35 Extract from Paper by Department of Industry and Commerce

Canberra, [October 1979]1

CONFIDENTIAL

Australia - New Zealand Economic Co-operation Implications for Australian Manufacturing Industry of (i) Expanded NAFTA (ii) Full Free Trade Area (iii) Customs Union (iv) Common Market (v) Economic Community

INTRODUCTION-AUSTRALIAN AND NZ MANUFACTURING INDUSTRY POLICY

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In August 1979 the Government announced that it accepted that the general policy direction advocated by the Crawford Report was in line with the Government's policy objectives relating to future development of manufacturing industry. Significant progress has already been made in implementing a number of the Report's proposals and the Government is responding positively to other recommendations.

New Zealand on the other hand has not developed a similar comprehensive long term strategy for the future development of its manufacturing sector. For many years policies in New Zealand were aimed at encouraging import replacement industries, however more recently specific policies have been introduced to encourage industry in New Zealand to adopt a more export-oriented attitude. The 1979-80 New Zealand Budget expanded on this new approach by increasing export incentives to the manufacturing sector. At the same time import licensing was liberalised for raw materials and components used in export production, for firms which undertake rationalisation to free resources for export production and more recently, for imports of cbu vehicles and motor vehicle components in return for exports of such components.

Inherent in this new approach is a growing realisation in NZ of a need for policy changes and economic restructuring with a view to improving the efficiency of its domestic manufacturing industry. The recent draft report by the New Zealand Industries Development Commission on the NZ textiles and clothing industries illustrates the direction in which manufacturing industry policy in New Zealand is developing. For example, the Commission notes that a reappraisal of resource use is inescapable and that the concept of 'net contribution to the balance of payments' should carry the greatest weight among criteria for development through to 1986. The industry should be encouraged to transfer resources into growth areas which would receive 'special' encouragement (including most of apparel, wool textiles and carpets, synthetic yarns and knitted fabric). Other sectors including man-made fibre carpet production would be actively discouraged. By mid-1981 a re-oriented apparel sector should be in a position to use more New Zealand yarns and fabrics in its exports and be in a better position to export selected products to selected segments of overseas markets.

GENERAL INDUSTRY POLICY CONSIDERATIONS

Australia and New Zealand share many of the same problems in the development of an efficient long term industry structure. We have in common the problems of a limited market place, a high wage labour force, the distance of overseas markets, the need for foreign investment and technical expertise, vulnerability to world economic fluctuations and inflation. In addition we both face an ever growing challenge in our own market place from the low cost efficient developing countries, especially in Asia (although this is diminished for New Zealand by the existence of closer Government control, especially through the operation of import licensing).

Under existing trading conditions Australian industry faces limited access to the New Zealand market through the NZ import licensing system (and tariffs), while at the same time NZ has open access (in most cases) to the Australian market at lower tariff rates and NZ exporters enjoy export incentives which are far more generous than those available to Australian producers. A move to unite the two markets means for Australian producers an increase from around 14 million people to 17.5 million people-in other words about a 25% increase in market size and this in terms of potential increase in economies of scale of production, while helpful, is by no means of the order we are seeking to make our industries competitive in international terms. Further, it should be borne in mind that Australia already has substantial trade in manufactures with NZ, so it would only be an increment on the existing established trade that would be the benefit, and not the apparent increase of 25%.

For New Zealand the increase would be 400% and this, even allowing for existing trade, does offer significant growth prospects for NZ producers which,when coupled with their generous export incentives scheme, could provide a springboard for further penetration in other export markets. Of course the fact that New Zealand would achieve greater gains in economies of scale in a freer trade situation will not of itself provide New Zealand industries with a competitive advantage over Australian manufacturers, who already have the benefits of producing for the larger Australian market. The significantly less developed industry infrastructure in NZ compared with Australia (in technology, manpower skills, diversity of products manufactured) could also substantially inhibit NZ from realising the apparent advantage. The pace of development of NZ industry is also likely to be influenced to a greater extent by corporate policies of major industrial interests including multinationals in Australia rather than by vested interests in NZ. These considerations could have a major influence on the extent to which NZ is able to benefit from a united market.

