Inside Story

It might say free trade on the label, but what’s in the tin?

Big numbers have a tendency to take on a life of their own, writes Tom Westland

Tom Westland 1 July 2015 1286 words

Big numbers, small differences: Chinese commerce minister Gao Hucheng with prime minister Tony Abbott and trade minister Andrew Robb after signing the trade agreement between China and Australia in Canberra in mid June. Lukas Coch/AAP Image

Economic modelling with unstated assumptions is a bit like chicken nuggets with unstated ingredients – one swallows at one’s own risk. And yet there’s been a lot of it about lately. Just this weekend, reporting on a new study of negative gearing, the Australian warned that abolishing this much-used tax concession could lead to “rents increasing by almost $10,000 on average each year.”

The ACIL Allen report was released by the Property Council of Australia and the article was written by the newspaper’s Troy Bramston, who was for a time employed by the Property Council. The $10,000 figure was based on a misunderstanding of the report’s observation that the immediate removal of negative gearing is likely to result in a “portion” of the average rental loss of $9500 being passed on to renters. The report didn't specify what the “portion” was, but it certainly can’t be more than the income tax that would hypothetically be paid on the no-longer-deductible $9500, which, given a top marginal tax rate of 49 cents in the dollar, would be less than $5000, and almost certainly much less.

But that author ought not feel too bad – or, at any rate, any worse than many of his colleagues, who had a little collective difficulty getting across the detail of a report modelling the expected impact of preferential trade agreements with South Korea, Japan and China. Prepared by the Centre for International Economics, or CIE, the report was released in mid June by the Department of Foreign Affairs and Trade to help make the case for the three deals.

A lot of the coverage of government policy can be explained by the happy confluence of politicians’ preference for announcing things with big numbers in them and journalists’ preference for reporting on things with big numbers in them. By 2035, says the CIE, Australia’s gross domestic product will be $2.2 billion larger than it would otherwise have been. This may sound like a large number to you, but it is equivalent to an increase of 0.05 per cent, which sounds a lot smaller. The gains seem even more forlorn when you realise that the model is looking at the combined impact of three separate deals, all of them with countries that are among Australia’s largest trading partners.

Some numbers look big until you compare them with other numbers. Our goods exports to China, Japan and South Korea are supposed to be 11.7 per cent higher in 2035 than they would be without the deals, but our total goods exports over that period will only go up 0.5 per cent. Given that the three countries represent well over half of our current exports, this seems an odd result, doesn’t it? The explanation is that some of the additional exports we’ll send to China, Japan and South Korea are goods that we would have sent elsewhere. In fact, exports to other countries will actually go down by 6.9 per cent. Something similar will happen to our imports.

This is partly a good thing. One of the reasons I am moderately in favour of the three new deals, at least on the trade aspects, is that they’ll undo a lot of the damage Australia did to itself when it signed a “free” trade agreement with the United States under the Howard government. That deal selectively cut tariffs on some of the goods traded between our two countries, making some of them cheaper than East Asian goods, which still faced tariffs. This distorted the pattern of our trade and actually made us worse off. Lowering tariffs for lower-cost exporters like China, Japan and South Korea will reverse the distortion and end discrimination in favour of the United States. (Now we’ve done this for our four largest trading partners, though, it’s pointless to keep signing deals: we should just lower our tariffs to the same level for everybody.)

But although the agreements bring benefits, some of the salesmanship has been a little over-enthusiastic. “There will be 178,000 more jobs than otherwise… because of this trifecta of trade,” said Tony Abbott in response to a tenderly worded inquiry from the Member for Capricornia. The Weekly Times agreed, saying there would be “170,000 additional jobs between 2016 and 2035.” The Herald Sun thought the same, as did the Sydney Morning Herald and SBS.

As it happens, they are wrong, at least if “job” is taken to mean the same thing it does to normal people. If you have a look at the report’s appendix, where the employment numbers are to be found, you will find that in 2016, the first year of the modelling, 7925 people have jobs who otherwise would not. In 2017, 11,119 people have jobs who otherwise would not. Can we add those and all the other years’ net gains together to get 178,000 “jobs created”? No, we cannot – because many of the people whom the trade deals will supposedly push from unemployment into employment in 2016 are likely to stay employed in 2017. Unless you think of two years in the workforce as constituting two separate jobs, summing the employment gains over the years to get 178,000 “jobs created” will involve substantial double counting. Best just to say that on average, according to the modelling, about 9000 people who otherwise would have been on the dole will have a job.

If you were being really honest, though, you’d probably go on to say that we don’t really know what the overall impact on employment will be, and it’s unlikely to be big either way. (Oddly, the report doesn’t say which specific areas of the economy will lose jobs and which will gain them, even though the very same firm also did a report on the deal with South Korea that showed jobs would be lost in manufacturing and gained in agriculture.) In an advanced economy like Australia’s, the level of employment is overwhelmingly determined by the response of the Reserve Bank and the federal budget to outside economic forces. The benefits of free trade come rather from lower prices for imports (which is actually what we want) and a warmer welcome abroad for our exports (which is what we pay for imports with), not from unrealistically lower unemployment.

A final note: even though the modelling does somewhat credibly show economic advantages to Australia from these agreements, it doesn’t include everything that’s been agreed to. For example, while the modelling shows that a decrease in the production of goods in Australia is offset by increased production of services, it doesn’t work out what the increase in services exports will be: the numbers used are just guesses, which may or may not be educated, on the part of the authors.

The public is nonetheless entitled to assess the agreements in their entirety. The inclusion of investor–state dispute settlement – without, as the Productivity Commission has repeatedly pointed out, any compelling economic justification – and other not-necessarily-liberal provisions is worrying, and well worth scrutiny. “No friend of free trade is such an idiot as to say that free trade is the only valuable thing in the world,” said Lord Macaulay in 1845, and he’s still right.

As a modest little friend of free trade, I’d merely add that you ought not be such an idiot as to think that just because the words “free trade” are on the label then that must be what’s in the tin. •

Article modified 2 July 2015 to clarify the source of the error in the Australian’s reporting of the negative gearing report and Troy Bramston’s previous role at the Property Council of Australia.