‘bilateral’ trade negotiations but which is evolving into something much more complex than purely bilateral trade deals.

Unilateral liberalisation is the tough way to integrate your economy into the global economy. It has played a vital part of the transformation of trade policy in NZ. We started our reform process 30 years ago and we began with very high protectionist barriers. It is a brutal way to proceed. For those economies with still high barriers to trade it is probably a vital tool in the toolkit. I say this simply because the pace of reciprocal trade negotiations is usually too slow to advance change quickly; countries with high barriers to trade need quick change or they will be left behind.

But in NZ we are well advanced. We no longer need the shock treatment of unilateral trade liberalisation. Our focus is now solidly on reciprocal trade liberalisation.

Amongst trade policy theorists and most practitioners, multilateral trade liberalisation, formerly through the GATT and now through the WTO is unquestionably the optimal approach. The problem is that the WTO negotiating process is suffering from sclerosis or, as the Russian delegate to last week’s OECD meeting put it so accurately, trade policy is suffering from inertia. I could not agree more.

It is now sixteen years since the conclusion of the last multilateral negotiating round, the Uruguay Round and there has been no repair or maintenance job done since. We have been living off past political capital.

In 2009 Governments everywhere, facing the worst downturn in world trade and output in 70 years, benefited enormously from the past achievements of the previous 8 Rounds of multilateral negotiations. Under immense political stress, with record unemployment in many key countries, the multilateral trading system, stood up remarkably well in net terms. We did not replicate the terrible mistake of the 1930s – “beggar-thy-neighbour” trade policies, which only deepened the downward spiral of unemployment and which played a part in creating a toxic political environment in which Fascism was to take hold.

It is quite untrue that people do not learn the lessons of history. It is, I would argue, clear that people learn lessons selectively and this lesson at least was absorbed in the great downturn of 2009.

However, while we can profit from our predecessors’ good work in building up incrementally a robust multilateral trading system, we seem unable to advance the frontier of trade liberalisation through multilateral negotiation, other than on a glacial level. The current negotiating Round – the Doha Development Agenda – has been under negotiation for either 8 or 11 years depending on how you define the initiation of negotiations.

Much progress has been made – the Director General uses the metaphor of having done 80% of the negotiation. But that last 20% - or whatever number you choose to illustrate the remaining negotiating gap - is proving elusive, to say the least. The WTO Doha Round is like a yacht becalmed in still waters. There are no signs of the favourable political winds required to bring the ship to home port.

I want to make one thing clear: NZ of all countries is not giving up on the WTO. Far from it. No bilateral or plurilateral deal can compare with the importance of completing this multilateral Round. We will not walk away from the Doha Round.

But NZ decided collectively in the early 1990s that we would not put all our eggs in the then GATT, now WTO, basket. Since then, while emphasising multilateral trade policy, successive NZ Governments have aggressively and successively pursued a bi-partisan strategy of developing FTAs with economies which were either major trading partners or promised to be – ie the emerging economies.

Generally, the emerging economies are to be found in the Asia Pacific, or APEC region. Today, we have agreed to commence a preparatory process towards an FTA. We are very conscious that Russia is the only country in the world that is both a European and an Asian economy.

The Shift in Power to Emerging Economies

We are living in a period of history characterised by a massive shift in relative economic power. A shift in relative political power is following ineluctably in its wake. Broadly speaking, one could say that in the last 200 years there has been a huge mis-match between where the world’s people are and where the world’s wealth lies. Without any damage whatsoever to the existing wealthy countries of the world – indeed they will benefit from the new opportunities in emerging economies - that mis-match between people and wealth is being corrected. Trade is at the heart of this transformation.

All projections suggest that in even twenty to thirty years’ time, the countries with the largest populations will have the largest economies. We will be living in a truly multi-polar world in which we are highly likely to have four economic super-powers with huge populations (China, India, the United States and the hybrid model of the 27 Member EU) plus a range of very significant economies on a second tier including Japan, Korea, Indonesia and, of course the other of the so-called ‘BRICs” – the formulation that includes not just China and India but also Brazil and Russia.

There are of course a set of crucial assumptions behind this – the most important of which is the avoidance of war or international terrorism backed by weapons of mass destruction.