There has been some tendency under NAFTA for both sides to adopt a defensive attitude towards expansion of freely traded goods. This derives very largely from divergent industry development objectives, and the fact that the Australian and New Zealand manufacturing sectors are becoming increasingly competitive rather than complementary. That is not to say however that the existence of complementary industry structures is necessarily a pre-requisite for benefits to be derived from freer trade, as significant growth in intra-industry trade may be generated between industrial structures which are basically competitive. Nevertheless there would be inevitably a need for a balance to be achieved through trans-Tasman industry rationalisation.

Closer economic ties with New Zealand would however require that the two Governments achieve greater co-ordination or harmonisation of industry policies (the extent would depend on what option is being considered) so as to achieve the maximum mutual advantage. The more short term, ad hoc nature of New Zealand's industry policy, and the lack of clearly articulated long term measures create considerable uncertainty, and the course of future NZ policies could pose problems for Australia. There is the implicit risk that the restructuring process in Australia could open the door, not so much to the efficient developing country exporters, but to further high cost, less efficient investment by NZ industry to take advantage, under preferred conditions, of the Australian market, perpetuating the structural problems that long term industry policies aim to resolve.

By the same token there is the possibility that, under one or more of the options for economic co-operation, Australian industry which is less efficient in world terms, might be encouraged to expand contrary to the objectives of long-term industry policy. In these circumstances the presence of New Zealand could complicate and retard the achievement of long term reductions in tariffs relative to third countries. This question is discussed further in the section following on a customs union.

A further important general consideration is the possibility that closer economic ties through development of one or more of the options could exacerbate irritants in trade relations that exist already between Australia and developing countries of the region. The Crawford Report emphasised the significant opportunities for Australian exports offered by the developing countries of East and South-East Asia. In fact the Crawford study group recommended that Australia examine the possibilities for strengthened bilateral trade agreements with these countries, because of their importance as markets for Australian industry. Adoption of some of the possible forms of economic co-operation between Australia and New Zealand, and in particular the option of a customs union with a common external tariff, could be seen by other countries in the region as a potentially provocative act. Obviously close account would need to be taken of developing countries' legitimate interests in considering closer trans-Tasman co-operation. This would apply especially to Papua New Guinea and other [South Pacific] Forum island members with whom close trading links exist already.

The remainder of this paper examines the implications for Australian manufacturing industry structure and policy of the options for closer economic association, viz: an expanded NAFTA, a full free trade area, a customs union and a common market. For purposes of illustration, reference is also made to the likely implications for specific sectors of Australian industry, with emphasis on those for which sectoral policies are in place. (Background papers on each of these sectors have been prepared for detailed reference.) An attempt has been made also to view each option not in isolation but as integral steps in a dynamic process towards full market integration.

THE OPTIONS

(i) Expanded NAFTA

The first option of an expanded NAFTA reflects the existing situation which was described by the Minister for Trade and Resources following the NAFTA meeting of 11 April 1979 in terms of 'Australia and New Zealand have reached a plateau in our relations under NAFTA and we have got to try to find ways and means of opening up our trade'.

The difficulties of any significant increase in trade under NAFTA result from three key factors which disadvantage Australian industry. These are the access to material inputs (generally, components and semi finished products) at world prices which NZ manufacturers enjoy; the hitherto severe constraints on market access to New Zealand through the imposition of import licensing; the very generous export and related investment incentives by the NZ Government. NZ competitiveness is further heightened by the significantly lower wage rates inNZ.

A further constraint, as far as Australian industry is concerned, is the exclusive trading practices which operate in New Zealand. Such practices are only classified as 'examinable' under NZ legislation. The franchise-tied relationships between manufacturers, wholesalers and retailers in NZ represent a significant barrier to access into the NZ market for Australian manufacturers.

There are also the broader constraints on expansion of NAFTA trade resulting from implementation of industry specific development policies in each country, (including State Governments) for example whitegoods, automotive products, carpets and forest products. On the other hand it should be noted that the development of Australia's sectoral policy for the apparel industry has in fact allowed for the controlled development of trans-Tasman trade in apparel. Imports from New Zealand increase rapidly while New Zealand was exempt from the global quota system. Recently, following negotiation of special apparel arrangements, Australian exports to New Zealand have in turn increased rapidly over previous low levels.

