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What's the FTA worth to us?

June 22, 2004

All the spin about this deal may amount to nothing if Mark Latham and John Kerry win, writes Tim Colebatch.

There are three economic studies of the Australia-US free trade agreement. One estimates it will raise Australian incomes by $52.5 billion over the next 20 years. A second says it will make us $47 billion worse off. And a third estimates that, at best, it will generate a tiny gain of $53 million a year.

The first, of course, is the report commissioned by the Australian Government. Carried out by Canberra's Centre for International Economics, it stunningly argued that most of the agreement's benefits would come from removing the need for most US investments in Australia to be approved by the Foreign Investment Review Board.

The CIE report estimated that while removing trade barriers would give Australians $16.5 billion more to spend over 20 years, the minor change to investment rules - except for real estate investments, FIRB is a rubber-stamp authority that on average rejects one proposal a year - would generate gains of more than $50 billion over the next 20 years.

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The report's reception was summed up by Professor Ross Garnaut's devastating putdown that it fails the "laugh test". In the real world, you don't get new greenfield investment of $3 billion a year from a minor change to investment rules.

The second report, by contrast, was commissioned by Australian Manufacturing Workers Union. Carried out by Melbourne's National Institute of Economic and Industry Research, under its director Peter Brain, it too took an unexpected tack, but one based on one of the most useful concepts in economics: opportunity cost.

The opportunity cost of doing something is the loss of the benefit you would gain from doing something else instead. Instead of spending $10,000 on an overseas holiday, for instance, you could repay $10,000 from the mortgage and have that benefit plus the savings in interest. And it's a concept that applies equally well to everything you do in life.

To Brain, the opportunity cost of the free trade agreement is that it will prevent Australia developing into a knowledge economy. He focuses on an area ignored in public debate: the restrictions the FTA imposes to prevent future Australian governments operating an industry policy.

Future governments will be forbidden to give preference to Australian firms in contracts, forbidden to require local content (or "offsets") in contracts with US firms, and of course, unable to prevent up-and-coming Australian firms being taken over by US rivals.

In Australia, the conventional wisdom assumes for ideological reasons that government intervention must worsen economic outcomes. Hence the FTA's restrictions on industry policy have passed virtually unnoticed; even Labor has made little of them.

But Brain points out that, in the real world, in all the success stories from Japan and Taiwan to Ireland and China, governments took a leading role to drive economic development. They negotiated the transfer of technology, created leading edge high-tech companies, got finance, resources and export support to growth firms, and protected home-grown intellectual property.

Despite the huge difference in their bottom lines, Brain and the CIE do agree on two things. Both believe the tariff reductions will work to Australia's benefit, mostly in agriculture. And both expect the agreement to create a small but noticeable "dynamic effect" in which increased competition lifts productivity.

There are two problems with Brain's modelling. He sees the killer cost coming from a new review body making pharmaceutical benefits far more expensive, as US drug companies get expensive drugs listed and keep out generics.

But the Australian Government insists that the review body will be outside the decision-making stream, and all decisions not to list drugs for benefits will be made, as now, by the Pharmaceutical Benefits Advisory Committee.

OK, the US Government has presented a very different spin, saying the new deal will raise prices (and hence US profits). And our Government has yet to explain who will be on the review body, and how it will work. But unless the Government has lied to us, it is hard to see how the changes as outlined could make more than a marginal difference to the cost of the scheme.

The second problem is that Brain's approach assumes that some future Australian government would want to follow the kind of policies he and I support. He's a more optimistic bloke than I am.

The third report was released last week by the Labor-led Senate committee on the deal, and produced by former Productivity Commission economist Philippa Dee, now of the Australian National University.

Labor is basically sitting on the fence deciding which way to jump, and appropriately Dee produced a neutral bottom line, picking apart the CIE's analysis and cutting the annual gains to "a mere $53 million a year . . . a tiny harvest from a major political and bureaucratic endeavour".

The Howard Government in turn will produce a reply picking apart Dee's analysis. Labor is still likely to support the FTA. But the intriguing question is what would happen if an election is called first, Labor wins, and then John Kerry unseats George Bush.

This free trade agreement might never become reality.

Tim Colebatch is economics editor.