Putting aside such catastrophic scenarios, the underlying transformation of economic power could accelerate. For example, the recent study by the Economist Intelligence Unit on this huge shift in relative power pointed out that in 2006 one of the world’s leading consumer research firms estimated that China would surpass the United States as the world’s largest auto market by 2025. But in 2009, with car sales up 44%, China had already surpassed the US by volume [“The Big Tilt: The Rise of the East and what it means for Business”, EIU, 2010, page 12.].

NZ’s ‘First Mover Advantage’ Strategy

NZ, a tiny but I hope ‘smart’, country is very deliberately following a strategy of developing its economic relationships with these economies. We are following an extreme application of what is called ‘first mover advantage’ strategy – getting in first, to avoid the possibility of being left to last. So far it is working pretty well. An FTA with Russia would be yet another example of future-proofing our economy.

NZ is the first developed country to have established a comprehensive FTA with China. More recently, we wanted to make that relationship more coherent and we negotiated a parallel FTA with Hong Kong – NZ is the only country in the world so far, other than China itself, to have such a relationship. Our trading relationship with China is powering ahead – a 40-60% increase in exports depending on which month you choose to measure the last 12 months’ growth. China passed the United States as NZ’s second largest export market a couple of months ago.

We have initiated FTA negotiations with India and Korea and of course already have a comprehensive FTA with Australia – the so-called CER, or Closer Economic Relations Agreement.

The agreements that we have concluded are characterised by high quality. This is not political rhetoric on my part – it is a measurable fact.

There was a very active debate amongst trade theorists in the 1990s decrying the growth of FTAs, largely on the basis that many were very low quality. Indeed, many of them were. But there has been a shift up the quality curve since. The FTAs that we have been involved with are extremely high quality – the deal with China encompasses 99% of our exports.

Convergent FTAs

The second, and most intriguing trend, is the development of what I call ‘convergent FTAs’. That is, NZ, usually with Australia, is involved in integrating FTAs in ever-wider regional concentric circles. In the process we are creating significant aggregates of economic power in which trade and investment integration is taking place.

The best example is the AANZFTA – an almost unpronounceable acronym that stands for the ASEAN, Australia/NZ FTA. It is fully negotiated, coming into force piece by piece this year and will create in a little more than a decade, an integrated sub-regional FTA of some 566 million. Its technical provisions – the region-wide Rules of Origin in particular – address the purists’ objections to the so-called ‘spaghetti in the bowl’ problem, which for reasons of time I shall not describe here.

This is important, though highly technical. It relates to the fact that global supply chains are now dominating world trade – the old concept of selling vertically integrated products made overwhelmingly in one’s own country is becoming outmoded. Recent OECD research has shown that 56% of overall goods trade flows are in intermediate products. The equivalent services figure is 73%. There are huge productivity gains from this.

We have recently initiated another of these sub-regional concentric FTAs – the so-called ‘Trans Pacific Partnership’ or TPP initiative. This is very much a NZ initiative. We proposed in the late 1990s and then successfully negotiated, an FTA with Singapore. Again, it was of almost no commercial significance – there were hardly any trade barriers between Singapore and NZ. It was, as is usually the case with our FTAs, ‘strategic’.

It was intended to be a bridge both to integrating the two separate regional FTAs we each belonged to – the CER and the AFTA, or ASEAN FTA. That integration is now done – the AANZFTA is the end product of a 12 year strategy. I have often said – trade policy is not a field for those who are into instant gratification.

But the Singapore NZ FTA was also intended to be a bridge to what we then called ‘Pacific Five’, with the United States at the centre of the proposal. That is now slowly coming into view.

Without going through the negotiating history of this initiative, this has now evolved into the TPP, which is a complex negotiation of eight APEC economies, including most importantly, the United States.

The TPP negotiations are in the very early stages and many architectural issues are unresolved. However, it is plain from statements from high level US officials, that the TPP is now the centrepiece for US involvement in the emerging architecture of the Asia Pacific region. This is particularly the case, given that two other convergent FTAs under long-term consideration – the so-called ASEAN plus 3 and ASEAN plus 6 proposals – exclude the United States. It is, to put it mildly, a rather significant exclusion.

Who is Going to Drive Asia Pacific Trade and Investment Integration?