In the case of whitegoods, Australia's sectoral policy calls for an increase in throughput of Australian production plant through rationalisation and reduced imports, thus increasing the local industry's ability to compete with imports in the local market. An increase in concessional imports from NZ could mean loss of market share and net reduction in production output for Australian manufacturers. There would have to be visible reciprocal gain for Australian manufacturers in the NZ market for expansion of whitegoods trade under NAFTA to be more compatible with the sectoral policy. Even so, expansion of white goods trade under 3:73 arrangements could still be in conflict with the trade policy insofar as the imports from NZ would tend to benefit certain manufacturers at the expense of others. 3:7 arrangements in whitegoods could be seen as an additional concession that could distort normal market forces and production decisions and as such would be inconsistent with the policy.

There are fundamental differences between the automotive industries of Australia and New Zealand which derive essentially from the different sizes of the two domestic markets, the different stages and emphasis of technological and general engineering development in the two countries and different government policy environments. Australia is and intends to remain a vehicle builder while New Zealand has concentrated on a motor vehicle assembly and component manufacture. New Zealand is therefore unlikely ever to build other than speciality cars but has potential to further expand its component manufacture, including exports to Australia which are carried out already under various 3:7 arrangements.

Wool rich carpet (containing more than 80% wool) was added to Schedule A in 1975. This addition, however, was subject to quantitative limitations in both directions and was made especially to protect New Zealand exports to Australia. NZ is limited to exporting 2.1 million square metres to Australia and Australia 0.2 million square metres to New Zealand. New Zealand, as a producer of the coarser type wools used in carpet manufacture, as distinct from Australia which produces finer wools and imports coarser wool and carpet yam, also discourages the marketing of man-made fibre carpet in New Zealand, an area where Australia is relatively efficient. To give effect to this policy New Zealand does not issue import licenses for man-made fibre carpet.

Most forest products are already traded duty free under NAFTA although NZ limits the level of access of some goods under import licensing. It is considered that, for forest products, closer economic co-operation would be better achieved by a more broadly-based scheme than an expanded NAFTA as the latter method has reached the stage where scope for increased trade and economic co-operation is limited.

It could be observed fairly that NAFTA has tended to 'drift' and that both sides have tended to lose sight of the objectives of some of the facilities within NAFTA. This is especially the case with 3:7s which manufacturers do not see as a transitional measure towards eventual product rationalisation and free trade. Invariably the central motive for proposing a 3:7 is to overcome the NZ licensing barrier. Probably very few 3:7 proposals would be initiated if they had to meet the requirement of the goods being eventually included in Schedule A.

There are perhaps opportunities, especially as economic recovery continues and is sustained, for limited initiatives within the existing NAFTA framework. One general approach could be a conscious policy of greater use of Schedule B4 arrangements with area content requirements modified according to specific industry needs. Schedule B was designed to encourage industries to work together to develop arrangements which facilitated the move towards free trade by giving them experience of partial free trade, with safeguards against disruption. It is indicative of the slow progress of NAFTA that there have been only two agreements under Schedule B since its inception in 1973, one of which has subsequently lapsed.

However, this type of arrangement could be a means of phasing into a broader free trade relationship on a sector by sector basis. Within each sector specific industry problems could be identified and resolved (e.g. removal of export incentives) to the degree and pace acceptable to both industries. The significance of 'Area Content' or 'Rules of Origin' in providing a means of equalising competitive opportunity in the respective markets, suggests that the introduction of special (higher) 'content rules' to OPTION (i) and particularly to OPTION (ii) could enhance the potential of these options for expanding trade and the regional industrial structure on an equitable and efficient basis. This could be so particularly where both countries already have in place significant manufacturing resources. However, there remains still the serious obstacles posed by the existence of divergent sectoral policies in key areas of manufacturing.

There could also be opportunities for specific limited initiatives through existings Article 3:7 arrangements in the apparel and footwear industry sectors. In the case of apparel a viable option in the short-term (to mid 1981) could be the continuation of an arrangement similar to that currently existing. Adoption of any longer term or more radical proposal before decisions by the Australian Government on the IAC's long term report or by the New Zealand Government on the NZ Industries Development Commission's report would seem premature. Over the longer term consideration could be given to arrangements under Article 3:7 which preserve mutually beneficial two-way trade without making long-term commitments to remove duties. Such arrangements would be basically a development of current arrangements. Where footwear is concerned, the existing 3:7 arrangement offers scope for extension. This form of arrangement provides for mutual gains from trade (which can be escalated in the light of appropriate circumstances) while retaining adequate options for control over import levels.

(ii) Full Free Trade

The option of Full Free Trade, in theory at least, should have substantial beneficial implications for trans-Tasman trade. It would offer Australian industry unrestricted access to the NZ market and disallow the existing generous NZ export incentives (and vice versa) where the Australian market is concerned. However, there would remain the problem of fair competition, because of the continued advantage for NZ industry of free access to imported inputs, which would almost certainly cause major difficulties for areas of Australian industry, especially for Australia's sectoral policies. It is therefore unlikely that an extension of NAFTA to a Full Free Trade Area would be an acceptable alternative to the present position reached under NAFTA for Australian industry as a whole. On the other hand this is the option most likely to be supported by New Zealand. If preliminary assessments suggest that Australia in the primary sector could stand to benefit more than New Zealand, the latter could in fact propose a partial free trade area, along EFTA lines, for manufactured goods.

The fact that a Full Free Trade Area covers only the elimination of tariffs or quantitative restrictions (and measures having equivalent effect) without necessarily movement towards harmonisation of industry and related policies raises a problem of some magnitude. That is the threat of third country investment in New Zealand to gain access to the Australian market under preferred conditions.

From both countries' point of view it is hard to see how in practice full free trade conditions could be achieved without long periods of phasing and tight controls, in view of the policy problems discussed earlier in the option of an expansion of NAFTA. It could be envisaged that a form of partial free trade beyond the present position under NAFTA could form a phase leading towards closer market integration under a Customs Union.

However, forest products, which is of basic importance as a 'comer stone' of NAFTA could be seen as one industry sector offering possible immediate prospects for Australian industry under a full free trade situation. With forest products, the problem of external tariffs is of much less significance. Under current conditions trade between the two countries in forest products is strongly in NZ's favour. Establishment of a full free trade area would give Australian forest product manufacturers significant access to the NZ market previously denied them because of import licensing, e.g. stationery, cartons, containers, [but]5 could equally create problems for certain currently sensitive Australian manufacturers such as particle board, plywood and similar products.

To illustrate further some of the problems of free trans-Tasman trade attention is drawn to the clothing, footwear and carpet industries. Generally, the implementation of a free trade area would involve real difficulties in the absence of harmonisation of Government policies towards those industries in terms of external tariffs and other forms of protection, rationalization and restructuring, export market development, distribution, trade practices law and so on. The difficulties in this area would be heightened by the sensitivity of these industries to changes in cost structure and their dependence on high levels of assistance.

Where apparel is concerned, the New Zealand industry has access in the main to imported raw materials at world prices because of the absence of domestic production of such goods. On the other hand in Australia the bulk of the textiles industry is heavily protected. To this extent the Australian clothing industry is disadvantaged.

There is also the question of assistance policy. As both industries are under review and the nature of longer term assistance policy is yet to be decided by respective Governments the implications of free trade would vary depending on the policies adopted particularly toward third country supplies. Given that there would almost certainly be different means of implementing policy objectives in Australia and New Zealand in granting protection to their clothing industries, it could be expected that the establishment of a free trade area would lead to structural imbalances and possible disruption to industries.

New Zealand has a much more liberal licensing policy in respect of imports of footwear parts and therefore the Australian industry could be seriously disadvantaged in a cost competitive context vis-a-vis New Zealand footwear incorporating imported parts.

Given the labour intensive nature of footwear manufacture and the current sensitivity of the employment problem, total free trade could impose limitations on the Government's options in respect of industry and employment policies. It could be expected that the net effects of a total free trade proposal on the industry's structure would be a reduction in the number of leather footwear producers in Australia, or at least a reduction in the volume of production and/or a reduction in prices with a downward thrust on profits and reduced employment. It may be that a marginal increase in the volume of non-leather footwear produced in Australia could occur.

As regards carpets, it is considered that New Zealand would make significant gains in the Australian market if total free trade in wool carpet was decided upon, whilst Australian producers would stand to make only small gains in the NZ market. However in a full free trade situation it could be expected that trade coverage in carpet would include man-made fibre carpet (presently excluded from Schedule A), and in this respect Australia could be expected to benefit substantially. On the other side of the coin it should be remarked that the New Zealand industry has installed a number of sophisticated carpet printers with capacity well in excess of local market requirements with possible significant implications for future trade in man-made fibre carpets.

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[NAA: 1838, 37011/19/18, ANNEX 5]