Behind all this is a big power strategic question – who is going to drive the process of trade and investment integration. China or the United States? Where does India fit in this question – in my opinion, India is a vital part of the equation. Can Japan - still almost 10% of world GDP - deal politically with its only real problem with trade liberalisation? That is, can it embrace comprehensive liberalisation or is Japan permanently blocked politically by agriculture? There are always negotiable solutions and pathways of course.

Russian Participation

Essentially, this is the game for which Russia today bought a low-cost entry ticket – the start of an preparatory process towards an FTA with a small APEC economy deeply involved in, and in many cases, designing the development of Asia Pacific trade and investment strategy. Russia, already the 12th largest economy in the world and a Member Economy of APEC, needs to participate in FTA strategy, if it wishes to shape the future of the world’s most dynamic region.

NZ – consistent with our over-arching ‘first mover strategy’ - was the first country in the developed world to negotiate a bilateral deal with Russia as part of Russia’s WTO Accession. But that Agreement necessarily sits on the political shelf, because the wider game of the Russian WTO Accession is the victim of the glacial pace of WTO developments.

If we can complete successfully - and I hope expeditiously - a high quality FTA with Russia, Russia will be sending out an unmistakeable strategic message to far more important economies than NZ that Russia is ready to deal in what is the real game in town – the process of trade and investment integration in the Asia Pacific.

In our discussions with Russia leading up to this development, we have been utterly realistic. We have said we fully recognise that this is a strategic play, not a commercial play, for Russia. But so it is for all the large economies that we have either negotiated or are currently negotiating FTAs. Nobody, with the exception perhaps of Australia, has ever done a deal with NZ for overtly commercial reasons.

That said, I would not wish to discount the long term possibility of a significant expansion of our bilateral economic relationship in one or two areas of real interest to Russia.

NZ – Strength in Niche Areas

Your President is working to modernise and stimulate innovation in the Russian economy. Clearly, that will have to include agriculture. In certain parts of world agriculture, NZ is not a small country. We are the largest exporter of dairy products and sheep meat in the world – by a considerable margin. We are, depending on the year, a significant beef exporter, a major player in one or two horticulture categories. In wine and fisheries we are small by world standards but near the top in quality.

We have world-class marketing channels – our largest company, Fonterra, has the distinction of being the largest single exporter of US milk. We have world class agriculture scientists. That is one reason why NZ has taken leadership in forging the Global Research Alliance. This is intended to address the most overlooked issue in climate change – the fact that food production is a major source of Greenhouse Gas Emissions.

The world needs to increase food production by 70% in the next four decades and it needs to do this without a remorseless increase in emissions. This initiative is strongly backed by the United States which has put serious money on the table to provide seed capital for this international research effort and we were delighted to be informed recently that Russia also has indicated its interest in becoming a Member.

Investment in agriculture outside NZ has proved more problematic. Paradoxically, the largest investment between our two countries is a Russian investment in NZ dairy production, not vice versa.

The structure of our farming system is based heavily on cooperatives and is therefore capital constrained. The cooperative structure of our farming systems has been a real source of strength internally – few in NZ, including me, want to see our farmers jettison that.

The debate now is how we might be able to move to overcome the implicit capital constraint and start to leverage in a serious way our great strength in agriculture technology and marketing. If we can do this, if we can develop a robust business model to allow us to escape the capital constraint of our chosen system, my personal view is that this could be transformational for NZ’s long term economic future.

Beyond agriculture and plantation forestry, we have world class capabilities in certain niche manufacturing – we are very strong, for example, in GPS applications, health software, film animation and a range of other, unexpected areas of goods and services, such as geothermal energy – one of the underpinnings behind the fact that 70% of our energy comes from renewable energy . I am certain that while we lack scale in these areas from the perspective of a country Russia’s size, there will indeed be niche areas where future economic exchanges can grow.

Make no mistake about it: a comprehensive FTA provides a platform for enhanced joint activities. There is even a fancy word in the relevant economic literature to describe that reality – the so-called ‘demonstration effect’ of customs unions and FTAs.

But the main game will be the bigger strategic advantage. As the negotiation now passes to agencies, my main hope is that this high level consideration will continue to drive the negotiation so that it becomes the next significant milestone in 66 years of diplomatic relations that grew out of the service of New Zealanders in the Arctic convoys.

ENDS

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